Just when we thought we could always confide in the publicly traded company, Coinbase, its hallmark product, the stablecoin USDC, depegged from the very thing it was never supposed to do. Falling to as low as 0.88 USD to the dollar.
Where did we do so wrong with Coinbase’s once magnificent product? And will the crypto community and investors at large ever be able to truly trust stablecoins?
What Caused the Downfall of USDC?
In the hours following Silicon Valley Bank’s collapse, news emerged that Circle, the issuer of the USDC stablecoin, held $3.3bn of reserves in SVB, triggering a panic that the stablecoin was no longer fully backed.
As of Sunday night, we know that Circle’s reserves are safe, but over the weekend, both centralized and decentralized markets descended into chaos. Today, we’ll walk you through what exactly happened here in a way that makes sense.
USDC’s primary use case is within the DeFi ecosystem, and as such, it is relatively illiquid on centralized exchanges. As of last week, it denominated less than 0.5% of the total CEX trade volume.
However, CEXs played an outsized role in initiating this weekend’s market chaos. This is because traders had only one thing on their minds amid the uncertainty: where to liquidate their USDC holdings.
Today, there are only 8 active USDCUSD trading pairs on CEXs, which effectively serve as a real-time exchange rate for the dollar.
Over the weekend, these trading pairs became the only direct fiat offramp amid a halt in redemptions with Circle and Coinbase.
Lack of Liquidity is the Main Problem
The problem, though, is that these USD pairs are relatively illiquid: daily average trade volume was just $20-$40 million in the first week of March. On Saturday, trade volume for these pairs hit an all-time high of $ 600 million, dominated by Kraken, which offers the most liquid USDCUSD pair.
As expected, order books could not support the influx in sell volume, which caused USDC’s exchange rate to nosedive. Before USDC depegged, under 20 million in bids sat on USDC-USD order books, which were overwhelmed by hundreds of millions in sell volume.
While USDC-USD trading pairs saw record volumes, the majority of crypto market activity is not actually conducted with the dollar.
Most traders use offshore exchanges, which don’t offer a direct USD conversion for USDC but do offer USDC-USDT pairs. The problem with this is that Binance, the world’s largest exchange, had delisted all USDC trading pairs back in September (uh oh).
By midday Saturday, Binance finally re-listed the USDC-USDT trading pair, but by then, it was already trading at a steep discount on less liquid CEXs. Shortly after, trade volume for USDC-USDT pairs hit $9.9bn, an all-time high, as traders rotated out of USDC or scooped up USDC at a discount.
Overall, the sales outweighed the buys, causing Tether to trade at a strong premium to both the dollar and USDC.
Why Trade Activity Played a Role in Market Upheaval
The quickest answer is that DeFi price feeds for stablecoins don’t provide a true USD exchange rate because you can’t trade fiat currencies. This is why many protocols use decentralized prices to determine liquidation levels, with data often pulled directly from centralized exchanges.
Overall, illiquid centralized spot markets, the emergence of several USDC derivatives contracts, and viral screenshots from price display websites exacerbated the de-pegging event. Much like a bank run, the narrative became reality, which flooded into the DeFi ecosystem