USDC Depegging and what it means for Web3 and Crypto with Cosmo Jiang
Fresh out of the studio and an emergency podcast, Cosmo Jiang from Nova River and host of the Global Coin Research Liquid podcast explained the implications of USDC depegging due to the bank run triggered by Silicon Valley Bank over the past weekend of 11 March. We dived deep into the implications of how it nearly destroyed the global web3 and crypto economy and what it means for the startups moving forward in an uncertain regulatory environment in the US. Last but not least, Cosmo shared his after-thoughts on the recent DCG settlement with Gemini and the other creditors on Genesis' bankruptcy.
Bernard Leong: Welcome to Analyse Asia, the premier podcast dedicated to dissecting the pulse of business, technology and media in Asia. The secondary effects from the SVB or Silicone Valley Bank saga since the circle stablecoin, USDC, de-pegged over the last weekend. But we start back to stability with the press release from the US Treasury, the US Federal Reserve, and F D I C. So to help me with this second big event, which is essentially a crypto and web3 story, I have Cosmo Jiang from Nova River and host of the liquid podcast from Global Coin Research. Last but not least, full disclaimer. I'm a Webre angel and retail crypto trader holding tokens in all ships and sizes. The discussion here is for information and purpose and does not constitute as investment advice. Please do your own research and make up your own mind. So Cosmo, welcome back to the show on such short notice.
Cosmos Jiang: Yeah. Thanks for having me, Bernard. It's been a crazy time and certainly a lot to talk about.
Bernard Leong: Yeah, it's probably the craziest week I have given that. The whole weekend I was having calls with every startup, whether it was web 2.0 or web3. Let's go straight to the conversation. There were a few preceding events that led to the temporary de-pegging of USDC. I want to start first by talking about the collapse of Silvergate Bank first, which is the precursor before SVB [Silicon Valley Bank] started its bank run. Why did Silvergate Bank collapse in the first place and what caused its bank run?
Cosmos Jiang: Yeah. It's probably first helpful to talk about who Silvergate bank is and why it's so important. Silvergate bank is a California-based regional bank. They were an early supporter of crypto-based businesses, and as an early entrant, they built a really strong brand. Along with Signature Bank in New York, Silvergate was one of the two most dominant banking providers in the crypto industry. It had over 1,600 crypto customers, which is a lot because we know there aren't that many crypto businesses. Throughout 2022, as the crypto markets and the broader markets collapsed, Silvergate bank's business unsurprisingly suffered material setbacks: key customers lost funds or its customers lost money. They had fewer money deposits and more business customers and more retail investors were pulling out of the industry. This was eventually enough to catalyze a loss of confidence, which is the key ingredient to any classic run on the bank. Just to put some numbers around it, they had about USD$14 billion in crypto-related client deposits at the end of 2021. This dropped to 12 billion at the end of the third quarter of 2022. There was a little bit of decline, but not the end of the world. With the FTX fallout, the deposit decline across the industry was just massive. From there, it went from USD$12 billion at the end of the 3rd quarter of 2022 to less than USD$4 billion at the end of 2022. Within three months, they lost over US$8 billion or two-thirds of their deposits.
As we all know, deposits are the lifeblood of any blank and any fundamental bank analyst will tell you the quality and stickiness of deposits are incredibly important. We had a case where the quality and stickiness of deposits in the Silvergate Bank were highly concentrated in crypto. Unfortunately, the stickiness of crypto deposits is very low when crypto is falling apart. So these deposit outflows resulted in a lot of concerns around Silvergate's business. The stock fell tremendously throughout 2022 and early into 2023. That being said, this all catalyzed or started to accelerate on March 1st when Silvergate failed to file its 10K because it had a material drop in its regulatory capital ratios, which was below the required levels. So the bank was starting to evaluate whether it could be a going concern or whether it could be even a business. What had happened was basically with all banks, they hold securities against deposits. When customers withdraw deposits, they have to sell their securities to have enough liquidity to fulfil those deposits.
