USDC is known to offer better transparency than any other competing stablecoin. But that quality of crypto soon proved of little value as it was depegged during March’s banking crisis.

Up until the weekend of March 10, 2023, Circle’s USD stablecoin USDC lost its 1-1 peg to the US dollar, plunging as low as 87 cents. That weekend in early March soon became a true test to how well stablecoins can hold up against market pressure.

Roughly a month later as things have calmed down since the Silicon Valley Bank (SVB) meltdown, those in the crypto sector have learnt some odd lessons. For one, transparency doesn’t seem to be a thing that’s worth it. Reserve management policies shouldn’t leave too much room for the future either.

The lessons learnt instead are quite the opposite of what one would expect: being opaque, and being sloppy in reserve management would reap the most benefits – as it would appear.

The case against transparency

Until that fateful weekend, USDC issuer Circle was arguably the stablecoin industry’s most transparent issuer.

Circle gave daily updates to its investors regarding its BlackRock-managed money market fund,  which backs USDC. Circle had also just recently adopted the New York Department of Financial Services’s (NYDFS) guidance for stablecoin transparency, which requires issuers to pass two attestation-of-reserves tests per month.

Traders found Circle a trustworthy partner to get into the DeFi (decentralised finance) economy. As such, Circle’s USDC is heavily rooted in the DeFi ecosystem, as it’s featured in top trading pairs, cross-chain bridges are heavily weighted towards USDC, and other stablecoins also have significant USDC collateral due to its popularity as a collateral type on lending marketplaces.

On the other hand, Circle’s main competitor Tether lags well behind Circle on transparency. Tether publishes its attestation reports each quarter. Tether is also well-known for its lack of transparency, as its own auditor does not examine the company’s internal controls. Its disclosure practices create trust gaps, making investors feel like they have to sell immediately once panic strikes.

Meanwhile in Cricle’s attestation reports, Circle disclosed all information regarding its reserves to its users– including individual Treasury bill CUSIP numbers, and where it banks. A CUSIP number, or Committee on Uniform Securities Identification Procedures number, identifies most financial instruments that are registered within the United States and Canada to distinguish between trades. On Circle’s list includes Silicon Valley Bank.

Soon after, that very trust that Circle built with abiding to the NYDFS’s stablecoin transparency guidelines bit the stablecoin issuer behind its back. Circle’s banking relationships revealed its dealings and deposits with SVB. 

Circle’s stumble

After SVB’s bank run throughout the week prior, the bank’s shares halted at 9:30 am local time after a 62% plunge in premarket trading. Then, the Federal Deposit Insurance Corporation (FDIC) announced SVB’s shutdown. But why were Circle investors concerned?

In the US, once a bank fails, the FDIC takes over. Upon takeover, the FDIC only protects depositors of the bank up to $250,000 per account – with the rest of the money at risk. As a result, users suspected that Circle may lose big-time, in the case Circle had funds stuck at SVB. The deficit in protection can result in Circle’s insolvency, which means USDC holders may not be refunded as appropriate.

Public outcry soon circulated, demanding Circle to make a statement ensuring the safety of USDC holders. Curve’s 3pool, a major source of stablecoin liquidity, drained as FUD (fear, uncertainty, doubt) increased, making traders swap their USDC for USDT. 

A few hours later, 3pool became empty. More and more market stress was introduced as Binance, the top crypto exchange by trading volume, suspended 1:1 conversions between Binance USD (BUSD) and USDC.

After a slight depeg occurred of USDC, Circle finally issued a public statement. In the statement, Circle disclosed that $.3.3 billion of USDC reserves were stuck in Silicon Valley Bank. The plunge became greater, weakening USDC to amounts below 90 cents.

How could things be done differently?

The unfortunate fact is that if Circle were more opaque like its competitors, no one would have realised that Circle was banking with SVB. Thus, USDC’s weekend run may have a chance of not even occurring, if the fact wasn’t revealed.

Neither of Circle’s competitors like Tether and Paxos disclose where, or who they bank with. Criticism of its competitors never really took flight, as no one knew where to point fingers. While USDC plunged, Tether and Paxos prices maintained stability.

This presents a dilemma against transparency. Is it worth it to stay 100% transparent? How much can a stablecoin issuer be transparent before it fails?

Circle can potentially learn from two options offered by its competitors.

In Paxos’s USDP attestation reports, Paxos discloses that it keeps hundreds of millions worth of deposits with banks – and all of these deposits are insured. As such, amounts over the FDIC’s $250,000 limit are insured. But how does Paxos bypass these limits?

Paxos properly manages its large cash balances in two ways: investments through placement networks, and being covered by private deposit insurance.

Through these placement networks, Paxos segments their money to farm out to partner banks in $250,000 blocks. These amounts in blocks are completely insured by the FDIC. As there’s 4,333 FDIC-insured banks in the US, all of these banks – including Paxos, are met with a theoretical coverage ceiling of $1.08 billion. This amount may not be enough to cover everyone  with USDP.

As such, with the remaining unprotected amounts, Paxos has contracted for private deposit insurance coverage. At that time, out of the $270 million in cash reserves that were used in USDP backing, $72 million was privately insured. 

Paxos has taken intricate steps to properly have coverage for its reserves. The theory is to have enough backups to guarantee account stability. But another fallacy arrives.

A huge oversight

After the events of USDC’s depeg, on Sunday March 12, the FDIC announced that its $250,000 insurance limit would be waived. Thus, all SVB deposits would be extended a blanket guarantee. As a result, people felt safer, USDC prices rocketed to its $1 peg, and Circle’s $3.3 billion was safe.

As a result, the crypto sector became a winner in its first federal bailout. The bailout wasn’t that small either – as the FDIC disclosed that the 10 largest deposit accounts at SVB held a combined $13.3 billion, it was implied that Circle was the largest beneficiary of the bailout.

There was another lesson learnt from these events – and a huge oversight at that one too. The US government’s FDIC protection cap of $250,000 wasn’t that much of a serious matter at all. It’s not written, but the FDIC theoretically protects everything. 

For Paxos, the events with Circle may have debunked its careful approach to insure. After all, if Circle just deposited without thinking, and benefitted from a large bailout, then that means Paxos wasted a large amount of time and resources to get the same benefits as Circle.

As a result, Circle now markets its USDC as “a stablecoin with GSIB cash.” Circle now doesn’t keep its reserves at mid-size banks like SVB, but rather with Bank of New York Mellon, a GSIB – a global systemically important bank – where investors are almost certain it would benefit from a bailout should it fail. In Circle’s one-step solution, it’s also implied that Circle wouldn’t go through the trouble of negotiating private deposit insurance.

Tether, known for being the least transparent of the major stablecoins, also hasn’t gone through the same steps as Paxos. In its public attestation reports, there’s no indication that Tether routes its $5 billion in cash through deposit networks, nor alternative forms of insurance, like private ones. Tether runs on full risk – in the case bankers decide to drain Tether’s USDT, it may fail splendidly.

Despite this fact, the amount of USDT in circulation had exploded by 11% – roughly $9 billion – since that fateful weekend. It’s also worth mentioning that outside America, the opaque USDT is popular in cross-border trade between China, Vietnam, and Eastern Europe, as it isn’t seen  as  solely intertwined with the American banking system, lending for more flexibility and interoperability.