The Breakdown - Apparently, U.S. Regulated Banks Are Riskier Than Stablecoins

Episode Date: March 17, 2023

Stablecoins have long been seen by U.S. policymakers as risky and a potential threat to U.S. financial stability. How ironic, then, that it was the failure of a U.S.-regulated bank in SVB that caused peril to USDC last weekend. NLW explains how USDC fell off and then recovered its peg, while also giving an update on Operation Choke Point 2.0.   Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big-picture power shifts remaking our world. The breakdown is produced and distributed by CoinDest. What's going on, guys? It is Thursday, March 16th, and today we are checking in on the Circle USD dimension of the recent banking crisis. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation. Come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, friends, well, today we are going to discuss the delicious irony of why, despite

all the teeth gnashing of politicians, it wasn't stable coins that disrupted the regulated financial system, but the regulated financial system that disrupted a stable coin. First, though, I want to do a few follow-ups from things we've discussed over the last few days. Yesterday, we talked about Credit Suisse. You'll remember that markets were freaking out about it and pricing in a huge chance of default after their biggest investor said absolutely not to further investment. As we discussed, despite the fact that its problems were quite different than Silicon Valley banks, having another bank imperiled so close to last week's dramatic events inherently

connected the two. Well, today, Credit Suisse has posted a record surge of as much as 40 percent and has seen major drops in their default swaps. The big update is that they were able to open up a 50 billion franc credit line, with the Swiss National Bank, which is about $54 billion U.S. They also announced plans to purchase some senior debt to the tune of about $3 billion. So, seems like the European banking crisis is over, right? Well, enough so that the ECB hiked rates by 50 basis points today, and I guess we'll have to see how that plays out over the next few days. Meanwhile, back in the U.S., all eyes have been on First

Republic. Indeed, before the New York Department of Financial Services decided to off-signature bank over the weekend, most believed that First Republic was the most likely next U.S. domino. Well, on Sunday, First Republic reported that it had more than 70 billion in unused liquidity from agreements with the Fed and JPMorgan Chase, but its stock still cratered this week. Given that, word is that they're exploring a sale. Unlike SVB's Silvergate or signature, no one industry makes up more than 9% of First Republic's depositor base, and their emphasis on private banking and wealth management seemingly make them a juicy target.

JPM is one that many have mentioned in conjunction with the sale, but it seems like others, including Bank of America subsidiary Merrill Lynch, and Morgan Stanley might also be interested. Now, given all of this, it feels a bit like the immediate storm in the banking sector is dissipating. In that more calm, sober environment, do our reflections on signature bank shutdown change? In other words, with the benefit of being removed a few days, does it seem less like a political hit job on a crypto target? Investor Nick Carter and Bitcoin magazine CEO David Bailey got in exactly this fight yesterday evening. The initial spark was another extensive interview with signature board member Barney Frank,

where he reiterated his belief that signature was singled out to send a message to the crypto industry. Nick tweeted the interview and said, shocking interview with Barney Frank. Pushes back at DFS's assertion that signature wasn't closed due to an anti-crypto animus. The whole thing is absolutely bananas, some extracts. If FDIC slash Fed had acted on Friday, the run wouldn't have taken place. Signature was ready and able to open on Monday. NYDFS never admitted that signature was insolvent. Instead, they claim that signature didn't give them sufficient data, but that's no reason to nationalize a bank.

Reiterates that DFS's main intention was to send an anti-crypto message. The government can apparently seize banks that are not insolvent just because they do not like them. The whole thing is just astounding. Now, importantly, Nick also added this little nugget. One last thing. To determine whether this theory has legs, if another bank acquires SDNY and Cig's, is not included in the package, it is clear that DFS took them down to take Cignt critical crypto infrastructure offline. Watch this part carefully. Signet is, of course,

Signature's custom clearing network for crypto companies. So keep an eye on that, we'll get back to it in just a minute. Now, after Nick posted this thread, Bitcoin magazine's David Bailey got into it with him. David writes, maybe they didn't say they were insolvent because signature wouldn't hand over data, but if you look at their financials, they were very distressed from deposit or bleed end of year, and Friday before they shut, lost 20% of deposits. So, yeah, they were insolvent. Nick Bitesback didn't take you for a Department of Financial Services Apologist. Bailey says, I'm not, but let me paint an alternative version of events.

