DeFi Implications Following USDC Depeg

Key Insights

• Silicon Valley Bank was taken over by regulators on Friday after a bank run ensued late last week.
• Circle, the firm behind USDC, held about $3.3 billion of cash at the bank which impacted its ability to meet redemption, inciting fear in USDC holders. As a result, the $1 peg broke falling to a low of $0.87.
• USDC is at the center of DeFi, and thus when the peg broke, liquidity conditions rapidly deteriorated across the board. USDC was offloaded by traders and LPs while in-demand stables like USDT were withdrawn at great cost.
• The government announced Sunday that a new Fed-backed entity would backstop depositors which ultimately reestablished the USDC peg.

Quick Synopsis of Events

Silicon Valley Bank (SVB), a $209 billion asset bank, was shut down by regulators on Friday, March 10, marking the largest bank failure since the global financial crisis (GFC). Unlike the GFC bank failures which were caused by poor management of collateral risks, the SVB collapse was caused by poor management of duration risk exacerbated by rapidly rising interest rates from a caught-in-headlights Federal Reserve facing high inflation. Duration risk arises when the bank locks up too much capital in long-term investments to the point where it is unable to fulfill short-term deposit withdrawal demand. Once the extent of the bank’s situation was shared on social media, depositors rushed to get out deposits leading to a run on the bank and ultimately the bank’s takeover by the FDIC.