The March 2023 collapse of Silicon Valley Bank (SVB) — aside from foregrounding the hypocrisy of neoliberal pundits and libertarian venture capitalists alike — spotlighted the instability of the cryptocurrency industry’s most ostensibly stable offering. Hidden within the uncertainty of SVB’s fate following a $42 billion withdrawal frenzy was a similar crisis of confidence for Circle Internet Financial and its stablecoin, USD Coin (USDC).
Stablecoins are a form of cryptocurrency whose value is pegged to the value of a sovereign currency, usually the U.S. dollar, hence the “stable” moniker. In theory, users can exchange one USDC for one US dollar at any time. Stablecoin issuers try to achieve and maintain this dollar parity using various schemes, including the use of cash and cash-like reserves, and algorithms that attempt to manage the supply and demand of the coin.
Circle, the Boston-based issuer of USDC, which is the second largest stablecoin by market cap, recently faced an existential crisis that illustrates the issues surrounding this crypto product. The day after SVB was brought under FDIC receivership, Circle confirmed initial speculation that $3.3 billion of its estimated $40 billion in reserves were stuck in the now defunct bank. By then, panicked customers rushing to convert their coins to dollars had caused USDC to de-peg and lose as much as 13% of its value. Despite the significant hit to USDC’s value, Circle was ultimately saved by the announcement of a full depositor bailout on Sunday, March 12th. This decision by federal regulators, which restored the firm’s access to its funds at SVB, allowed USDC to regain its peg and ultimately helped the stablecoin industry avoid another crisis, which could have been more devastating than the TerraUSD/LUNA de-peg.
Dante Disparte, Circle’s Chief Strategy Officer and Head of Global Policy, described the SVB-induced run on USDC as a “black swan event” — a scenario defined by both severe negative consequences and severe improbability. But was USDC’s near-collapse truly unlikely? I’d argue not. In fact, a closer examination of Circle reveals that its declarations of USDC’s stability have always been questionable.
A BRIEF HISTORY OF (NOT SO) STABLECOINS
Stablecoins play an important role in the crypto ecosystem, often serving as both collateral for loans within the space as well as the point of entry or exit for those wishing to engage in the market. However, despite their name and centrality, stablecoins have historically been far from stable.
Over a dozen have failed since 2020 alone, the most high profile of which being last year’s collapse of TerraUSD/LUNA. TerraUSD was a stablecoin issued by Terraform Labs which maintained U.S. dollar-per-coin parity through an algorithmic trading relationship with its sister token, LUNA. The firm also established the Terra Foundation, which supposedly held sufficient reserves to support the TerraUSD/LUNA trading relationship.
This, however, turned out not to be true. And in May 2022 — after reporting began to raise doubts over the TerraUSD/LUNA relationship and adequacy of its supporting reserves — the stablecoin lost its peg, and the price of both TerraUSD and LUNA plummeted toward worthlessness. TerraUSD’s collapse was a systemic shock to the crypto world and contagion from the event has been implicated in everything from the de-pegging of other large stablecoins to the collapse of FTX.
THE BEST OF A BAD BUNCH
Circle, for its part, avoided both TerraUSD and FTX-related contagion, and was even able to grow during the otherwise tumultuous periods that followed their implosions. In an industry rife with spectacular and recurring instances of fraud, Circle has gone to great lengths to market itself as a trustworthy, by-the-books operator.
Unlike TerraUSD, Circle’s claimed mechanism for maintaining USDC’s parity with the dollar is much more straightforward: cash reserves and short-dated U.S. treasury bills. To assuage concerns over the actual existence of these reserve assets, Circle regularly releases attestation reports conducted by third-party accounting firms. These reports claim that “every digital dollar of USDC can always be exchanged 1:1 for cash.” The firm is incorporated in the U.S. and has branded itself as “the most conservative [and] most embracing of regulation” in the crypto space — as opposed to its rivals, whom CEO Jeremy Allaire has referred to as “opaque offshore hydra compan[ies].” Gordon Liao, the firm’s Chief Economist, has even gone as far as to argue that USDC constitutes an entirely new class of stablecoin, distinguished by its supposed primary use for payments rather than speculation.
It’s worth stepping back for a second to look at what Circle claims to be. Even if all of its value-pegging tools worked perfectly (and there’s good reason to be suspicious, as I’ll discuss later in this post), Circle would essentially be a privatized version of a greenback dollar. Like all stablecoins, it’s developed a hyper-complex apparatus to keep its value aligned with US sovereign currency. But if the federal government believed there was value to having an online version of the dollar (and since federal leaders have tolerated and even celebrated the stablecoin industry, they implicitly do), there’s no reason Congress couldn’t pass legislation permitting the Federal Reserve to issue true digital dollars.
Law professor Rohan Grey has called this “digital fiat currency” or DFC. These would offer all of the payments functionality of Circle’s product, and would probably be easier to use, without needing to convert cash to USDC and back again. Most relevantly, they wouldn’t need hyper-complex, dubious schemes to maintain par convertibility to the dollar. DFC would be equivalent to a dollar because it’s written into law and backed by the United States government. Simple as that. And people would be able to make private online payments without a private company taking a share of the transaction.
