By Matt Maximo and Michael Zhao
Despite the closure of three U.S. banks over the weekend — which caused panic and contributed to a temporary dip in prices — crypto losses were erased for a small gain of about 0.13% since March 1, 2023.1 Among the banks affected were Silvergate (SI) and Signature (SBNY), which operated the Silvergate Exchange Network (SEN) and Signet networks, respectively. These networks played a vital role in connecting crypto businesses to the traditional banking system among other things — a historically challenging task.
The impact of the closure of these banks highlights a key difficulty of operating a business within or adjacent to the crypto ecosystem: the difficulty of finding reliable banking partners. Historically, this difficulty has been a significant driver of the growth of stablecoins, like Tether. Crypto exchanges, especially those outside the U.S., rely on stablecoins, which are pegged to the U.S. dollar, to offer trading pairs that users want.
Figure 1: Bank Closure Timeline and Total Crypto Market Cap
Source: CoinMetrics, Grayscale Research. As of 3/1/2023 – 3/13/2023 as of 2pm ET
Sunday night, on March 12, 2023, the Federal Reserve stated that the Depositors Insurance Fund would guarantee deposits held at Silicon Valley Bank (SVB) and SBNY. The issuer of the second-largest stablecoin, USDC, Circle, holds a 1:1 reserve of cash or cash equivalents like U.S. Treasury Bills. The stablecoin had 77% collateral in Treasury Bills with a duration of three months or less, and 23% in cash at various banks, with around $3.3 billion at SVB, which was approximately 8% of the total USDC reserves.2 As a result, the USDC peg fell to 82 cents and then quickly returned to parity after the announcement of the backstop. Circle’s CEO announced that USDC reserves would be fully recovered following the announcement. The Federal Reserve and President Biden emphasized that no taxpayer funds would be utilized to safeguard deposits.
Figure 2: USDC Peg
Source: TradingView as of 3/05/23 – 3/13/2023 as of 11 am ET
How Did Each Bank Go Down?
Silvergate took a major hit in Q4 2022 with deposits down 70% sparked by FTX’s collapse, as the now-bankrupt exchange was one of their largest customers. Silvergate was forced to sell assets at a loss to keep up with withdrawals, ultimately leading them to close their doors and fully return all deposits. Silvergate was well known in the crypto industry for its Silvergate Exchange Network (SEN), a 24/7 instant settlement network that was used by crypto exchanges, including Gemini, Kraken, and ErisX. SEN was valuable because it allowed large institutions to instantly move U.S.dollars into these exchanges. Despite these difficulties, Silvergate has historically been considered to be a well-managed institution with a reputation for supporting the crypto industry.
Silicon Valley Bank
Silicon Valley Bank (SVB) — the flagship provider of banking services to the tech and VC industries — was the next to experience problems. After announcing a $2.25 billion share sale to raise capital, Silicon Valley Bank experienced a bank run3 with more than $42 billion in attempted withdrawals. Since the bank had developed a niche catering to startups, deposits primarily came from venture capital-backed companies rather than traditional retail deposits. SVB’s loan-to-deposit ratio4 was also high (figure 3), with a small amount of stickier retail deposits,5 setting it up for potential capital shortfalls in the event of rising interest rates, deposit outflows, and forced asset sales — all of which have occurred recently.
Figure 3: U.S. Bank Loan-to-Deposit Ratios vs Estimated Percentage of Retail Deposits
Source: JPM Asset Management. Securities include Hold to Maturity and Available for Sale Categories. Q3 2022.
Signature Bank had a similar niche and balance sheet as Silicon Valley Bank, with a loan-to-deposit ratio close to 100% (figure 3). Since 2022, the bank has been reducing its crypto exposure from 25% to 15%. However, the night of Sunday March 12, the Federal Reserve shut down the bank to prevent further systemic risk as the market opened up on Monday. Similar to Silvergate’s SEN, Signature’s Signet network was the only other banking alternative that also offered a 24/7 instant settlement network. With the absence of SEN and Signet, overall crypto liquidity may be reduced given there are likely to be less avenues for fiat to crypto conversions.
