USDC Depeg has given yet another opportunity to reflect on the problems in the cryptocurrency market. A chance to consider solutions for future challenges.
The rate of USDC is slowly making its way back to the $1 mark after depeg and a 15% drop, brought about by the freezing of some reserves in a closed bank. This is yet another example of the vulnerability of the cryptocurrency market, and the need for caution when dealing with it.
We've compiled 5 key takeaways from the USDC depeg.
Centralisation isn't inevitably evil
USDC is a centralised stablecoin issued by Circle and Coinbase. The quick response of both institutions prevented any severe negative impact on the token. After the USDC rate dropped, the issuer suspended the possibility of converting coins into USD at a 1:1 ratio. This averted a potential liquidity crisis that could have been caused by arbitrage traders. In addition, Circle immediately initiated the withdrawal of funds from SVB Bank after its bankruptcy and also warned the community that in the worst case scenario all funds would be compensated from internal reserves and corporate bonds.
If this situation had arisen for a decentralized or algorithmic stablecoin, it would have taken much longer to resolve the problems. The management of those stablecoins is often spread across a large cryptocurrency community. It's also a fact that centralized stablecoins are better backed by real currency and more resilient to market shocks.
Panic reigns over market
At the time that Silicon Valley Bank was shut down by the California Department of Financial Protection and Innovation, it held $3.3 billion. With 41 billion USDC coins in circulation, this represents 8% of reserves. In theory, the maximum decline in USDC should be within 8%, as all other backing, held in short-term US treasury bills and in several banks, was not affected.
The USDC stablecoin's price dropped by 15-20% on some cryptocurrency exchanges due to panic selling by users and depletion of liquidity for USDC trading pairs. Such trader activity has a negative impact on the overall state of the cryptocurrency market as a whole.
Diversification protects!|saves the day
From a technical point of view, Circle made things right. 77% of the USDC is backed by US commercial paper, while the remaining 23% is held in cash by the six largest and most reliable institutions in the US.
Few could have imagined that the 16th largest bank in the US, with $209 billion in deposits, could be shut down in a single day. This situation is not a matter of crypto, but of the instability of the stock market and traditional finance. Therefore, the diversification of USDC reserves proved to be quite useful. It halted the situation from escalating to a crisis.
The US regulator - a figure of power
US monetary policy has long had an impact on the cryptocurrency market. However, while the focus used to be on the Fed's interest rate and inflation levels, the crypto community is now closely watching every step and word during each meeting.
No wonder, since one state's regulator might have such a vast impact on the digital asset industry. Still, it's unclear whether the Fed is aware of its actions, as to address the consequences of closing such large institutions as SVB and Signature, a plan should be put in place to rehabilitate user deposits and refunds. It is far easier to resolve such matters prior to a bank's winding up.
Cryptocurrencies: interconnection holds firm
The USDC depeg caused a decoupling of the exchange rates for many stablecoins, including USDP, DAI, FRAX, GUSD, and others. This was due to a large percentage of USDC being held in the reserves of those. Some of the tokens held more than 50% of their collateral in the stablecoin issued by Circle, so their exchange rate started to decline in sync with the main asset.
The potential impact could have been far greater if Circle hadn't responded promptly and if the reserves weren't diversified enough. USDC's price could have plummeted to $0.4-0.5, dragging other stablecoins down with it, and causing a reduction in the volume of many tokens in liquidity pools, particularly DAI, which is a key component of the DeFi sector. Panic withdrawals and selling of assets from yield farming programs often followed these types of situations, leading to a negative impact on the overall liquidity of the crypto market, including BTC.
But such a scenario was prevented on 12 March. For now.
