The Wall Street Journal writes, "Circle's USDC Stablecoin Breaks Peg With $3.3 Billion Stuck at Silicon Valley Bank." They explain, "A major cryptocurrency operated by Circle Internet Financial Ltd. meant to mimic the value of the U.S. dollar dropped sharply after the company said it had $3.3 billion tied up in the collapsed Silicon Valley Bank. USD Coin fell below 87 cents on Saturday morning, according to data from CoinDesk. The virtual currency, known as a stablecoin, is designed to trade exactly at $1. It is backed by real U.S. dollars and short-term government debt, and sits at the heart of cryptocurrency trading. Breaking its peg with the dollar has the potential to send shock waves through the cryptocurrency world still reeling from the collapse of FTX. For crypto traders, the decline in the value of USD Coin is reminiscent of the worst moments of the 2008 financial crisis when money-market funds that most investors treated as the equivalent of cash 'broke the buck' in the wake of Lehman Brothers failure."
The Journal says, "Another stablecoin, Dai, also broke from its $1 peg, trading as low as 90 cents Saturday. Dai, the fourth-largest stablecoin worth around $5 billion, is partially backed by USD Coin, also known by traders as USDC." The article continues, "The USD Coin reserves remaining at Silicon Valley Bank comprise about 8% of the roughly $40 billion in assets backing the token, according to Circle. Circle has said it maintains around 20% of its holdings in bank deposits and 80% in three-month government securities. Without access to the bank deposits, Circle may face difficulty meeting redemption requests.... Like banks, stablecoins are subject to runs. If holders of the coins believe there aren't enough dollars in reserve, they may rush to exchange their coins -- or to sell them to someone else. That selling has driven down the price."
It adds, "Cryptocurrency investors redeemed more than $2 billion in Circle's stablecoin in the past 24 hours, according to blockchain data provider Nansen as of 10 p.m. ET on Friday. The pace of USD Coin redemptions accelerated through Friday, with most of the USD Coin burned in the last eight hours, Nansen said.... As with Silicon Valley Bank, Circle is a creature of the tech startup community. It earned early backing from Silicon Valley firms and later started its own Circle Ventures investment firm. It also has deep ties on Wall Street. Circle has raised around $850 million from investors including asset manager BlackRock Inc., Fidelity Management and hedge fund firm Marshall Wace. Bank of New York Mellon Corp. serves as the primary custodian for USD Coin reserves, according to Circle."
In other news, MarketWatch discusses the looming debt ceiling battle in its article, "As money-market funds rake in cash, analysts see debt-ceiling risks." The piece explains, "As investors pour cash into money-market funds, analysts are warning that the Congressional standoff over raising the federal government's debt limit will put pressure on these traditional safe haven holdings. Money-market funds focused on U.S. Treasury securities, generally considered the safest of money funds, 'could face increased volatility in the Treasury market and heightened investor redemptions as the debt ceiling deadline approaches,' Fitch Ratings said in a late February report. If investors stampede out of money-market funds as that deadline nears, the funds' managers may be forced to sell Treasury holdings in a volatile market, putting them at greater risk of 'breaking the buck,' or falling below the steady $1 share price money funds typically aim to maintain, analysts say." (See our March 7 News, "March MFI: Treasury Debt Ceiling, BlackRock's Clay; Federated's 10-K" and our Feb. 24 News, "MMF Assets Run at Record Again; JPMorgan, Fitch Warn on Treasury Debt.")
The article continues, "Money-fund assets climbed $56 billion last month, hitting a record $5.3 trillion in early March, according to Crane Data. In a shift from years past, much of the recent growth in assets has come from mom and pop investors rather than big institutions, said Crane Data president Peter Crane, as those retail investors seek out higher-yielding parking spots for their cash. The 100 largest taxable money funds had an average seven-day yield of 4.39% at the end of February -- a level last seen before the 2007-2009 global financial crisis -- whereas brokerage sweep accounts tracked by Crane had an average yield of 0.43%. Money fund yields are expected to move higher after the Federal Reserve's next meeting later this month."
It adds, "Past debt-ceiling crises indicate some of the challenges that money funds may face this time around. In 2011 and 2013, Congress resolved debt-ceiling issues shortly before the drop-dead date–and in both cases, short-term Treasury bill rates rose sharply about two weeks before the x-date, according to a recent report from the Federal Reserve Bank of Kansas City. Money-market funds, particularly government funds, also had unusually large outflows in the two weeks before the debt-ceiling resolution in 2013, the report said."
The aforementioned Federal Reserve Bank of Kansas City study, "Pushing the Limit: Last-Minute Debt Limit Resolutions Have Increased Market Volatility and Uncertainty," explains, "Since reaching the debt limit in January 2023, the U.S. Treasury has used extraordinary measures to fund the government. However, the Treasury estimates those measures will be exhausted later this year. To gauge possible effects, we review economic and financial market outcomes during previous debt limit episodes. In each case, these episodes led to increased borrowing costs, financial market volatility, and uncertainty, particularly when the resolutions were prolonged."
The paper explains, "The U.S. Treasury reached its statutory debt limit on January 19, 2023, and began using extraordinary measures to continue funding the government without increasing the debt. However, it expects to reach the 'x-date,' at which time extraordinary measures will be exhausted, sometime mid-year. Treasury debt serves as a bedrock of the global financial system, being a key source of collateral for many financial transactions and held broadly by investors. As a result, concerns about Treasury debt obligations, or even uncertainty about how those concerns will be resolved, could have broad destabilizing consequences for the economy."
It continues, "Prior U.S. debt ceiling episodes differed in how quickly a resolution was reached, providing a natural setting for understanding how economic and financial conditions could respond to various resolution timelines today. For example, in October 2021, Congress reached a temporary resolution several weeks in advance of the projected x-date, while resolutions in 2011 and 2013 occurred just days before the x-date."
The KC Fed says, "In addition, financial intermediaries experienced greater liquidity strains when debt ceiling episodes were resolved closer to the expected x-date. Chart 2 shows that money market funds, particularly government funds, experienced unusually large outflows in the two weeks prior to the debt ceiling resolution in 2013. During this time, large commercial banks experienced an associated influx of deposits (not shown). However, these flows quickly reversed following resolution. Because both money market funds and banks engage in maturity transformation, rapid funding outflows could potentially destabilize the financial system."
They comment, "The economic environment during previous debt limit episodes differs from the current episode in three important ways, potentially changing how markets may react to the ongoing debate. First, in both the 2011 and 2013 debt limit episodes, the Federal Reserve was in an accommodative policy stance and providing additional liquidity to the financial system. Today, in contrast, the Federal Reserve is actively withdrawing liquidity from financial markets by shrinking its balance sheet. Thus, any disruption to market liquidity could strain banks and money market funds. Second, government money market fund assets grew substantially since 2013 following money market fund reforms in 2016 and pandemic-era increases in the Federal Reserve's balance sheet. Thus, liquidity swings could be larger and more destabilizing today."
The study adds, "Third, money market funds use the Federal Reserve's overnight reverse repurchase facility (ON RRP) -- which allows them to make loans collateralized by government debt to the Federal Reserve -- to a much larger extent today than during previous episodes (Marsh and Sengupta 2022). Although money market funds could harbor concerns about holding collateral with limited marketability, participants may be more willing to transact with the Federal Reserve. Indeed, the Federal Open Market Committee (FOMC) appeared willing to accept Treasury securities in Federal Reserve operations at market prices during past episodes (Davidson 2017). If money market funds expect that the FOMC may be willing to do so again, they may shift their investments to the ON RRP, reducing investor fears and tempering run risk."
