Silicon Valley Bank's collapse leads to USDC's unpegging from the dollar - is it panic or market-making?

On the 10th of March, the Federal Deposit Insurance Corp (FDIC) took control of Silicon Valley Bank (SVB), a crypto-friendly financial institution, harkening back to the 2008 global financial crisis. The incident began on the 8th of March, when SVB Financial Group went public with its financial difficulties, causing many clients to panic, and resulting in a run on the bank. In a last-ditch effort to repay the clients, SVB sold its medium and long-term treasury bonds at a discount, losing $1.8 billion in the process. Later that day, they announced that they would be issuing shares in SVB worth $2.25 billion to compensate for losses incurred. 

The news of SVB's collapse caused concern among many, and the stablecoin USDC was unpegged from the US dollar as a result. While some wondered whether this was a sign of an impending economic crisis, others questioned whether it was simply market-making.

USDC Value Falls as Low as $0.85

Whilst a 1.8 billion loss may seem very significant, compared to the total investment amount of $21 billion, it is merely a <10% loss, much less than the bad debts of many other financial institutions. In the worst-case scenario, it is still likely that clients of SVB could recover 80-90% of their deposits.

However, on the 11th of March, Circle, the issuer of USDC announced that $3.3 billion in cash reserves were deposited in SVB, accounting for about 8% of its total circulation. This caused a market panic, with USDC dropping to a low of $0.85. Some users may even have sold their holdings without slippage control, resulting in significant losses.

Did Circle know about the bailout?

If SVB was completely insolvent and Circle couldn’t withdraw from them, an 8% loss is still relatively insignificant. In theory, Circle could earn approx. 3-4% back simply through short-term loans. If they could retrieve more than 50% of their deposits from SVB, they wouldn’t have to unpeg from the dollar. So why did they? I believe that there are three main reasons. 

1. A big client of Circle started dumping massive amounts of USDC on the market, causing the price to plummet

2. Circle purposefully publicized the SVB information to trigger a panic selling of USDC, so that they could buy back at a lower price afterward

3. Larger clients of Circle exchange USDC for USD 1:1 on the weekend, short-selling USDC on the side, increasing the proportion of funds held in SVB

However, on Sunday, the Federal Reserve issued an emergency statement, guaranteeing that 100% of deposits could be withdrawn from SVB. At present, USDC has returned to a stable level of 0.99. As for whether Circle was aware that the Federal Reserve would take action and save SVB, only they know.