[Feature] Circle’s USDC Depegging: Aren’t Stablecoins Supposed to be Stable?

The cryptocurrency market had gone through upheaval after upheaval, and it does not look like there will be much rest or calm any time soon. There was unrest over the weekend in particular ─ Saturday saw Circle, the U.S. firm behind the USD Coin (USDC), announcing that it was depegging its stablecoin from the US dollar due to a scandal involving its reserve held at Silicon Valley Bank (SVB). The news sent shockwaves through the cryptocurrency market, with the value of UDSC plummeting in just a few hours.

Source: CoinMarketCap ─ the value dropped to the $0.80 range at that time

But aren't stablecoins supposed to be stable hence its namesake?

Well, to touch briefly on stablecoins, they are cryptocurrencies that are designed to maintain a stable value relative to a traditional currency, such as the US dollar. The idea behind stablecoins is to provide a digital asset that has the benefits of cryptocurrency, such as fast and cheap transactions, while avoiding the volatility that is commonly associated with other cryptocurrencies, like Bitcoin (BTC).

As the name implies, stablecoins aim to address this problem by promising to hold the value of the cryptocurrencies steady in a variety of ways.

While they are designed to maintain a stable value, it is important to remember that they are still subject to market forces and fluctuations, and can depeg from their target value.

So how did USDC depg?
According to Cointelegraph, Circle initiated a wire transfer on 9 March to remove its funds from SVB as the Federal Deposit Insurance Corporation-insured (FDIC) bank was about to shut operations. Just two days later, Circle confirmed that the wire transfers were not wholly processed, with $3.3 billion of its $40 billion reserves still with SVB. The resultant sell-off caused the coin to break its 1:1 dollar peg.

So why did USDC only depeg now and not before?
That is due to the fact that SVB collapsed on Friday and the revelation from Circle of its reserves in SVB came just a day later. The Guardian reported that "worried depositors formed queues outside SVB's branches hoping to withdraw funds beyond the $250,000 guaranteed by federal banking regulations…the gathering fallout followed reports that SVB did not have a chief risk officer in place in the months leading up to the collapse, while more than 90% of its more than $121 billion in deposits were not insured."

Jeremy Allaire, co-founder and CEO of Circle, tweeted in detail about what transpired and how it happened, as well as what to expect with SVB and FDIC. See below:

He also shared an update that is on Circle's blog.

While Circle and USDC's troubles stem from SVB, the company pointed out that its stablecoin has zero exposure to the collapsed crypto-friendly bank Silvergate, and said that the "limited reserves" the company had at silvergate has already been transferred out before the bank closed.

Then on 13 March, Jeremy tweeted that the company was "heartened to see the US government and financial regulators take crucial steps to mitigate risks extending from the fractional banking system.”

Hours later, he posted a press release from Circle.

With USDC regaining its dollar peg, the extension of the U.S. government's emergency procedures, and his assurance that Circle's holdings are secure, Jeremy also mentioned about the Payment Stablecoin Act. The Act is still being actively pursued by Congress and would establish in law a system in which stablecoin money would be stored with cash at the U.S. central bank and short-term Treasury bills.

Source: TradingView ─ USDC, at the time of writing is $0.9942

The scandal involving SVB followed by USDC's depegging has raised questions about the reliability and accountability of banks that hold reserves for stablecoins. Many are left wondering how this could have happened, and what it means for the future of stablecoins and the cryptocurrency market as a whole.

Stablecoins depend on banks to hold their reserves, and if banks fail, these coins' stability is at risk. This incident raises concerns about the transparency and accountability of these coins' issuers, as well as highlights the need for better regulation and oversight in the cryptocurrency market.

Some experts predict that this incident could lead to increased regulatory scrutiny and tighter controls on stablecoins issuers, while others believe that the market will eventually stabilise and continue to grow. It has been noted that several industry players have called for changes in the market ─ to require stablecoin issuers to hold their reserves with multiple banks so as to reduce the risk of default, or for greater disclosure of issuers' reserve holdings to increase transparency and accountability.

Importance of Stablecoin Pegs
The importance lies in their ability to maintain a stable value relative to a traditional currency or asset. Stablecoins are designed to be a bridge between the benefits of cryptocurrencies and the stability of traditional currencies.

Stablecoin pegs help to provide confidence in the stability and reliability of stablecoins. Users can trust that the stablecoin will maintain its value to the asset or currency that it is pegged to. Moreover, they are important for the broader cryptocurrency ecosystem as they provide a way for users to move funds in and out of cryptocurrencies without being exposed to the volatility of other digital assets. Stablecoins can be used to trade in and out of other cryptocurrencies without having to convert back to a traditional currency, which can be time-consuming and costly.

Then what are the reasons why stablecoins depeg?
Some common reasons include:

1) Insufficient reserves: Stablecoins are usually backed by a reserve of the asset or currency they are pegged to like the U.S dollar. If there is a shortage of reserves to back the stablecoin, its value may fall below its target value. This can happen if demand for the stablecoin exceeds the available reserves, or if there are issues with the custodian banks holding the reserves (SVB and USDC for example).

2) Market volatility: Although stablecoins are designed to be stable, they are still subject to market forces and fluctuations. If the asset or currency that the stablecoin is pegged to experiences significant volatility, the stablecoin may also be affected and depeg from its target value.

3) Technical issues: Stablecoins are digital assets that rely on complex algorithms and systems to maintain their stability. If technical issues arise from the stablecoin’s infrastructure, such as bugs or glitches, it can affect its stability and depeg.

4) Regulatory changes: Stablecoins are still a relatively new financial innovation and are subject to changing regulatory environments. If there are changes in regulations or stablecoins-related legal issues, it can affect their stability and result in depegging.

One thing is clear, the cryptocurrency market is still in its infancy, and there are many challenges and uncertainties that lie ahead. As investors and enthusiasts continue to navigate this rapidly evolving landscape, it is important to remain vigilant and informed, and to demand transparency and accountability from those who hold our digital assets.