Silvergate and Signature were among the most prominent banks trusted by cryptocurrency companies, while Silicon Valley Bank had many cryptocurrency startups and venture capitalists as customers.
The recent failures of these banks caused a ripple effect in the stablecoin market over the weekend.
On Sunday night, when the federal government intervened to guarantee deposits at Signature and SVB, cryptocurrency prices increased, and stablecoins regained their pegs.
These two banking giants, which were not only friendly towards the crypto sector but also the biggest banks for tech startups, all failed in less than a week. While cryptocurrency prices rallied after the federal government stepped in to back depositors in two banks, the events caused instability in the stablecoin market.
The Crypto Banking Trifecta: A Blow to Crypto Liquidity
Silvergate Capital, a central lender to the cryptocurrency industry, announced on Wednesday that it would be winding down operations and liquidating its bank. Silicon Valley Bank, a major lender to startups, collapsed on Friday after depositors withdrew more than $42 billion following the bank's statement on Wednesday that it needed to raise $2.25 billion to shore up its balance sheet.
Banking Giant Signature, which also had a strong focus on cryptocurrency but was much larger than Silvergate, was seized on Sunday evening by banking regulators.
Signature and Silvergate were the two main cryptocurrency companies' main banks. Nearly half of all U.S. venture-backed startups kept cash with Silicon Valley Bank, including cryptocurrency-friendly venture capital funds and some digital asset firms.
The federal government intervened on Sunday to guarantee all deposits for SVB and Signature depositors, adding confidence and sparking a small rally in the cryptocurrency markets. Both bitcoin and ether rose by almost 10% in the last 24 hours.
Fed intervention is believed to be the immediate cause
According to Nic Carter of Castle Island Ventures, the government's willingness to backstop both banks signifies that it's back in the mode of providing liquidity rather than tightening, and loose monetary policy has historically proven to be a boon for cryptocurrencies and other speculative asset classes.
However, the instability once again revealed the vulnerability of stablecoins, a subset of the cryptocurrency ecosystem that investors can typically rely on to maintain a set price. Stablecoins are supposed to be pegged to the value of a real-world asset, such as a fiat currency like the U.S. dollar or a commodity like gold. But unusual financial conditions can cause them to drop below their pegged value.
Many of cryptocurrency's problems in the last year originated in the stablecoin sector, beginning with TerraUSD's collapse last May. Meanwhile, regulators have been focusing on stablecoins in recent weeks. Binance's dollar-pegged stablecoin, BUSD, saw massive outflows after New York regulators and the Securities and Exchange Commission pressured its issuer, Paxos.
The correction in crypto prices
Over the weekend, confidence in this sector again took a hit as USDC - the second-most liquid U.S. dollar-pegged stablecoin - lost its peg, dropping below 87 cents at one point on Saturday after its issuer, Circle, admitted to having $3.3 billion banked with SVB. Within the digital assets ecosystem, Circle has long been regarded as one of the adults in the room, boasting close connections and backing from the world of traditional finance. It raised $850 million from investors like BlackRock and Fidelity and had long said it planned to go public.
DAI, another popular dollar-pegged virtual currency partially backed by USDC, traded as low as 90 cents on Saturday. Both Coinbase and Binance temporarily paused USDC-to-dollar conversions.
Over the weekend, some traders started exchanging their USDC and DAI for Tether, the largest stablecoin with a market value of over $72 billion, as Tether's issuing company had no exposure to SVB, and it's currently trading above its $1 peg, despite concerns about its business practices and reserves.
The stablecoin market began to recover after Circle's blog post, which stated that they would cover any shortfall using corporate resources, and both USDC and DAI have shifted back towards their dollar peg.
Decentralised Finance: A More Reliable Alternative
Decentralised finance (DeFi) provides several advantages over the traditional legacy banking system, especially in light of recent events such as major banks collapsing abruptly. Here are some of the key advantages of DeFi in comparison to the legacy banking system:
Decentralisation: DeFi operates on a decentralised network of computers, which eliminates the risk of a single point of failure. In contrast, the legacy banking system is centralized, and the failure of one institution can have a ripple effect throughout the entire financial system. Decentralisation makes the DeFi system more resilient and less prone to sudden failures.
Transparency: DeFi protocols are open-source, which means that anyone can view the code and audit the system. This transparency ensures that the system is fair and unbiased and reduces the likelihood of fraud or manipulation. In contrast, the legacy banking system is often characterized by opaque transactions and hidden fees that erode trust in financial institutions.
Accessibility: DeFi is more accessible than the legacy banking system. Traditional financial institutions often have strict requirements for opening accounts and accessing financial services, which can exclude underserved communities. In contrast, DeFi applications are open to anyone with an internet connection, making financial services more accessible to everyone.
Lower transaction costs: DeFi operates on a permissionless network, meaning that users can transact without requiring permission from a centralized authority. This eliminates the need for intermediaries and reduces transaction costs, making financial services more affordable for everyone. In contrast, the legacy banking system is often characterized by high fees and complex bureaucracies that limit access to financial services.
Innovation: DeFi is a rapidly evolving ecosystem that is fostering innovation and experimentation in financial services. Developers can build new applications on top of the DeFi infrastructure, leading to a wide range of innovative financial products and services. In contrast, the legacy banking system is often slow to innovate and can be resistant to change.
DeFi provides several advantages over the legacy banking system, including decentralization, transparency, accessibility, lower transaction costs, and innovation. These advantages make DeFi a compelling alternative for those seeking a more reliable and accessible financial system, especially in light of recent events such as major banks collapsing abruptly.