One of the stopgaps is that it borrowed a lot of debt from a lender of last resort, which is the Federal Home Loan Bank, a US-regulated entity to cover the deposit hole. But this is a very short-term debt. It had a ton of this debt at the end of the 4th quarter. Deposits continue to come out in 2023. As it tried to repay this debt, they ultimately were not able to without having its equity capital ratio fall below what's the regulatory requirement. Because when they're selling securities to satisfy these deposit outflows, they have to recognize losses and are happy to describe the mechanics of these mark-to-market losses if that's helpful. Ultimately, it resulted in the bank filing that many people were worried about going concerns. Everyone started running for the hills and by March 8th 2023, it announced it was winding down and voluntarily liquidating.
I want to get into the mechanics that you talk about on Silvergate Bank. One thing very similar to Silicon Valley Bank, but not in the mechanism they both have following deposits. They're dealing with a very concentrated risk with a very specific group of depositors, for example, Silvergate is for crypto and Silicon Valley Bank is for startups globally. What happens to both of them is that deposits started falling. That's the first part. Then it's exacerbated, specifically in Slivergate's case, which I find ironic, that they were just subjected to durational risk by buying treasury bonds.
Cosmos Jiang: Yeah. The classic case for every blow-up this year and last year has been a case of a mismatch of asset duration and liability duration. That's right. They hold what are supposedly extreme, and are like very safe US treasury bonds. But when yields (interest rates) move 400 basis points over a year, the mark to market on those bonds is pretty severe. If you hold them into maturity, no problem, but if you have to sell them in a hurry, big problem.
Bernard Leong: I'm coming to the real main subject of the day. Can you first introduce how USDC or the circle stablecoin maintains its peg with the US dollar one-to-one?
Cosmos Jiang: Yeah. I guess as a quick background, USDC as we all know, is issued by Circle which is a US-based company regulated as a money transmitter. They have a money transmitter license from the government. It issues the USDC [stablecoin] which is supposed to be fully backed by highly liquid reserves that are primarily cash in US treasuries. These are held segregated from Circle's operating funds. Circle is very transparent about reporting it. As far as transparency goes, circle issues a lot of transparency reports. They self-report daily on total balances and reserves, issuances, and redemptions. In addition, every month it publishes and is audited by Deloitte monthly attestation with a granular balance sheet of exactly how much the reserves are, where they're sitting and what securities they own and against how much USDC is circulating. So with that is how they try to give confidence.
All USDC is backed at least one-to-one, in fact, more than one-to-one, but at least one-to-one by reserves. So how does it maintain its peg? As with most stablecoins, the value of USDC is free floating. But market forces cause it to usually maintain its peg other than this last weekend. If USDC trades below $1, then anyone can redeem it for exactly a dollar. Just by going, taking that USDC in Coinbase and saying, "Hey, give me a dollar, and you gotta collect a spread." If USDC trades above a dollar, it doesn't happen. But if it were to, someone could just wire a dollar to USDC to Coinbase and you tell them to make them a USDC coin and then they sell it for more than a dollar and collect the spread. It's market forces that cause it to maintain its peg. But the market forces are driven by the confidence in Circle reporting about its financial reserves.
Bernard Leong: So before this second emergency podcast interview, I covered the saga of the Silicon Valley Bank and its impact on the startups and VCs in the Asia Pacific with Shai Oster, the Asia Bureau chief from The Information who has done a very good coverage across the board over the last weekend. We start with the assumption that everybody knows that story already.
Bernard Leong: How did the Silicon Valley Bank run trigger the USDC de-pegging?
Cosmos Jiang: Yeah. Circle has US$43 billion of reserves held for USDC and about US$43 billion circulating. The delta is about a hundred million of extra excess reserves that they have. As I mentioned, it says it stores these assets segregated from its operating accounts and stores them in regulated financial custodians and banks in the United States. One of these banks is Silicon Valley Bank. It's one of the eight banks that it names in its monthly transparency report, so everyone knows that to be the case. As Silicon Valley Bank started to go under, questions began being asked this past week. At first, the number of deposits at Silicon Valley Bank wasn't totally clear because like in Circle's reports, they mentioned eight different banks where they stored their deposits. So you don't know. But it was about US$8 billion of deposits at these eight different banks. So it could be a large number. The questions became much louder after a Silicon Valley bank went under FDIC receivership on Friday and stopped sending out wires. Then that Friday afternoon, Binance was the first exchange to stop accepting automatic USDC to USD conversions. So Binance customers could no longer peg out one to one and immediately USDC dropped to 99 cents a few hours later. On that Friday evening, Circle disclosed that it had US$3.3 billion of funds stuck on Silicon Valley Bank. So 3.3 out of 43 billion is not a small amount, about 8% of its total reserves was stuck. Then Coinbase stopped accepting USDC-USD conversions at one-to-one. Shortly thereafter, it attributes to the fed wire system being closed on the weekend, which I believe and accept. But panic ensues, free fall begins and within the next few hours, USDC traded from 99 cents or even a dollar earlier that morning to as low as 88 cents in the very early hours of Friday evening US time.
