Panic Not Confined to The Banking World. Crypto World Is Imploding Too.

Readers are well aware of the banking crisis going on around us. Silicon Valley Bank, First Republic Bank and Credit Suisse are the best-known banks that have either failed or been rescued by central banks in the past few weeks. But there are other names that have failed as well.

What readers may not know is that there’s a meltdown going on in the crypto world also. The crypto-crash began in November 2021 with the collapse of Bitcoin from its all-time high of $68,990 to a low of $15,759 in November 2022; a 77% crash in one year. As is always the case in a collapse of that magnitude, there was collateral damage and a series of other failures.

A crypto hedge fund called Three Arrows collapsed in late 2022 when it was revealed that it had invested heavily in Bitcoin and other cryptos that crashed in sync with Bitcoin. Then came the spectacular crash of FTX and its associated hedge fund Alameda. That double collapse was the greatest financial fraud in history, costing investors as much as $5 billion.

Courts and regulators are still sorting out the damage. Three senior executives have already pleaded guilty to felonies. The founder and CEO, Sam Bankman-Fried, is under house arrest and awaiting trial on fraud charges.

In the wake of FTX, several crypto exchanges, including Genesis, failed. Then the crypto-bank Silvergate crashed. This was the bridge from the crypto world to the world of mainstream banking and contributed to the lost confidence that led to a run on Silicon Valley Bank. That’s how contagion works.

Now an even larger threat has emerged that could lead to a much greater panic than we have seen so far. As described in this article, this threat involves a kind of crypto-currency called a stablecoin.

A stablecoin is pegged to the U.S. dollar (usually at a rate of 1 coin = $1.00). When you buy one, you give the sponsor $1.00 and the sponsor promises to repay you exactly $1.00 on demand when you redeem the coin.

This has led to speculation about what the sponsors do with the dollars you give them for the coins. Do they put it in highly liquid safe assets so they can keep their promise? Do they invest it in other cryptos in the belief that they can sell those cryptos if they need dollars? Is the money invested in other risky assets? Is some of the money simply stolen, setting up another FTX-type situation?

The truth is that no one knows because the stablecoin sponsors do not offer any transparency, and they have never provided audited financial statements about the type and whereabouts of the assets they claim to hold.

The financial contagion hit this sector two weeks ago when a stablecoin called USDC crashed from its $1.00 peg to as low as $0.86. By last week, it had rallied back closer to $0.95. But that’s not a real rally because USDC never should have departed from $1.00 in the first place.

The USDC sponsor, Circle Bank, blamed the fact that it had $3.3 billion of cash stuck at Silicon Valley Bank. That’s no excuse; it just shows how interconnected (and therefore vulnerable) the financial system really is.

Stablecoins are a $500 billion market. If you’re in stablecoins, you should cash out for dollars as fast as you can. The entire sector seems primed for the mother of all crashes.

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