Silicon Valley Bank Collapses and Takes Out USDC, New York Declares ETH a Security

After the collapse of Silvergate Bank on March 8 and Signature Bank's near call, Silicon Valley Bank failed on Friday, March 10.

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SVB isn't crypto, but it's crypto-ish, and it shared Silvergate's failed banking model.

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SVB's primary clients were Silicon Valley venture capital firms and their portfolio businesses – tech startups flush with cash during the epidemic. As Silvergate collapsed, numerous venture capital firms panicked, with Peter Thiel purportedly ringing around his portfolio businesses and ordering them to get their money out. SVB attempted and failed to obtain more money. SVB was shut down by California's Department of Financial Protection and Innovation on Friday morning, and the FDIC was appointed as receiver.

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SVB invested its savings in mortgage-backed securities. They weren't horrible assets, but they were quite liquid. As the Fed hiked interest rates, MBS prices fell, and SVB's customers needed cash fast. SVB was forced to sell $21 billion in long-term securities for a $1.8 billion loss. SVB reported a negative cash balance of $958 million at the end of business on March 9.

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FDIC-insured deposits of up to $250,000 will be repaid in full. Nonetheless, the majority of funds at SVB were in accounts with balances much more than that amount. Huge uninsured depositors are significantly more likely to panic and flee.

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Uninsured depositors will get an "advance dividend" to cover payroll and other expenses, and an IOU for the remainder. When the FDIC sells SVB's assets, it will pay depositors everything it can.

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SVB made the same error as Silvergate in focusing on boom-and-bust consumers and piling deposits into long-term assets.

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During the 2008 financial crisis, Basel III enacted regulations prohibiting banks from doing what SVB did. Nevertheless, President Trump eliminated these criteria for community banks in 2018, and despite its vast deposit base, SVB claimed to be a community bank. Greg Becker, CEO of SVB, was among those who advocated for the regulation modification. 

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SVB had some cryptocurrency consumers. Circle, with $3.3 billion, and BlockFi, with $227 million in a money market fund, were the two largest. On Monday, the bankruptcy trustee alerted BlockFi that the money was in an MMF and was uninsured, which might be a concern under bankruptcy law. 

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On Monday, more banks with shaky balance sheets will follow suit. On Saturday, there were long lines at First Republic Bank locations. 

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Signature Bank, which is still removing its crypto exposure, has not succumbed to contagion. Nevertheless, its shares dropped 23% in a single day on Friday.  

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The USDC stablecoin, released by the Circle and Coinbase Centre partnership, is — or was — a rather solid dollar equivalent. Even we believed USDC was about as excellent crypto money as you could get.

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The Centre accepted deposits, invested them in stocks, and minted its dollar tokens. Functionally, Centre is a bank — albeit a rogue bank. And, like Silvergate and SVB, it expanded rapidly. The issue of USDCs increased from $1 billion in mid-2020 to $56 billion two years later.

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Centre's banking model suffers from the same flaws as Silvergate and SVB. The majority of banks accept deposits and offer loans. Nonetheless, SVB, Silvergate, and Centre all made deposits and purchased bonds, exposing themselves to interest rate risks.

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As we stated in June, USDC is "dollars" unless there is a problem with Circle or Coinbase. There was a problem on Friday.

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Circle claims to have $32.4 million of the $42 billion reserve at Blackrock in a money market fund. Circle divides down the $9.7 billion in cash as follows:

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• $5.4 billion at BNY Mellon
• $3.3 billion at Silicon Valley Bank
• $1 billion at Customers Bank

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SVB still has $3.3 billion in USDC backing. However, only $250,000 of that is covered. The $3.3 billion is now essentially unreachable.

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Uninsured depositors at SVB should expect to receive at least 80 to 90 cents on the dollar back. In the worst-case scenario, Circle will require $300 million to $600 million to make USDC whole.

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Because there is no FDIC protection, anxious "depositors" are prone to stampeding at the first indication of danger. On Friday, the price of USDC plummeted below $1, reaching as low as $0.90 on Bitstamp.

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Coinbase announced on Friday that it was "pausing" USDC redemptions for the weekend due to "heightened activity," which would represent a couple of billion dollars in redemptions in only a few hours, according to blockchain statistics. We'll have to wait and watch whether Coinbase begins redemptions on Monday. [Twitter archive; archive; archive; archive]

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Binance has temporarily halted USDC to BUSD auto-conversion. "This is a standard risk-management procedure," it appears.

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We projected in December that USDC would be depleted this year, but we didn't expect it to be from a portion of the backup reserve just disappearing.

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USDC's problems are reverberating across DeFi, as USDC is the preferred currency. Users of DeFi are flocking to alternative stablecoins.

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Traders removed Pax Dollars from MakerDAO and replaced them with USDC – Maker hard-coded USDC to always be worth $1.00. DAI is more than 40% backed by USDC and has traded as low as $0.90. 

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Not all of the traders will make it out alive. Here's how one unfortunate customer spent $2,080,468.85 to obtain $0.05 in USDT. 

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Circle declared on Saturday that it "will stand behind USDC and pay any gap using business resources, engaging external finance if necessary."

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Paxos did not deposit the funds supporting the Pax Dollar in SVB, although it did keep some with Silvergate, as well as BMO Harris, Signature, State Street, and Consumers Bank. However, the USDP fell as low as $0.85 at about 08:00 UTC on Saturday, March 11. 

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NY sues KuCoin, claiming that ETH is security.

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New York is suing KuCoin in the same way that it sued CoinEx earlier this month.

This litigation is important because it classifies ether, Ethereum's native cryptocurrency, as a security under the Martin Act.

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According to New York Attorney General Letitia James, KuCoin offered commodities and securities tokens ETH, LUNA, and UST to New York consumers. KuCoin referred to itself as an "exchange," even though it was not registered with the CFTC or the SEC. KuCoin also offered a loan and staking services.

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When William Hinman, the former director of the SEC's Division of Corporate Finance, stated in a lecture in 2018 that ETH was "sufficiently decentralized," the SEC attempted to retract Hinman's comments when Ripple brought it up in the SEC's case against XRP. Hinman has joined the advisory board of a16z Crypto.

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New York disagrees with Hinman's evaluation. The complaint claims that Vitalik Buterin and the Ethereum Foundation are a "driving force" behind important Ethereum efforts that affect the price of ETH.

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New York specifically mentions Ethereum's transition to proof of stake:

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Most importantly, Buterin and the Ethereum Foundation were instrumental in supporting the recent fundamental transition in the transaction verification mechanism from proof-of-work to proof-of-stake.

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New York is pursuing disgorgement of ill-gotten earnings from New Yorkers, injunctive relief, and other remedies.

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This is more than simply KuCoin and CoinEx. It's clear that the NYAG issued subpoenas to all crypto exchanges doing business in the state and is suing those who rejected them.

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All exchanges should check to see if they serve New York clients, as required by the law. Furthermore, check their inboxes.

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Other parties are unable to enter the KuCoin lawsuit to claim that ETH is not a security. But, we anticipate that every crypto enterprise and group in the United States will soon file amicus papers.

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Can the NYAG go after anybody else who deals in ETH to New York consumers if the court rules that ETH is a security in New York? What does this mean for Coinbase, the crypto casino's cashier's desk in particular?

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