Why Stablecoin USDC’s Unstable Weekend Matters

Crypto markets are still reeling from a turbulent weekend, after one of the market’s leading stablecoins, Circle’s USD coin (USDC), lost its 1-to-1 peg to the U.S. dollar and plunged to as low as 87 cents. USDC restored its peg on Monday and continues to hover close to $1 as of writing, but the crisis might have broader implications for crypto and decentralized finance (DeFi).

On Friday, Circle confirmed it had been holding $3.3 billion of its reserves at the failed Silicon Valley Bank (SVB). Many USDC holders suspected potential consequences from the SVB crash and quickly redeemed over $1 billion of USDC for U.S. dollars, causing the USDC price to lose the peg. Late Friday, the Coinbase crypto exchange, the largest based in the U.S., paused customers’ ability to convert USDC to dollars until Monday morning, when U.S. banks were open.

As a result, USDC market capitalization dropped to the lowest point over the past year, to $39.5 billion (USDC’s highest point was last summer at $55.9 billion). USDC remains the second-largest stablecoin by market cap, following tether (USDT) at $72.4 billion, according to CoinGecko. Tether gained about $2 billion in market capitalization since Friday, likely profiting from its closest rival’s troubles because USDT was not affected by SVB’s collapse.

On Sunday, Circle CEO Jeremy Allaire tweeted that Circle would be transferring $3.3 billion of its funds from SVB to BNY Mellon.

Allaire also noted the problems Circle endured from the crash of another crypto-friendly bank, Signature Bank. When Signature has been shut down by state regulators, Circle could no longer use the bank’s SigNet settlement network. Allaire tweeted that Circle would switch to the service by Cross River Bank immediately.

On Monday, USDC restored its dollar peg.

Why stablecoins are key to the DeFi ecosystem

USDC has been a crucial part of the DeFi economy. In DeFi, people use stablecoins to buy other tokens as well as to speculate on stablecoins’ own fluctuating value, said Andrew Thurman, head of content at a blockchain analytics firm Nansen.

“Many of the top decentralized exchange pools have USDC in one of the [trading] pairs, cross-chain bridges are heavily weighted towards USDC, other stablecoins such as DAI and FRAX have significant (if not majority) USDC collateral and it’s a popular collateral type on lending marketplaces,” Thurman told CoinDesk.

Tether’s USDT, despite its leading position on the market, is not as popular for those use cases, Thurman added, possibly because USDC has been traditionally perceived as more transparent and less risky than USTD. How Tether maintains its reserves has been a long-standing question in the industry, and the company has repeatedly dodged requests to reveal which assets are backing its stablecoin.

Andriy Velikiy, co-founder of token swap service Allbridge, told CoinDesk USDC is especially popular among crypto startups operating in the U.S. and Europe due to its good reputation and lack of regulatory issues to date.

“USDC is this official, fully backed stablecoin, and if you’re raising funds in the U.S. an American fund would be comfortable sending you USDC and you would be comfortable keeping it,” Velikiy said.

Outside of the West, Velikiy noted, the most popular stablecoin is USDT, which is broadly used in cross-border trade among China, Vietnam and Eastern Europe. “Traditionally, the entire market in Eastern Europe is running on USDT on the Tron blockchain.”

Arbitrage never sleeps

One man’s crisis is another man’s opportunity, and many traders rushed to make some money on USDC’s Friday crash, Velikiy said. He said on Allbridge the daily volume of USDC went up by 10 times on Friday night.

“People were trying to get rid of USDC at any price, they were swapping it for other assets and running between centralized exchanges and DeFi pools until the pools’ liquidity was drained and USDC was trading on DeFi platforms with the same discount as on centralized exchanges,” he said.

Velikiy said the wildfire did not spread with the same speed in all parts of the crypto ecosystem at once, so during several hours on Friday night there was a window for arbitrage between centralized exchanges and DeFi pools, because the price of USDC was higher on platforms where traders hasn’t withdrawn liquidity yet.

The price gap closed on the most popular DeFi platforms quickly, but savvy traders were still taking advantage of a price gap on Tezos, where USDC was still trading at 96 cents while Ethereum-based USDC had slipped to 90 cents. “People who know how to move between different chains could make money on that,” Velikiy explained.

At the same time, many used an opportunity to pay back their USDC-denominated DeFi loans at a lower price; Aave and Compound repayments surged on Saturday, said Axios reporter Brady Dale. In this case, they could buy USDC to pay back their loans much cheaper than before.

“This weekend I asked if folks were paying back DeFi loans like crazy because of an effective discount on the debt. Looks like: Yes, yes they were,” Dale tweeted.

Is this the end for stability from stablecoins?

There are not many alternatives to USDC’s current role on the market, given all the circumstances, said Velikiy. One reason, he said, is USDT does not look reliable enough for USDC holders.

Another previously popular stablecoin, Binance’s BUSD, has been in regulators’ crosshairs since February, when the New York Department of Financial Services questioned its legality and ordered Paxos to stop minting the currency.

Stablecoins DAI and FRAX, on the other hand, rely on USDC for their reserves (they are backed by other cryptocurrencies, not dollars in a bank account), and algorithmic stablecoins lost trust after the crash of Terra’s terraUSD stablecoin.

“After the most reliable and regulated stablecoin lost 10% of value in one night, some people will just quit crypto,” Velikiy said, which could make the USDC market cap fall by more.

According to Nansen’s Thurman, classic volatile crypto assets like bitcoin and ether are currently on the rise, especially among the institutional players. “Unbacked crypto assets such as BTC and ETH are ripping. Indeed, smart money is leveraging up to buy more, while they’re ignoring an asset backed by the fractional reserve banking system, USDC,” Thurman said.

Has the crypto industry gone full circle, going from not trusting the traditional financial system to relying on it for stability and regulatory calm to not trusting banks again? It’s one possibility.

“Up until very recently, investors were thrilled with the idea of having safe dollars on-chain. Now they’re reconsidering what “safe” means in the context of banks collapsing,” Thurman said.

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