That being said, given Circle’s purported commitment to sensible management and use cases, Circle’s characterization as one of crypto’s safest actors, overseeing one of crypto’s safest assets, is not at all surprising. However, this characterization has less to do with the firm’s actual prudence and more to do with the rampant malfeasance observed throughout the industry. Remember, this is crypto we’re talking about. More than anything, Circle’s elevated status is because its C-suite executives haven’t yet been arrested — an incredibly low bar which its industry contemporaries still can’t manage to clear.
Let’s unpack the monthly reports the firm releases asserting that the total value of its reserve assets either match, or exceed, the total value of USDC in circulation. These attestations offer far less convincing proof of sufficient stablecoin backing than Circle, and its boosters, would like to admit. In fact, a May 2021 report revealed a reliance on commercial paper and corporate bonds for reserves, directly contradicting the promise that every single USDC was “100% collateralized by a corresponding [U.S. dollar] held in bank accounts of the issuer.” This could mean that USDC was falsely marketed, which would be a consumer protection violation, according to financial law expert Lev Menand. Furthermore, a reliance on reserve assets that are both less liquid and more susceptible to potential losses in value than cash would limit Circle’s ability to fulfill requests should a large number of customers seek to exchange their coins for dollars at the same time (sound familiar?) Being ill-prepared for such a scenario is a recipe for disaster considering how much larger the magnitude of stablecoin redemptions are compared to those observed in the traditional banking system. USDC in particular had already experienced a $3.8 billion single day of redemptions — more than 8 percent of its 2021 market cap — prior to any SVB-related turmoil.
If the foregoing incident wasn’t concerning enough, Grant Thorton LLP, the firm formerly tasked with verifying Circle’s reserves, was caught altering the fine print in their reports. From October 2018 (the earliest point when attestations were made publicly available) to December 2021, Grant Thorton wrote that Circle’s reserve accounts were “correctly stated.” However, from January 2022 until December 2022 the firm wrote that Circle’s reserve accounts were only “fairly stated.” It’s bizarre for any accounting firm to be so definitive as to say that the accounts were “correctly stated,” and even more eyebrow-raising to then walk the statement back. The implications of this seemingly minor change go far beyond semantics and could indicate anything from a simple, yet egregious, mistake to the revocation of complete assurance over USDC’s backing, according to accounting professors Stephani Mason and Francine McKenna. Regardless, the sufficiency of Grant Thorton’s examinations of Circle’s reserves must be called into question.
ATTESTATIONS VS. AUDITS: BRONZE VS GOLD STANDARD OF TRANSPARENCY
The issue however, is not simply Grant Thorton’s lack of rigor, but more importantly Circle’s insistence on attestations as proof of reserve adequacy. Imagine if your friend was trying to get you to buy his car, and you asked him for information about its manufacturer, repair history, miles per gallon, and so on. Imagine if in response, your friend didn’t provide you with that information directly, but pointed you to a dozen of his friends who all said they’d reviewed the information and promised everything about the car was great. Would you feel completely reassured?
Attestations rely heavily on management representations of information, which may not even be verified by those conducting the report. As such, they are both less intense in investigation and less comprehensive in scope than a full audit — the gold standard for financial transparency. Evidence of these fundamental limitations abound in Circle’s monthly disclosures. For example, the firm’s attestations are only accurate to singular points in time, experience long lags in publishing (the most current report available, as of writing, is for March 2023), and offer either no opinion on, or even mention of, the internal controls relevant to the production of reserve account information.
Yet rather than addressing these shortcomings and opting for auditing their reserves, Circle has instead shifted from Grant Thorton to Deloitte for accounting services. What this newfound partnership with a Big Four accounting firm offers in perceived legitimacy, it lacks in increased financial transparency. This is par for the course for a firm seeking to maintain the veneer of credibility. Emphasis on veneer, because Circle continues to release fundamentally limited attestations asserting USDC’s full backing. But hey, at least they’ve finally added the segregation of customer and company accounts to the examination criteria!
ERASING THE ELEPHANT IN THE ROOM
Given the aforementioned examples of inconsistencies in, and concerns with, Circle’s reserve reporting, the stablecoin’s eventual “breaking of the buck” was likely only a matter of time. While it is notable that this unmooring was brought about by a bank failure, it strains credulity to argue that USDC’s de-peg was an unexpected event. Doing so both rewrites the history of an asset that is stable in name only, and offers unwarranted legitimacy to a firm whose purported commitments to prudence are, in reality, extremely shallow.
During last month’s House Financial Services Committee hearing on stablecoin regulation, Rep. Frank Lucas (R-OK) asked what lessons Circle gleaned from the SVB collapse. Disparte replied, “We learned a lot of lessons. The first of which being that while many of the policy conversations have been about what risks could crypto and digital assets introduce to the traditional banking system and the traditional sector, we learned […] that we had to protect our business from risks in banking.”
This statement implies that the largely unregulated crypto and digital asset industry is somehow less risky than the regulated banking system. Even though banking regulators clearly made mistakes leading up to the SVB crash, having some sort of oversight in place, and an architecture to resolve the bank’s failure, dramatically limited the fallout from the crash.
Such a stance is unsurprising from Disparte, though, considering Circle and USDC were able to survive their brush with disaster relatively unscathed. But it should not be the takeaway for regulators and legislators. If anything, SVB’s failure and the ensuing stablecoin crisis that wasn’t should serve as a reminder (or wake up call) to the fundamental instability of crypto — an instability that remains equally as present in the industry’s ostensible best and worst actors alike.
IMAGE: “Set of cryptocurrencies on dollar bills“ by marcoverch is marked with CC BY 2.0.