Here’s How the Banking Crisis Is Leading People Back to Bitcoin
As more banks struggle, Bitcoin rises as the decentralized currency alternative
It’s been less than a week since the California Department of Financial Protection & Innovation closed Silicon Valley Bank and appointed the Federal Deposit Insurance Corporation (FDIC) to take over.
This event marked the second largest bank failure in United States history — the first one being Lehman Brothers in 2008.
However, this time around, we had Bitcoin.
Indeed, the Silicon Valley Bank closure has had — and will continue to have — collateral events across several industries, especially in the tech and cryptocurrency sectors. But it also served as a reminder for many people about Bitcoin’s true value.
In this article, we’ll explore how the banking crisis affected the crypto industry and led to a spike in Bitcoin’s price.
What Happened With Silicon Valley Bank, Exactly?
The traditional banking system uses what’s called a “fractional reserve” mechanism.
This means that when someone — either a person or a company — deposits money in the bank, the latter only has to keep a fraction of it in their reserves, and are free to invest or lend the rest of it for profit.
In other words, banks use their customers’ money for investments.
Virtually every bank does this, and Silicon Valley Bank was no exception. In fact, before it collapsed, SVB had been acquiring U.S. sovereign and government-backed mortgage bonds. It’s important to note that these are considered the safest assets in the world to invest in.
Yet, these bonds took a hit as the Federal Reserve kept increasing rates. The United States government continued to issue new bonds with higher interest payments, causing investors to sell their older, lower-paying bonds to move to the new ones.
And so, SVB’s bond portfolio value started to plummet.
Now, this likely wouldn’t have been a problem if the bank could have just waited until the bonds matured and collected their interests and liquidity. However, the bank was hit by a $42B withdrawal request in under a day.
Because of fractional reserve banking, SVB didn’t have enough cash to process such withdrawals, and so it had to sell the bonds at a massive loss. This kept going throughout the day until the bank started having liquidity issues, and so the FDIC took over.
Repercussions in the Cryptocurrency Industry
A particular fact about this situation is that most Silicon Valley Bank customers were not individuals, but emerging businesses and startups, especially in the tech and the cryptocurrency industries.
Among them was Circle, the issuer of the USDC stablecoin, which had around $3.3B of its reserves deposited at the bank.
These funds were used as collateral for the stablecoin, meaning that they were backing the value of the token. So, when the bank collapsed, the entire sector panicked, fearing that the stablecoin was no longer fully collateralized.
In fears of holding an uncollateralized token, USDC users started swapping them for other stablecoins or, in many cases, even Bitcoin. The selling pressure led to Circle’s stablecoin suffering the largest de-peg in its history, deviating up to 12% from its supposed $1 value, and reaching $0.88.
The good news is that the de-peg wasn’t really a reserves issue, as the U.S. government announced that all depositors would have access to their funds.
Nevertheless, these events did expose the vulnerabilities of the DeFi sector.
USDC is a critical component of most decentralized applications for lending and borrowing, payments, and liquidity providing, among others. More importantly, it’s also a major collateral for so-called “decentralized” stablecoins like DAI, which also suffered de-pegging following USDC.
All these circumstances show how close many DeFi applications are to the traditional banking system, and serve as a wake-up call for builders in the space. Decentralization must remain the priority.
Bitcoin Surges After the Collapse
Finally, it’s worth mentioning the positive response Bitcoin had to the entire series of events.
As we mentioned at the beginning of the article, Bitcoin wasn’t around for 2008. In fact, it was created because of it. And last week, it showed why.
Fractional reserve banking is the industry standard. Bank customers don’t get to decide whether they let the bank invest their funds or not — they have to comply.
Without any scalable and efficient self-custody solutions for fiat currency and cash — stashing bank dollar bills under the mattress isn’t really an answer — Bitcoin emerges as the ultimate alternative. It’s secure, scalable, and, most importantly, users hold their own keys.
We said Silicon Valley Bank were mostly tech businesses, and it makes sense that most tech-savvy entrepreneurs know at least the basics of Bitcoin and understand its core value.
Additionally, those who wanted to exit USDC and didn’t trust other collateralized stablecoins were also incentivized to acquire Bitcoin.
The combination of the two factors led to Bitcoin demand skyrocketing, mostly from people who wanted to move their funds into a safer and non-custodial store of value asset. As a result, Bitcoin rose over 20% in a few hours.
What to Expect in the Future?
The second largest bank failure in the history of a country as big as the United States cannot be is not to be taken lightly.
Many things are changing both in the macroeconomic landscape and in our own perception of our financial and banking system. What was considered the safest investment in the world has led to several renowned financial institutions collapsing and billions being lost.
Similarly, what was considered by most as a risky and volatile investment turned out to be a haven for people looking to preserve their liquidity and access to their funds.
After last week’s events, many are speculating that the Fed will abandon its hawkish approach and cool down on rate hikes, as well as resume monetary emission to provide support to the banking system. If that happens, we can expect inflationary pressure to return.
This means that the macroeconomics landscape will be much different from that of 2022. It’s critical to stay alert, keep an eye on market updates and policy changes, and act accordingly.