Signature was insolvent, as made clear by their financials. The FHLB lent them tens of billions of dollars in order to help shore up their liquidity. When that wasn't enough, regulators stepped in and insured all deposits, effectively bailing out 25 billion of uninsured deposits belonging to 1,000-plus exchanges, corporate treasuries, crypto funds, and stablecoins. That if lost, would have decimated our industry and affected millions of people. 25 billion is a very large percent of all fiat liquidity in crypto. The signature board, in an effort to deflect legal liability,

invented crypto as the cause of their failure rather than their own financial mismanagement. While the regulators insist that had nothing to do with what happened, banks across the country read the headlines in media and say, hmm, crypto is really risky. Look what happened to these other banks. We shouldn't touch it. thereby damaging our industry's ability to secure new banking relationships for years to come. So my argument is that perhaps we shouldn't spread a fake narrative about what actually happened here so that we don't end up creating false perception resulting in real harm,

and be thankful that the government just bailed us out because of our systemic importance to the U.S. financial system. Just a thought. Now, David wasn't alone in this alternative narrative. Nourage from Coin Center said, basically where I am, let's not create headlines that make us look worse. If every regulator is saying crypto is not the cause, do we really want to push the idea that it is? Isn't that worse overall? Now, all of this is totally plausible, and frankly, in some ways I wish it were the explanation that I believed. But friends,

as they say in the Princess Bride, these well-meaning folks fell victim to one of the classic blunders, the most famous of witches never get involved in a land war in Asia, but only slightly less well-known is this. Never go in against Nick Carter when the death of a bank is on the line. Literally just an hour after this whole exchange, Reuters published a piece about the government's process for selling SVB and Signature Bank. According to people familiar with the matter, the FDIC is collecting bids which need to come in by March 17th. They've retained investment bank Piper Sandler to help and are trying to sell SVB in signature in their entirety. There are some conditions. For example, only companies with an existing bank charter will be allowed to look at the bank's financials

before submitting their bid. This is, according to sources, a way to prioritize traditional lenders over private equity firms. There's also one condition for Signature, and at this point, I want to go back to Nick's thread where he said one last thing to determine whether this theory has legs. If another bank acquires SDNY and Signet is not included, it is clear that DFS took them down to take Signet, critical crypto infrastructure offline. So the other condition, listed in Reuters article, quote, any buyer of signature must agree to give up all the crypto business at the bank. Bitcoin Core developer Matt Corallo says, wait, what? The government making explicit decisions on who gets a bank account?

It has been pointed out to me that NYDFS isn't the one who gets to set sale conditions, given the bank is now an FDIC receivership. While this isn't a smoking gun that NYDFS lied about the reasons for the shutdown, it is absolutely overstepping FDIC authority. FDIC is tasked with getting the maximum value. Signatures, crypto product arm is a huge value. Join CoinDesk's Consensus 20203. the most important conversation in crypto and Web3,

happening April 26th through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web3, and the Metaverse. Immerse yourself in all that blockchain technology has to offer creators, builders, founders, founders, brand leaders, entrepreneurs, and more. Use code Breakdown to get 15% off your pass. Visit Consensus.com or check the link in the show notes.