Bernard Leong: That Friday evening US time is Asia's afternoon on Saturday Singapore time. It's probably the most exciting time for me during that weekend as an angel investor who has a portfolio of web3 startups, but let's share some more stories here. So it sent all the web3 and crypto companies into a tailspin. The founders in my portfolio of companies with USDC exposure started calling me for help. Some of them were very smart. They preempted it and converted up their U S D C to another stablecoin to hold for a while. Surprise because some of them are based in Singapore, there's a Singapore stablecoin, XSGD which they can swap to. They managed to allow them to maintain the peg through a private company called Straits X under Fazz Group and they were regulated by the Monetary Authority of Singapore (MAS) for those listening from all other parts of the world, to have a proper peg of that particular stablecoin XSGD to the Singapore dollar. So maybe before I talk about my war stories, what is the immediate impact of the USDC on the rest of the crypto ecosystem?
Cosmos Jiang: Yeah, the impact is tremendous. USDC has always been viewed as the gold standard for a stablecoin, and almost no one except for the craziest outsiders thought it would falter, right? Tether, which is the other large stablecoin, was supposed to be one with an opaque balance sheet, like unclear management, and unclear ownership, and funnily enough, We saw an immediate flight to safety of people swapping all the USDC for Tether and Tether traded above a dollar for, even now it's slightly trading above a dollar, which is wild, and pricing of all assets went haywire. Almost everyone, because USDC is viewed as the gold standard. USDC has been used in their DeFi (decentralized finance) applications and their exchanges for base pairs trading. A lot of price indices are based on USDC pairs, including Coinbase. Immediately prices started going haywire across different exchanges. For example, ETH was trading for US$1650 on one exchange and US$1450 on another exchange to reflect the discrepancy of USDC. There were massive weird arbitrage opportunities that presented themselves if you were able to transfer your funds around, but chances are you weren't. It was a truly wild time and a lot of things in DeFi started to break. There are a couple of hacks that came out that we found today on exploits related to the USDC depegging in DeFi applications. The crypto world went bananas because everyone was trying to figure out what will happen and how to manage risk.
I can share my own war story, it does not help at all that these depegging, when I remember the last time I was on this podcast we talked about the USD Terra depegging, these depegs always tend to happen on weekends, late at night in US east coast hours. From a US-centric viewpoint, most investment teams sit in New York or other parts of the US, and none of them is at work when these depegs happen. As things go, extra liquidity is extremely low and things go extra haywire. I was just up all night buying USDC as I was going down after analyzing to figure out that I thought it was sound. But it was a scary time.
Bernard Leong: So do you make 11 cents per every dollar that you purchase during this period?
Cosmos Jiang: I didn't quite bottom-tick everything. I was buying it at 94 cents downwards, probably an average of 92 cents.
Bernard Leong: I will just basically provide some colour on the startups on my portfolio. They have treasuries that have a lot of USDC. When I say a lot, mean they are at least six-digit figures going on. At that point, the question in the Asia Pacific and calls everywhere, Telegram channels are going crazy because I do a lot of crypto trading. So what I just suggested to them is the following, "Why don't you try to first convert into Ethereum or Bitcoin? Because I think that, what is happening is that when things are going towards low trust like in this period, people will tend to flock towards the most decentralized currency and they will accept a little bit of the volatility. One thing that came out over the weekend, I don't know whether you realize this, is that Bitcoin and Ethereum prices were holding relatively well where USDC was depegging at the same time.
