The past two weeks have been a tumultuous period. On the traditional financial system side, we appear to be in the middle of—or at least the onset of—a banking crisis, something not seen since the Global Financial Crisis (GFC) of 2007-2008. This has led to the wind down, receivership, or rescue of Silvergate Bank, Signature Bank, Silicon Valley Bank, and Credit Suisse and a reconstitution of the deposit base of First Republic. On the crypto side, the industry lost important fiat onramps with the failures of Silvergate and Signature, major stablecoins lost their peg, and regulatory rhetoric and actions have been taken to new heights.
Against this backdrop, bitcoin, the financial asset, has performed admirably. In the past week, the price of bitcoin is up 24.4%. This is important because this is Bitcoin’s first major banking crisis. While much has been made over the years of bitcoin as a risk-on or off instrument, its usefulness as an inflation hedge, or its ability to hedge financial market drawdowns, this is its first test in a banking crisis. It is also the first time, at least in nearly 15 years, that many are questioning the safety and security of the banking system (Bitcoiners seem to do this regularly). While things continue to develop and change even as we write, we wanted to share important observations from the past week or so.
While the media has at times tried to portray the current crisis as somehow centered around crypto, our read of the situation is anything but that. Silvergate and Signature were important partners to digital asset service providers, but Silicon Valley Bank and Credit Suisse were not. Our broad understanding of the root causes had to do with a duration mismatch between assets and liabilities, deposit concentrations around specific industries, and unrealized losses from the rising rate environment. When depositors all simultaneously ask for their money back, banks can take losses on even the safest securities they hold on the asset side, endangering bank capital ratios, and thus solvency. While the GFC was more about asset credit risk for banks, this crisis has been more about duration risk as interest has risen sharply over the past year. Credit risk may indeed become an important factor at some point if the crisis drags on, but it has not been a focal point yet, in our view.
While a review of the GFC often includes seminal moments such as the failure of Lehman Brothers and the 11th-hour rescues of Bear Stearns and Merrill Lynch, the reality is the crisis was protracted, with many twists and turns along the way. From the initial failure of subprime lender New Century in April 2007, it took nearly two years—not until March 2009—for the stock market to finally bottom.
One of the differences this time, and something we also saw in the wake of the COVID healthcare crisis, has been the speed at which bank regulators and monetary officials have been willing and able to act. In its closure of Silicon Valley Bank and Signature Bank, officials guaranteed the balances of all depositors, even those above the FDIC insurance limit of $250,000, a solid signal to the market. In addition, the Fed announced a new Bank Term Funding Program (BTFP) of up to $25B to help stressed banks with their liquidity needs. By contrast, during the GFC, monetary and fiscal support was slow to develop, perhaps exacerbating the depth and duration of the crisis. Officials even denied the existence of a subprime credit bubble at the onset. While things seem to be very different from a support standpoint this time, the root cause of the issues, long-duration investments in a rising rate environment, have yet to be addressed.
In the wake of instability in the banking system, stablecoins, digital assets on a blockchain designed to trade at or near $1.00, experienced significant volatility themselves. This was initially due to the reserve status of the second largest stablecoin, USD Coin (USDC), which had 8% of its reserve backing tied up in Silicon Valley Bank. Off-chain reserve-style stablecoins, like USDC and Tether (USDT), purport to hold $1 of assets, such as cash or securities, for every digital token issued on-chain. In response to the news about USDC, traders began to dump the coin, sending it down below $0.90. Dai (DAI), the largest on-chain collateralized stablecoin, which held 36% of its reserves in USDC also traded down significantly, also falling below $0.90. This is even though Dai was collateralized 147%, meaning that even if all the USDC that backed it were somehow worthless, it still would’ve been over-collateralized.
With the de-peg of USDC and DAI and the continuing wind down of Binance USD (BUSD), the primary beneficiary has been the controversial Tether, which has seen continual growth in supply and has traded at a substantial premium to par. Given the shifting regulatory backdrop and changing access to the US banking system, we may be headed back to a previous state of crypto, one with offshore exchanges powered by Tether (and possibly bitcoin) and onshore exchanges powered by the US dollar.