Now, it's not just crypto Twitter that's a bit up in arms about all of this. We finally had one of our congressional allies speak up. This week, Tom Emmer sent a letter to the head of the FDIC effectively accusing the Biden administration of weaponizing bank regulators against crypto. The letter says, reports indicate that federal financial regulators have effectively weaponized their authorities over the last several months to purge legal digital asset entities and opportunities from the United States. Recent bank closures have highlighted the targeted nature of these regulatory efforts

to single out financial institutions and send a message to get people away from crypto. These actions to weaponize recent instability in the banking sector are deeply inappropriate and could lead to broader financial instability. As evidence, Emmer points to all the same things we've been discussing on this show. The January 3rd Fed FDIC OCC statement, discouraging banks from holding crypto and servicing crypto clients, the February 7th formalization of that into a rule without any public comment period. The January 27th White House National Economic Council report on a roadmap to mitigate cryptocurrencies risk. Emmer even repeats the industry's argument that the aggressive public statements from these regulators and their political allies undermine confidence in these institutions and contributed to the bank runs they experienced.

Emmer writes, regulatory statement-driven market fear drove mass withdrawals at the few remaining banks to provide legal crypto firms with access to financial services. Now, whether anyone will care about this remains to be seen. Gary Gensler is clearly making a bet on congressional ineptitude and division to run rampant, so we'll just have to say. Still definitely represents a rhetorical ratcheting up of this battle. Now, one piece of the whole story of last weekend that we haven't had a chance to cover, but I think deserves mention, is everything that happened around Circle and USDC. When Silicon Valley Bank went down, people immediately started speculating about the impact for Circle's USDC. USDC keeps most of its reserves in U.S. Treasuries.

I believe the number is around 77%. However, it also keeps some in cash. That cash was split up between a number of different banks, which, clearly looks like smart risk management in retrospect. Yet on Friday night, after SVB had been put into receivership, there was a period before Circle had commented where speculation was running pretty wild. The problem showed up first in a liquid defy venues with USDC trading at a few cents discount to its price, but the issue soon spread, with curve-seeing massive volume of conversions from

USDC to other stable coins, which unbalanced the liquidity pool. There was a long period of deafening silence from Circle on Friday night, as trader speculated on just how much money the firm had locked up in the SVB failure. Shortly after 10 o'clock Eastern time, Circle disclosed that it had 3.3 billion in cash reserves stuck in the bank. The firm had attempted to wire out the amount on Thursday, but that transaction had not been processed by close of business on Friday. Simultaneously, it appeared that signature signet system had stopped processing transactions, meaning there seemed to be no way to convert or redeem USDC over the weekend. At 1030 on Friday night, Circle's chief strategy officer Dante

DeSparte tweeted, Circle is currently protecting USDC from a black swan failure in the U.S. banking system. SVB is a critical bank in the U.S. economy and its failure, without a federal rescue plan, will have broader implications for business, banking, and entrepreneurs. At 1040, Coinbase halted conversion of USDC, with a tweet that gave a little more information on the nature of the problem. We are temporarily pausing USDC to USDA conversions over the weekend while banks are closed. During periods of heightened activity, conversions rely on USD transfers from the banks that

clear during normal banking hours. When banks open on Monday, we plan to recommence conversions. Late into Friday night, the situation worsened, with USDC showing up as low as 87 cents on crypto indices. Traders across crypto Twitter were hurriedly doing the math on USDC's reserves. At the time, Circle had around 43 billion in reserves, with most of that stored in treasuries but 9.8 billion in cash. In the absence of any clarity from banking regulators, a pretty hysterical mood gripped crypto Twitter. Traders quickly began to price in the worst-case scenario that Circle would lose its entire SVB deploy. or around 7.5% of its total reserve. Then an even more extreme scenario was put forward,

that as USDC was redeemed, the hole would get larger and larger as a fraction of the remaining reserves, leaving the stable coin substantially unbacked. Even as that fear gripped the market, other, more-level-headed traders decided that a 10% premium for USDC was a bargain and loaded up to wait out the weekend. On Sunday night, once the panic had subsided and the government had made clear that depositors would be made whole, the USDC peg began to repair itself. As redemptions became available again on Monday morning, USDC quickly snapped back to trade at par. As analysts surveyed the damage, it was discovered that a huge $3 billion in USDC was redeemed on Friday, with a further $1.2 billion converted into MakerDAO's on-chain stable coin die.