Cosmos Jiang: Yeah.
Bernard Leong: So what happened was that they just make the swap. On Monday morning in Singapore time, after the announcement on your Sunday evening in the US time where the FDIC, US Federal Reserve and Treasury announced to backstop the depositors, and then the USDC peg is starting to restore towards $1. The Bitcoin and Ethereum prices went up because I suspect with no data but anecdotally hearing that everybody making the swaps. I just told them that they need to swap it back to a stablecoin. They recovered all the losses that are caused by the depeg. They went back to normal. We got lucky this round. So I got a messaging from one of my founders that I have made a good call and advised them very well in this crisis. I was just thinking this is probably what's gonna happen because Bitcoin price is pretty directional. But to me, I am being lucky after going through after three crypto winters and being profitable.
How do you see during that point in time what was happening in let's say crypto startups or VCs who are holding the USDC?
Cosmos Jiang: Yeah, I managed a hedge fund at Nova River and closely watched where the flows were going at this time. There are a lot of startups and crypto funds that did sell out of their USDC. Many of them did swap for USDT or tether out of panic, which is unfortunate and realised losses. I don't know a lot of people who did this, but the smart people did exactly what you did, which is, turns out buying U S D C at 91 cents was nice, but buying ETH instead was a much better trade, and so those who did that ended up doing a lot better.
Bernard Leong: Yeah I think Bitcoin as well, because Bitcoin was, I think hovering around USD$21k. Based on our timing now, which is my 14th of March, early morning at 5:00 AM and still in your evening in the US time, Bitcoin's just gone up to USD$24K for the first time. I think it's caused by all this depegging. Because of these large inflows and outflows going on and off, that's why the Bitcoin price is just surging like crazy.
Cosmos Jiang: It's hard to exactly prognosticate what causes the prices, but for sure the strength in Bitcoin and ETH on Friday night was due to people swapping out of U S D C into Bitcoin and Ethereum. Clearly, for the last couple of days, the 15% surge in both cryptocurrencies was largely due to this belief that the F D I C would come in and bail out or not bail out. But the FDIC would figure out a way to resolve Silicon Valley's issues appropriately. This would cause the Fed to have to question whether they could keep tightening, and as we saw today in the markets, rates collapsed in the market today. It was the credit risk on that day that drove the surge in Bitcoin and Ethereum.
Bernard Leong: Let's get back to in time. On the 12th of March evening in US time, at 6.15 pm, the US Treasury. Federal Reserve and FDIC are guaranteeing the depositors that they will get their money back. So the peg went back to $1, and at the same time, they also announced the failure of Signature Bank in New York at the same time in that press release. This has been coming after Silvergate collapsed as well. What do you think the Signature bank's collapse will mean for crypto in the US and then after that percolate to the rest of the financial system out there?
Cosmos Jiang: Yeah I want to clarify something first and I think this is important that Signature Bank didn't fail or collapse. It was solvent. The New York regulator chose to shut it down out of a qualitative risk assessment. I think this is important to point out because it's a very specific shot at the crypto industry. Yes. There's probably reason to believe that Signature bank does have large exposure to crypto. It's the largest bank in the crypto industry. But it had a very large business outside of crypto too. Based on reports, the capital ratios even with very reasonable markdowns seemed okay. So, the New York regulator was either making an example out of Signature Bank or more generously, just trying to get ahead in case something bad happened. But the Signature bank is solvent or was solvent when it was shut down.
But that being said, what's the impact? The impact is pretty meaningful. Both Signature and Silvergate bank 85% of the crypto industry in the US. So everyone that I've talked to, is scrambling to find a new banking provider. Thankfully, my fund does not use Signature or Silvergate bank, so we're okay. But I've been referring a lot of people to my bank, which is Customers Bank, as well as several other banks that still do bank crypto companies. For the next couple of weeks, a lot of crypto companies don't have a bank, which is scary and that means that the availability of credit and liquidity will be lower going forward.
