Stablecoins: when fully backed does not equal fully confident
Prasad Gollakota
Silicon Valley Bank will be remembered for making the most obvious mistake in banking; ineffectively managing the risk created by a mismatch between the duration of its assets and liabilities. When rates rose, SVB was exposed, leading to a deposit run on the bank, followed by a federal backstop of deposits.
Less remembered, but perhaps now the most interesting tale to emerge from SVB’s collapse, is that it also briefly shook confidence in USDC, providing a rare moment when a major stablecoin traded away from “par” for reasons that had little to do with the technology and everything to do with confidence in the underlying reserves.
USDC is a dollar-referenced stablecoin issued by Circle, a US payments and crypto infrastructure company that operates the primary “mint and redeem” channels through which approved institutions exchange dollars for USDC and USDC for dollars. For a brief period, USDC failed at the very thing it was built for, underscoring that stability is not a slogan, but a design challenge that only shows itself in the hours when confidence breaks.
Mind the peg
Stablecoins are digital tokens designed to behave like money: their aim is to hold a steady value, typically one for one against a reference asset such as the US dollar. That promise of stability is the entire product. To ensure this stability, stablecoins are typically backed by high quality reserve assets. If a stablecoin can trade materially away from par in stressed conditions, it stops being a reliable medium of exchange and becomes just another risk asset with a marketing label.
In normal conditions, the stability peg for USDC is supported by a simple mechanism: if USDC trades slightly below US$1, market arbitrageurs buy it and redeem it with the issuer for US$1; if it trades above US$1, they mint new tokens and sell them, pushing the price back down. The stabiliser is this mint and redemption mechanism, along with the credibility of the underlying reserves.
On March 10 2023 when SVB went into resolution, Circle disclosed it had US$3.3bn of USDC reserves deposited at SVB and the market suddenly had to price a simple question at the worst moment: could those reserves be accessed at par? The result was USDC’s peg collapsed and, at its trough, USDC traded in the high 80 cents to the dollar over the weekend. The peg failed because the market feared the real-world reserves behind the token could become unavailable.
It is tempting to describe what happened next as a stablecoin bailout, but the more precise description is that on March 12 authorities backstopped all SVB depositors, including Circle. With that, the core fear evaporated. The reserves backing USDC were expected to be available in full, and the peg recovered.
The uncomfortable truth is that in the moment that mattered, USDC was stabilised because public authorities restored certainty over the SVB reserves backing it. This is where stablecoins can become psychologically bank like. A bank run is often not just about solvency. Ultimately, it is a collapse in confidence. The USDC episode shows that “fully backed” is not the same as “fully confident”.
Fed’s analysis
A recent analysis by the US Federal Reserve highlights two invaluable, albeit unsurprising, lessons. First, that stablecoin “runs” are fundamentally confidence events, and confidence rests on reserve access as much as reserve quality. Once the market started to doubt whether Circle could access the SVB-linked reserves, the peg came under pressure in secondary markets. Stablecoins trade 24/7 on exchanges but minting and redemption are anchored in US banking hours because they involve real US dollars. The stabilising mechanism weakened precisely when it was most needed, creating a weekend window in which fear set the price.
The Fed’s second insight is that stablecoins do not fail in isolation: they transmit stress through the stablecoin market infrastructure. The Fed emphasises how interconnected the digital payment infrastructure ecosystem is, so a wobble in one major coin can trigger mechanical responses elsewhere. During the SVB weekend, the de-peg in USDC pulled another stablecoin –DAI (issued by MakerDAO) – below par as users swapped into and out of USDC, even though DAI had no direct SVB exposure.
The stress further propagated into other stablecoins, contributing to “de-pegs” in coins such as USDP and GUSD. These coins did not share USDC’s reserve problem. They de-pegged because interlocking mechanisms turned a USDC wobble into a broader repricing. This pattern will feel familiar.
A question of design
The SVB weekend showed that a stablecoin can be fully reserved and still be runnable. Reserve coverage and quality matters, but reserve access and redeemability are what markets price in the hours that matter, as confidence falters.
The USDC episode is useful reference point for the BoE’s thinking in its consultation around a sterling stablecoin, where it proposes that reserves comprise up to 60% in short term UK government debt, with the remaining 40% held in unremunerated deposits at the BoE.
Sarah Breeden, the deputy governor, has explicitly stated the 40% figure was grounded in precedents when depositors ran for the exit, and referred to SVB. The BoE’s approach is an embedded backstop and seeks to hardwire confidence into the design of the reserve stack and the redemption mechanism underlying future sterling stablecoins.
Quite how investors react when reserve rules diverge across jurisdictions will be interesting to watch. In principle, every fiat referenced stablecoin promises par redemption in its reference currency. In practice, markets will rank that promise by the quality and accessibility of the reserves sitting behind it, and by the credibility of the redemption plumbing that turns reserves into cash at speed. In calm conditions, most coins will trade close to par. Under stress, the coin backed by the most credible reserves and the strongest, most reliable redemption infrastructure will most likely maintain parity, while weaker reserve standards will show up as wider discounts to the peg.
In short, in stress there will be a flight to quality, and stablecoins will be ranked against one another.
Prasad Gollakota is a former FIG banker and co-head of the global capital solutions group at UBS. He was later chief content and operating officer at edtech company xUnlocked and specialises in financial institutions, banking regulation, capital markets and complex capital and funding solutions.