With the Silvergate Exchange Network (SEN) decommissioned and the pending shutdown of Signature’s Signet, a significant source of real-time cash settlement for crypto trading operations and, thus, liquidity is being removed from the market. Even with the issues experienced over the weekend with the price dips of USDC and DAI, blockchain analytics shows an interesting pattern emerging with the movement of stablecoins around US trading hours. We have noticed an increase in the movement of funds around the opening of the US market, Sunday evening at 6:00 PM at the open of CME futures trading and again on weekday mornings around the 9:30 AM open. Our guess is that some traders are pre-funding accounts before the day’s trading activity, perhaps a shift away from post-trade settlement given all the counterparty risks that have emerged over the past year.
Early Sunday morning, CZ, Binance’s CEO, tweeted that the company would convert $1B in BUSD into BTC, ETH, and BNB. The funds initially earmarked for the Industry Recovery Initiative (IRI), a collaborative industry effort to support projects negatively impacted by the events of 2022, were quickly sent from a private wallet to the Binance exchange, presumably to buy those assets on the secondary market. We do not know the split of the assets Binance purchased or their price, but it is likely that their transactions added fuel to the ongoing crypto rally.
Perhaps Binance wanted to support the industry by deploying capital directly into some of the top assets in a time of tumult or perhaps it thought that these cryptocurrencies were less connected to the traditional banking system. With the changing banking landscape, crypto markets feel like they are destined to be bifurcated like they were pre-2020, where offshore exchanges were powered by stablecoin and bitcoin trading as quote currencies, and the onshore exchanges were USD-dominated.
Bitcoin has really shined during this banking crisis, not just in relation to traditional assets, but in relation to other cryptocurrencies. In the past 7 days, bitcoin has outperformed ether, the second largest digital asset, by 5.3%, not an insignificant amount given their size. As a result, bitcoin’s dominance, as measured by its share of the crypto industry’s market cap, has spiked to over 46%.
We think there are a couple of components to this outperformance. First is that this environment, a crisis in the banking system, is what bitcoin was explicitly designed for. As investors lose confidence in financial institutions and the ability to access their cash deposits, bitcoin offers an alternative store of value that requires no trust in such institutions. Second, as investors lose confidence in other digital assets, like stablecoins still rooted in the traditional banking system, or question the legality of other digital assets, bitcoin increasingly becomes the “reserve currency” of crypto. This is perhaps a return to a world before Tether’s dominance as the quote currency of offshore exchanges, where bitcoin was the quote currency for most altcoin trading.
One of the hallmarks of the 2020 – 2021 rally was the outperformance of bitcoin during US trading hours vs Asia and Europe. In the recent rally, however, the tables appear to be turned, and now outside of the US trading hours seem to be in the driver’s seat. Since March 10, the average hourly return during US trading hours (9 AM ET – 5 PM ET) is +0.12% while the non-US trading hours (5 PM ET – 9 AM ET) is +0.18%. This is an important narrative point, and it may be that non-US investors are more fearful of the US banking system or more readily leaving it, than US-based investors.
It is worth remembering that Bitcoin was born from the ashes of the last major banking crisis. “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks” is the message that Satoshi inscribed in Bitcoin’s genesis block. Since that time, Bitcoin has become recognized as both a technical marvel and an economic expression, yet it has not been tested in a major banking crisis until now. Bitcoin has fared well so far, but the journey ahead of us is likely long. The root issue of flighty deposits and unrealized losses on assets caused by a rising rate environment has yet to be systematically addressed. It may not always be obvious why Bitcoin is needed, but it is times like this that remind us.
The price of bitcoin rocketed up 24.4% in the past week as the US grapples with its first major banking crisis since the Global Financial Crisis. Supportive measures meant to shore up the banking system benefitted stocks, with the S&P 500 up 1.1% and the Nasdaq Composite up 3.4%. Gold, a long-standing hedge against fiat debasement also performed well, up 5.3% on the week. Oil fell substantially on the back of economic fears, down 14.8%. Bonds rose on the week after real yields and inflation expectations fell. Investment grade corporate bonds rose 2.0%, high yield corporate bonds rose 0.5%, and long-term US treasuries rose 3.1%.
Joint Statement by Treasury, Federal Reserve, and FDIC - Fed, Treasury, FDIC
Additional Funding Made Available to Eligible Institutions - Federal Reserve Board of Governors
The Innovation Imperative: Modernizing Traditional Banking - Fed Governor Michelle W. Bowman
Meta Winds Down Work on NFTs - Twitter
Mar 22 - FOMC rate decision
Mar 31 - CME expiry
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