Signature and Silvergate both operated their own digital stablecoin transfer networks that operated like Fedwire except it's free and accessible 24-7 and that facilitated liquidity flows across different exchanges. Now that both banks are shut down and gone, it'll be much harder to transfer money in and out between exchanges, especially on weekends, which could cause freaky weekend price activity. So, a lot of people are now struggling to find new banking providers. Liquidity is going to be tight. Credit will be a lot tighter for the crypto.
Bernard Leong: Do you think that the US crypto scene will end up like China, where there's no more trading activity because the capital outflows are going to either Europe or the Asia Pacific? I think a lot of those freaky activities are coming from Asia because the trading volume is extremely high in the Asia Pacific region.
Cosmos Jiang: Yeah. I have a strong feeling and I have strong hopes that US regulators and lawmakers will do the right thing in creating a good regulatory environment for crypto companies in the US. I don't think it's within the US's national interest or growth interest to let crypto go offshore. We've seen that. Non-regulated crypto companies are what caused a lot of issues in the crypto industry. They must be regulated and stay onshore because US customers will figure out a way to trade even if it's not through US exchanges. So let's let them do it in the US in a regulated & safe way. I am hopeful that will not happen. That's yet to be seen, or the story's yet to be written, whether or not lawmakers can come together and come up with a good regulatory plan for the crypto industry in the future.
Bernard Leong: So if I ask you now, what would be your advice from a perspective angle to the web3 startups globally in the ecosystem? What do they have to watch out for?
Cosmos Jiang: Yeah, we've already started to hear this. I have two thoughts. One is where do you set up and what do you think about innovation? Two is, what do you think about treasury management?
Maybe just on the first part, where do companies set up? We're already starting to see a lot of crypto founders who are based in the US, decide that it's just not worth it and the regulatory clarity is not worth it. They either need to shut down or move abroad, which is very sad for the US. A lot of investors are more eager to deploy capital towards foreign-based or non-US-based teams. DeFi protocols are set up outside of the US to avoid this regulatory opacity and the lack of clarity in the US, which is again, all very unfortunate for the US, although good for the rest of the world in the short term, not long term. If the US doesn't accept crypto long-term, then you know we're not going anywhere.
On the treasury management front, the second point, I think it's tricky. I remain a USDC maxi. But I could see the argument going both ways. I like that USDC relies clearly on centralized third parties. This case study showed the fragility of the US banking system, which the USDC relies on as well, but also the fortitude and resolve of the US government in backing that. So that's good. But you do rely on the US government and I can see why it always makes sense to diversify your treasury. I tend to trust USDC the most. The other ways you can diversify your treasury though is by owning Tether or by owning decentralized alternatives, which might make sense, like FRAX or other types of liquidity which issue LUSD, both of which, I'm very supportive of. So I could see it going both ways.
Bernard Leong: I disagree with this about the US. When more crypto is coming back to the US in the last two to three years, it zapped off all the innovation coming from the rest of the world. The US crypto scene being heavily stopped by the regulatory system benefits the rest of the world in building a different financial system that's out of the US. If you think about the emerging markets where actual crypto is having actual applications and that's where they need it versus the US dollar, I think there are things to be said that this may be the only way to decouple and letting decentralized cryptocurrencies being decentralized rather than being centralized either towards to one side of the world (the US) or the other side of the world (China), but remain some form of a minimum of exchange that the rest of the world will not be held hostage to.
Cosmos Jiang: I think that's a fair point and a good point. I do think that it is important that cryptocurrency remains decentralized and that development, innovation and ownership remain globally decentralized. I agree that the use case for crypto as a form means of exchange certainly is way more important outside of the US than it is in the US. So all that is very good. This is maybe my US-centric view, and so I pre-apologize for that. But I do think that if the US government cannot come to terms with an acceptable regulatory framework for crypto, I find it very hard to believe crypto can survive without the support of a major country in the world or maybe not the explicit support, but at least implicit support of a major country in the world.
Bernard Leong: I cannot leave this conversation without asking you this last question. What's your perspective on the Genesis bankruptcy? I got you the last time on the show to talk about it and now we have the (Digital Currency Group) DCG's final settlement with Gemini and the other creditors and the fallout from Genesis' bankruptcy which transpired after our last conversation.
