The Ripple Effect: How Bank Runs Could Impact Stablecoins

With the bankruptcies of Silicon Valley Bank and Signature Bank, the future of traditional banking institutions is being called into question. As more people seek out alternative currency options, stablecoins like $USDC, $FRAX, and $DAI have become attractive options for diversifying portfolios. However, the bankruptcies of these banks have raised concerns about the stability of stablecoins. In this article, we’ll analyze the potential impacts of the bankruptcies of these banks and future banking turbulence on stablecoins, exploring what this could mean for the future of the DeFi industry.

The Fall Of Silicon Valley Bank

With the efforts of fighting inflation, the sudden federal interest rate increase put a lot of banks into a rough situation as they were caught in the fastest fed rate hike unprepared. If we oversimplify, banks are making money in two main ways along with the fees they charge for specific services.

• Banks often lend customer deposits at a higher interest rate and profit from the difference. For instance, a bank may offer a 3% annual percentage rate (APR) on client deposits while lending at 5%. If everything goes according to plan, the bank will earn a profit of 2%.
• Another way banks generate profits is by investing client deposits in higher-yielding assets. For example, if a bank offers a 3% APR on deposits and US Treasuries are yielding 5%, the bank could invest client deposits in Treasuries to earn the difference.

However, this practice has been one of the main causes of the recent surge in bank bankruptcies.

Silicon Valley Bank has encountered an issue with its investment in US Treasuries and mortgage-backed securities. The bank invested in these securities when interest rates were at all-time lows, and the sudden increase in interest rates caused these bond investments to be significantly underwater.

Please note that the interest rates of a bond and its price are inversely correlated. This is because a Treasury bond that yields 1.5% and another that yields 5% carry the same risks while offering different returns. For example, if a 5-year bond offers a 5% APR while another offers 1.5%, this would result in an annual difference of 3.5%. As a result, the bond with the lower yield would be priced cheaper than newly issued bonds.

The bond liquidations resulted in SVB losing roughly $1.8 billion, which then triggered a bank run. Within a day, clients withdrew $42 billion from the bank, leading to a liquidity crunch.

The DePeg Of $USDC & $DAI & FRAX

Circle, the issuer of $USDC, was among the depositors in SVB with a total of $3.2 billion in assets deposited in the bank. As the liquidity crunch deepened, fear surrounding SVB grew, causing $USDC to de-peg as low as $0.87.

Since $DAI and $FRAX heavily rely on $USDC as collateral, their depegging to $0.87 was inevitable. This event caused significant fear in the DeFi market as the biggest stablecoins used in DeFi de-pegged one after another.

FDIC normally insures bank deposits, but the limit per account is $250,000, which was not enough to cover Circle’s $3.2 billion assets in the bank. However, to prevent the domino effect from affecting other banks, the USA announced that every client would be made whole, resulting in no loss to any depositors.

After the announcement, $USDC, $DAI, and $FRAX were re-pegged. However, this event served as a reminder to everyone that stablecoins are not as stable as people typically believe.

What To Expect From the Future:

The banking crisis shows no signs of slowing down, with US banks like Silvergate, SVB, and Signature already facing bankruptcy, and Credit Suisse, one of the world’s largest banks, being forced to merge with UBS.

ProMarket reports that over 190 banks with assets totaling $300 billion are at risk of impairment. Centralized stablecoins are heavily interconnected with banks, making it crucial to understand that this situation could lead to unfortunate scenarios for the future of stablecoins.

How To Protect Yourself?

To safeguard against similar events in the future, our stablecoin de-pegging covers provide reliable protection. For an annual premium starting at just 0.75%, you can stay secure against future incidents.

It’s crucial for every DAO, DeFi protocol, crypto company, and individual investor to have a plan in place against black-swan events that could impact stablecoins. Our de-pegging covers offer a cost-effective solution that ensures a secure infrastructure for the future of DeFi.

Conclusion:

In conclusion, the recent bankruptcies of traditional banking institutions and their impact on stablecoins have raised concerns among investors and DeFi actors. It is crucial for individuals and organizations to have a plan in place to protect themselves and their communities against black-swan events that could impact stablecoins.

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Uno Re is building a fully secure decentralized insurance ecosystem to serve our institutional and individual clients. Despite daily heavy losses incurred by DeFi exploits, our clients can rest easy with our customizable, affordable, and convenient coverage.

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