As a result, USDC's market cap fell by about 10%. Now, during Circle's weekend crisis communications, they were clearly walking a line between providing clarity to a rattled market and ensuring that they didn't provide material for an SEC complaint. Gabriel Shapiro, the general counsel at Delphi Labs, explained the predicament. He said, I think Circle is out of the frying pan and into the fire. I expect class action and regulatory lawsuits.

Likely regulatory investigations were already underway so they can move pretty fast. I was always surprised custodial stablecoins got this far without a massive government crackdown. Indeed, many sharp crypto mines were discussing exactly this point over the weekend. Mark Boyer and the chief legal officer at Polygon Labs said the size of any hole in USC isn't important. Everyone is missing that Circle should never fill a hole from its own balance sheet. That's how the SEC would win. Andrew at AP Abacus, who is both a rumor mill but has been mostly accurate so far, writes update.

The SEC was very aware of Circle's exposure to at-risk banks and specifically Silicon Valley Bank. Source says the SEC absolutely believes that USDA is a security. Expect further action in the weeks to come. Bitcoin or Dot Crypto replied to that saying, this is ironic. Circle did the right thing by having transparent reserves inside regulated banks. One of the regulated banks royally effed up the management of its bond holdings, but the SEC is targeting action against Circle as the innocent depositor? What is this madness? I agree entirely with that point, and also Ryan Selkis, who put it more crisply.

The Masari CEO wrote, a regulated bank threatened the stability of a stable coin before. A stable coin threatened the stability of a regulated U.S. bank. Will that matter, to Gensler? Probably not. Indeed, the most disappointing thing is that it didn't have to be this way. Congress was tantalizingly close to completing work on standalone legislation that would have legalized and provided a regulatory framework for U.S.-based stablecoins. It was a framework that Circle likely would have been able to comply with and may have provided them with additional tools to support the USDC peg over the weekend. Instead, however, of granting Stablecoins regulatory legitimacy, recognizing them for what they are, were it stuck in the situation where stable coins exist, but the regulations jam them into a money transmitter framework.

In an article on CoinDesk this week, John Rizzo, who was the spokesperson for the U.S. Treasury during their work on stablecoin legislation last year, gave a glimpse into the fissures in Congress that have stood in the way of getting clear stablecoin legislation in place. He writes, those on the left who wish to banish crypto into the dustman of history are acting out of a genuine belief in what's best for the economy in the American people. However, I believe this perspective is risky and wrong. This thinking misunderstands how assets acquire legitimacy. Many on the progressive left believe that government regulation of stable coins in crypto more broadly would provide

undue legitimacy. In contrast, I assert that it is crypto's market cap, which indicates its use, which gives it legitimacy. It's the people that get to decide, not the government. There is no political or practical pathway to a ban on crypto or stablecoins. From Mount Gox to FTX, crypto has proved more resilient than the proverbial cat with nine lives. So instead of pursuing bans, we should foster crypto's innovative potential and mitigate risks, beginning with stable coins. I think Rizzo is exactly right here. I think it's chilling to see that part of the blockage for legislation is that opponents on one side of the political aisle seem to believe that any sort of legislation would confer legitimacy. But I also believe that Rizzo is right that that's sort of a battle they've already lost. And the only question now is how much damage happens for not having that

legislation and for not having that regulation in the meantime. Anyways, guys, this was an important part of this whole story, one that shows, I believe, resilience in the stable coin and larger crypto infrastructure. Many in the industry have suggested that one of the next big legal battles might be around something like USDC. So that's the situation I'm watching quite closely. For now, I appreciate you guys listening. And until tomorrow, be safe and take care of each other. Peace.