Cosmos Jiang: Yeah. I remember the last time when we spoke, we were in the meat of it and it wasn't clear what the resolution would be. But nowadays, although not clear yet, Genesis and DCG as of about a little over a month ago agreed on an initial restructuring plan with their creditors. So they finally came to the table and talked it out. Genesis is winding down its loan book. It's selling both its Genesis entities. DCG and Genesis are refinancing their outstanding loans and the creditors at Genesis which include Gemini as well as others, are getting convertible warrants and convertible equity so that they're getting at least 80 cents on the dollar immediate base recovery and then upside from thereafter from any equity upside that there is remaining in the Genesis business. Gemini is contributing a hundred million dollars to help fill out whatever hole there is remaining to Gemini earn customers. Unfortunately, the big boys in this situation took their lumps and both absorbed some losses with DCG giving up some equity and Gemini coughing up some cash to make sure that their customers remain whole. One open question is whether that the ongoing DOJ (US Department of Justice and SEC investigations into DCG will throw a wrench into these restructuring plans. Because they've come to a restructuring plan, there isn't an aggrieved counterparty anymore. There are no issues anymore, Other than there are potentially some laws broken and how DCG structured its intercompany loans with Genesis and in particular how they conveyed that to their borrowing and lending counterparties and whether their accounting was correct or whether their accounting was valid.
If the SEC and DOJ want to make a point out of it, they definitely could. But there's no one in the loss anymore. They could make an example out of DCG. That may throw a wrench into the restructuring plans.
Bernard Leong: One of the really interesting stories that went past the last week, but thanks to the whole debacle by Silicon Valley Bank, was the Grayscale lawsuit with the SEC on the GBTC converting from a trust to spot ETF. I think that it seems that when the opening statements are made and the initial sentiment from the courts seems that they favour GBTC. We will have to wait and see whether it's going to be converted into a spot ETF anytime.
Cosmos Jiang: Yeah, that whole situation is very interesting because at least to me it's very clear that DCG does not want the Grayscale GBTC ETF to go through as much as they claim they do because it's enterprise value dilutive. If the ETF application goes through, they have to argue in favour of the ETF application, otherwise, they get sued by their customers.
Bernard Leong: I'm beginning to have a different point of view. After hearing the CEO on the different podcasts across the crypto ecosystem, I think they would rather get the ETF with the viewpoint that the market becomes bigger rather than having these US$ 300 - 400 million management fees, but with a smaller market. Because I think they would want the institutions to come in to expand the GBTC ownership. that may be the reason why they're going ahead. The game theory of it seems to suggest to me that they're moving towards that direction.
Cosmos Jiang: My addendum to that is that I do think their willingness to argue more in favour of the ETF application is that they sold some of their equity to Gemini effectively. So now, they're somewhat off the hook in the sense that they share the downside if there is any downside with Gemini now, and so they're more okay with the ETF going through. But I hear that point too, if fees on the ETF need to drop, I call it like two-thirds, but they can be three times the size of the fund, then they come out even stronger.
Bernard Leong: So I think it would still end up going well for Grayscale. Cosmo, many thanks for coming to do this emergency podcast. Seriously, we have a lot more to discuss given these few crazy weeks and all that has happened. So where can my audience find you?
Cosmos Jiang: Yeah. You can find me on LinkedIn or Twitter. My name is Cosmo Jiang. You can also hear more of my interviews with other liquid managers on the Global Coin Research Liquid podcast available on all podcasting platforms.
Bernard Leong: Find, of course, Analyse Asia is now on YouTube and our podcast feeds [Spotify, Apple Podcasts, SoundCloud & Overcast FM]. Do sign up for our newsletter where we do a monthly summary of the episodes. So course, many thanks for coming to the show and I look forward to speaking to you soon.
Cosmos Jiang: Yeah. Thanks, Bernard. This was a lot of fun. Thanks for having me and take care.
Podcast Information: The show is hosted and produced by Bernard Leong (@bernardleong, Linkedin) and Carol Yin (@CarolYujiaYin, LinkedIn). Proper credits for the intro and end music: "Energetic Sports Drive" and the episode is mixed & edited in both video and audio format by G.Thomas Craig (@gthomascraig, LinkedIn).
