‘Be Your Own Bank’ Mantra More Relevant Than Ever

We’re not even three months into 2023 and we’ve already had the first major instance of contagion in the crypto industry. The collapse of Silicon Valley Bank (SVB), New York lender Signature Bank, and crypto-friendly bank Silvergate sent shockwaves through the financial world over the past week as investors, regulators and customers scrambled to get their ducks in a row (and in the case of the latter, desperately withdraw deposits). 

These banking disasters, just like FTX’s collapse last year, shine a spotlight once more on the counterparty risk inherent not just in the banking system — but in any centralized financial system at all. And although the US government stepped in to assure depositors they would be able to recover their capital, the imbroglio saw top stablecoin USD Coin (USDC) depeg, at one stage dropping to just 87 cents as contagion fears spread. The world’s fifth largest cryptocurrency is owned by Circle, which had $3.3 billion deposited at the doomed SVB.

An eye-opening near miss

Although USDC has thankfully since regained its dollar peg, it would be foolish to breathe a sigh of relief and take an “all’s well that ends well” outlook going forward. It is deeply troubling that the collapse of a fiat bank could rock a top five digital asset to this extent. It’s even more troubling that 33% of the cash reserves backing USDC were held at a bank with a $1.8 billion hole in its balance sheet. The initial fears of contagion were clearly not without foundation either: Multiple stablecoins, including DAI and FRAX, use USD Coin as collateral and also lost their peg as a result.

As in the aftermath of FTX, Three Arrows, Terra and Celsius last year, crypto investors have received yet another warning shot. The mantra “Be your own bank” has been repeated ad nauseam, but perhaps the message will finally hit home for the wilfully blind in 2023. In this case, of course, it was fiat banks tanking and Uncle Sam that made them whole — but the significance for crypto cannot be ignored.

Some of the main problems with “crypto” right now are the points of friction between the traditional financial system and the parallel digital assets exchanges and tokens systems. These pain points stand out most in terms of how traditional firms are regulated versus this newer breed of financial instruments.

Circle isn’t the only crypto bellwether that keeps reserves in fiat banks like SVB, whose deposits expanded significantly during the pandemic while tech stocks boomed. Crypto-friendly bank Silvergate, meanwhile, was one of comparatively few regulated financial firms that provided banking services to a swath of crypto companies and platforms.

In the not too distant past, banks wouldn’t touch crypto companies with a barge pole. That’s no longer necessarily the case, with regulators having forced the crypto industry to bend the knee to operate and establish partnerships that could bridge both worlds. But if you cast your mind back far enough, you’ll recall that crypto only bloomed into being because the bright minds pushing it forward were deeply cynical about the traditional system itself. It was broken, they said, and decentralization was the answer.

Bitcoin was introduced to the world right after the 2008 financial crash, and fifteen years later, we’re witnessing anew the failure of reserve banking and a debt-based system. Effectively, we’re paying the bill for a decade of partying and profligacy with no accountability thanks to 0% interest rates. Alas, the bill must be settled eventually.

Where do we go now?

Certainly, Circle’s close call has highlighted the very real possibility of fiat banking failures impacting not just any singular token involved, but the crypto industry at large. While it’s tempting to think this reality then emphasizes the value of a decentralized stablecoin like DAI, as mentioned, DAI is partly backed by a basket of stables including USDC itself.

This is not a rallying cry for the industry’s power brokers to abandon the traditional banking world en masse. Rather, it is an acknowledgement that we remain very dependent on TradFi, and particularly its rails, to do business. Perhaps it was naive to think this was not the case, but it is eye-opening nonetheless.

The world viewed USDC as one of the safest stablecoins, and since it did regain its peg in just a few days, it’s just about managed to preserve that reputation. But make no mistake, what happened was a near miss, and it almost caused a catastrophic cascade of instability across all markets. And this catastrophic cascade would not and could not have been blamed on any “crypto problem” — it would have been due to the collapse of a fully regulated, 40-year-old bank.

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