Implications for Crypto
Despite a week of difficult news, the crypto market erased losses with BTC and ETH gaining 5.78% and 6.65%, respectively (figure 5), which we believe was largely driven by the offloading of stablecoins. Investors looking to offload stablecoins generally have three options of ranging difficulty:
Figure 4: Options for Investors Offloading Stablecoins
Source: Grayscale Research
USDC was not the only stablecoin to depeg during recent events. Every stablecoin in the top 100 digital assets by market cap —except for Tether and TrueUSD—also momentarily lost their peg.6 A stablecoin’s peg can break when volatility exceeds liquidity, which is typically driven by a lack of trust in the reserves backing the token. During the period when the USDC peg broke and was later restored, both Bitcoin and Ethereum demonstrated a consistent upward trend, indicating that investors were using stablecoins to purchase these digital assets.
- Option 1 trades stablecoin risk for bank risk, which is perceived to be especially high at the moment amongst smaller banks.7
- Option 2 has a low apparent risk, given Tether’s consistent track record thus far, but limited liquidity can make this nearly impossible and involves transferring counterparty risk to an opaque, overseas institution.
- Option 3 is the only option that gives the user complete control over their assets, while removing all counterparty risk when held in self-custody. The upward trend during the time of USDC’s peg breaking and restoration suggests that this was a popular choice for investors.
Figure 5: Bitcoin and Ethereum Returns
Source: TradingView as of 3/8/2023 – 3/13/2023 as of 11 am ET
DeFi Demonstrates Resilience
Figure 6: DEX Trading Volume by Protocol
Source: Dune Analytics (@hagaetc). 2/11/2023 – 3/13/2023 as of 11 am ET
Trading volume on the stablecoin DEX, Curve Finance, also surged as people rushed to swap Dai and USDC for Tether during the recent crisis. While the 3Pool reached a severe imbalance with USDT balances (figure 7), no major problems occurred, especially since the USDC peg returned relatively quickly, within a few days. The pool has already started to slowly rebalance, and we expect this to continue to rebalance over time.
Figure 7: Curve 3Pool Composition
Source: Flipside Crypto (@rackhael). 3/1/2023 – 3/13/2023 as of 11 am ET
Looking ahead, we believe the next key event will be The Federal Open Market Committee (FOMC) meeting on March 22, 2023. Given recent market events, it seems unlikely that the Fed will continue an aggressive rate raising regime. The market is mostly pricing in a 25 bps hike, but if banking issues persist, the Fed may decide to ease off entirely and halt rate increases this month. It’s worth noting that the rapid increase in rates was a key factor in the fall of SVB, in particular, so it seems particularly unlikely that the Fed would remain aggressive less than two weeks after the second-largest bank failure in U.S. history.
Figure 8: FOMC Rate Prediction
Source: Bloomberg as of 3/13/2023
In the unlikely event that the Fed continues to aggressively raise rates, we believe the outlook for crypto would continue to strengthen. Historically, crypto has benefited from quantitative easing measures, and we believe should stand to benefit from any government spending or intervention. Ultimately, the recent failure of these banks has — once again — reminded us of the risks of fractional reserve banking, and could potentially drive further adoption of self-sovereign, decentralized digital assets, like Bitcoin and Ethereum.
1. Total crypto market cap increase. Source: Trading View as of 3/01/23 – 3/13/2023 as of 2 pm ET.
2. As of March 11 statement released by Circle.
3. A bank run is a situation where a large number of depositors withdraw their funds from a bank at the same time due to concerns about the bank’s solvency or ability to meet its financial obligations.
4. The loan-to-deposit ratio is a financial metric that compares the amount of loans issued by a bank to the amount of deposits it has received from customers. It is calculated by dividing the bank’s total loans by its total deposits.
5. Deposits and other sources of bank funding are considered ‘sticky’ if they are likely to be renewed or rolled over by the customer as part of the bank’s funding, including under conditions of stress. Retail customers’ current accounts are often relatively sticky.
6. As of March 11, 2023.
7. Smaller banks defined in this context as banks with less than $200b in consolidated assets.
8. Uniswap Volume as of 3/11/2023 (Saturday) compared to the NASDAQ trading volume from the prior day on 3/10/2023 (Friday).