Opinion: USDC Can Face Redemption, but Negative Impact on Crypto Industry
Colin Wu . 2023-03-12 . Data
Author: 0xLoki @Loki_Zeng

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USDC made a detailed information disclosure today, the core contents include:

1) Circle’s funds in SVB are already in the transfer sequence. According to FDIC rules, the transfer should be completed next Monday.

2) It is still not ruled out that the funds cannot be received, but even so, it only takes time to recover or partially recover the funds, not all losses.

3) Even if the above situation occurs, Circle has the ability to cover the loss and guarantee a 1:1 exchange.

4) Of the remaining cash deposits, 5.4 billion is in BNY Melon, and 1 billion is in Customers Bank

None of this new information is bad news. BNY Melon is a low-risk bank in the previous analysis, Customers Bank is a medium-risk bank, and SVB’s 3.3 billion high probability will not suffer losses. Even if extreme situations occur, Circle also has ability to fill gaps. If the above information is true, USDC will not have any risk of “insolvency”.

It can be seen that the confidence of the market has increased significantly, and the pricing of USDC has also entered a reasonable range. However, the difference of 0.04U means that there are still concerns in the market, and this part of the concern is mainly about the run on USDC. So the core question in the second round of poker is will there be a run? What would happen if there was a run?

There may be variables in the price trend of USDC, but what will happen next week is almost certain:

The first inevitable event is that Circle will open the redemption channel. Circle said that it has the ability to guarantee the full payment of 1:1. Circle’s liquidity is also sufficient to support them doing so. Even considering only the funds of BNY Melon and Customers Bank, Circle has 6.4 billion in cash and 100% solvency. On the premise that there is no funding gap, open redemption is the fastest way to stabilize the currency price and eliminate FUD.

The second inevitable event is that there will be a lot of redemptions (you can also call it a “run”). The demand for a run includes two aspects: (1) Arbitrage demand. As long as USDC does not return to 1U, arbitrage opportunities will exist. (2) Hedging demand. Out of concern about the systemic risks of USDC and Bank of America, USDC was exchanged for legal tender.

Then, under the premise that Circle is open to redemption, institutions or users with arbitrage capabilities will continue to redeem their own USDC and USDC purchased in the secondary market. These arbitrage behaviors will push up the price of USDC and reduce the price difference.

If things go smoothly, Circle will lose some of the USDC issuance scale, in exchange for USDC price stability and market confidence, and USDC will rise to 0.99 or 1.00 (it may be 0.99 because the reversal of market confidence does not happen overnight).

Of course, there are also unsatisfactory situations (although the probability is very small), such as the excessive redemption amount on the first day leading to slow or suspended redemption, and financial market fluctuations causing further panic. In this case, the USDC price will have a wave of decline after rising, but I still think it will eventually return to 0.99/1.00, the reason is simple, because Circle has a 1:1 redemption ability, the redemption may slow down , but will not be aborted.

The third inevitable event is that USDC will not be fully redeemed. There are two reasons. The first is that with the opening of the Circle redemption channel and the peg of USDC, market confidence will gradually increase. The second point is that USDC still has many passive holding needs, such as Maker’s PSM module, cross-chain bridge locked assets, assets to be liquidated (such as FTX, Voyager), and dydx’s contract locked assets. Time will not withdraw immediately at the moment of opening, the total amount of these funds has far exceeded 3.3 billion. How long this redemption will last and how large the redemption will be is currently unknown. My personal opinion is 10%-30% of the total issuance, that is, 4 billion to 12 billion.

So I am more inclined to call what will happen on Monday a [large-scale redemption] rather than a [run].

Although USDC has a high probability of returning to 1.00/0.99 soon and the risk of Circle crash is almost zero, the impact on the following market has just begun.

The first impact is a blow to market liquidity. Even if USDC returns to the peg soon, this process will bring about a large loss of USDC. At the same time, panic and hedging demand will not disappear. In the next few months, various stablecoins including USDC may still continue to lose. The current market is already in a state of extreme lack of liquidity, and the outflow of stablecoins will make the market even worse.

The second is that the USDC incident will intensify their distrust of the crypto ecology. For insititutions, they need to face more complex fund custody issues and higher costs. Panic will also make them seek more liquid investment portfolios (such as reducing Alts, increasing BTC and fiat currencies), and pessimistic It will make everyone more cautious in investing (whether primary or secondary). In addition, there are many projects that are strongly related to USDC (such as Maker/Frax), and they will be more directly impacted.

The third is the regulatory and compliance market level. FTX, a good student, has a problem. Circle, a good student, is also in trouble now. How to explain the great vision of compliance to regulators and users?

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