The immediate risk to US dollar stablecoin issuers posed by the failure of US banks acting as custodians for their deposits appears to have receded, but recent developments have highlighted the issuers’ exposure to contagion and counterparty risk, Fitch Ratings says.
In January 2023, Fitch stated that stablecoin operators were vulnerable to contagion risks linked to the cryptocurrency ecosystem and highlighted the potential counterparty risks that were flagged by a sudden drop in deposits at Silvergate Bank, a key custodian for crypto entities. Silvergate announced plans to wind down and liquidate in March 2023, while two other partner banks for the crypto sector, Signature Bank and Silicon Valley Bank (SVB), were also taken into receivership by the authorities this month.
The dominant stablecoin issuers generally support their tokens by holding collateralisation reserves at least as large as the value of their issuance. Circle, issuer of the second-largest US dollar stablecoin, USDC, disclosed on 11 March that it had USD3.3 billion of its USD9.7 billion of total cash reserves with SVB. The remaining USD32.4 billion of its collateralisation was in short-dated US Treasury Bills with a maturity of less than three months, with BNY Mellon acting as custodian. Circle also maintained transaction and settlement accounts for USDC with Signature Bank.
Tether, issuer of the largest US dollar stablecoin (USDT), said that it does not have exposure to SVB or Signature, while Paxos, the issuer of the third-largest (BUSD), said it held USD250 million with Signature but had no SVB exposure. Together USDT, USDC and BUSD accounted for roughly 89% of stablecoin issuance, as of 14 March.
The US authorities have indicated that even uninsured depositors at SVB and Signature will be made whole, which we believe reduces immediate risks to stablecoin issuers’ reserves and the credibility of their peg regimes. Nonetheless, the authorities could take a different approach in the future, so reserve custody counterparty risk will remain important for stablecoin issuers. Support from parent entities may help to offset this risk, or that from substantial realised valuation losses on sales of securities held as collateral, depending on the parent’s capacity to provide extraordinary assistance. Circle’s 11 March statement indicated that it would cover any shortfall in USDC’s reserve, as required by law.
The closure of several technology-focused US banks will present other challenges for the digital asset sector. We said in January that US banking regulators’ concerns about the soundness of business models that were concentrated in crypto-asset-related activities or have concentrated exposure to the crypto-asset sector could make it more difficult for non-bank crypto-focused stablecoin issuers to find reliable banking partners. Banks may now also become more focused on deposit concentration risks associated with stablecoin issuers that could need to run down deposits quickly in the event of pressure on their peg, deterring them from such relationships. A reduction in the pool of potential banking partners could, for example, influence stablecoin issuers’ operational costs or deposit interest earnings.
Several US dollar stablecoins, including USDC, depegged temporarily as concerns about SVB and other mid-sized US banks mounted over 10-13 March. The price volatility of the main US dollar stablecoins remains much higher compared with money market funds. In addition to the contagion and counterparty risks discussed above, this may reflect lingering risks around reserving practices and transparency, operational risks (including cyber risks), and the legal rights of stablecoin holders – notably around redemption rights. Some crypto exchanges temporarily suspended USDC-related transactions amid the market turmoil on 10-11 March, highlighting redemption risks. The evolving state of the regulatory regime for stablecoins further heightens the risk facing stablecoin issuers.