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Cryptocurrencies: Stablecoins no more stable after collapse of Silicon Valley Bank –Report

*Experts say the temporary loss of its peg against the US Dollar Coin(USDC), second-largest stablecoin by market capitalisation after Tether, has exposed a very different set of governance risks related to the custody of reserve assets

Isola Moses | ConsumerConnect

Experts have opined that stablecoins, for long, have long been associated with a form of safe investment that is much less susceptible to the volatility of the wider cryptocurrency market.

However, with the recent phenomenal collapse of Silicon Valley Bank (SVB), new data indicated that stablecoins are fast losing their stable reputation, according to report.

What are stablecoins?

Stablecoins, according to

Investopedia, are cryptocurrencies whose value is pegged, or tied, to that of another currency, commodity, or financial instrument.

They aim to provide an alternative to the high volatility of the most popular cryptocurrencies, including Bitcoin (BTC), which has made crypto investments less suitable for common transactions in recent times.

In a new report, nonetheless, Moody’s Investors Service has raised questions about the resilience of stablecoins to declines in traditional finance, particularly in regard to the fall of Silicon Valley Bank.

The firm’s latest analysis indicated that although the industry and regulators have been concerned about the risk of cryptocurrency-to-traditional finance contagion, the collapse of the United States (US) regional bank demonstrates that contagion risk works in both directions, reports TheFinTechTimes.

Stable coins?

The USD Coin (USDC) March 10, 2023, was reported to have lost its peg to the Dollar, dipping below $0.90 in a process known as ‘depegging’. This development confirmed Moody’s concerns about the close correlation between the two sides of the industry, report stated.

US FinTech Circle issued USDC, and Moody’s strongly attribute the decline in the stablecoin’s price to the recent deposit run at Silicon Valley Bank. As highlighted by the report, Circle had up to $3.3billion in exposure to the fallen bank.

It was learnt shortly after, the Federal Deposit Insurance Corporation (FDIC), the US Department of the Treasury and the Federal Reserve Board of Governors jointly announced that they would make all of the bank’s depositors whole. As a result, USDC quickly regained its peg against the US Dollar.

But USDC was not the only one in the sinbin, as the prices of Binance USD (BUSD) and Maker DAO’s DAI stablecoins all fell below the $1 mark last week.

However, the price of Tether’s USDT stablecoin was observed rising above $1.

Between traditional and decentralised finance (DeFi)

It is suggested these findings have confirmed the unpredictability of interlinkages between traditional and decentralised finance (DeFi), while  indicating that fiat-backed stablecoins are more volatile than market participants initially believed, report noted.

Ripple effect of traditional finance

Analysts stressed in terms of the ripple effect of traditional finance, Moody’s makes clear that it is the realised problems of the traditional finance sector that ultimately cost these stablecoins their peg and that the cryptocurrency industry is not immune to said problems after all.

Until now, large fiat-backed stablecoins have been praised for their remarkable resilience, having emerged unscathed from past scandals, such as the collapse of FTX.

However, more recent events have drawn increasing attention to how stablecoin issuers’ reliance on a relatively small set of off-chain financial institutions is limiting the asset’s reputation for stability.

According to experts, this concerning reliance has even popped up on the radar of Binance, whose Chief Executive Officer (CEO), Changpeng Zhao, announced the cryptocurrency exchange’s plan to convert what remains of the $1billion industry recovery initiative funds from BUSD stablecoin to native cryptocurrency, including BTC, ETH, and its native token BNB.

On US regulator’s decision to repay Silicon Valley Bank’s unsecured deposits

Meanwhile, it is said USDC would be thankful for the US regulator’s recent pronouncement to repay SVB’s unsecured deposits in full.

It was gathered that the  decision had allowed the bank’s price to recover. Otherwise, the stablecoin could itself have been at risk of suffering a run and thus forcing the liquidation of its assets.

In regard to the volatility of the current investment climate, Moody’s indicated that such a scenario could, in turn, have caused any bank holding Circle’s assets to suffer their own run, resulting in the depegging of other stablecoins.

In this way, the cryptocurrency industry might have been at risk itself of amplifying the shock that originated from the traditional economy, report said.

Ultimately, this activity, alongside USDC’s depegging, would have left financial institutions reconsidering how they work and interact with stablecoin operators; increasing stablecoins’ dependence on a smaller circle of institutions and containing their ability to maintain the stable exchange rates they were once synonymous with.

The rising scrutiny of stablecoins

The report further showed it is no wonder that in light of these recent events in the global markets, regulators are taking a more critical look at the nature of stablecoins.

This increasing level of scrutiny perhaps first caught fire in the wake of the Terra/Luna downfall of last year, which exposed concerns about stablecoins’ reserves and led regulators to recommend additional transparency and liquidity requirements.

With the temporary loss of its peg against the US dollar, USDC – the second-largest stablecoin by market capitalisation after Tether – has exposed a very different set of governance risks related to the custody of reserve assets.

In view of this, the report also cited how the advent of the EU cryptoasset regulation (MiCA) is looking to mitigate these newfound risks by requiring stablecoin issuers to ‘evaluate their exposure to third-party custodians, taking into account the full scope of their relationship with them, and monitor their financial conditions on an ongoing basis’.

The European Banking Association, in collaboration with the European Securities and Markets Authority (ESMA) and the European Central Bank (ECB), has yet to determine the precise nature of this regulation and the succeeding regulatory standards, according to report.

Meanwhile, the realised failures of the traditional finance sector could ultimately trigger the rise of additional requirements, particularly with respect to counterparty diversification.

Institutions might consider adopting stablecoins to settle agreements involving tokenised securities out of concern over the coins’ potential volatility, despite the limited availability of alternate solutions.

The report as well indicated that tokenise commercial bank deposits might provide a solution.

However, this approach could create a dependency on the bank that decides to issue them, it stated.

Settling transactions with Central Bank Digital Currencies (CBDCs) that are compatible with distributed ledger technologies (DLT) could alleviate credit risk, but most such projects are still in the testing phase, report said.

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