MONDAY, April 15, 2024

Get to know bank run, the current financial crisis and its effects on cryptocurrency

Get to know bank run, the current financial crisis and its effects on cryptocurrency

During March, there was an incident in the financial industry in the US: The collapse of Silicon Valley Bank, one of the banks that has large impact to the US technology industry. This also affects digital asset matket.

In this article, I will tell you about this incident which many of you might call it “Bank Run” and its effect to the cryptocurrency market.

What is Bank Run

Bank Run is a situation when large number of customers withdraw their money from the bank due to the worry about the bank’s liquidity and ability to pay off the debt. This situation might lead to the collapse of the bank which could expand into the financial crisis.

Although it is rare for Bank Run to happen nowadays, during The Great Depression around the 1930s when the economic was at its lowest point in the history, Bank Run happened to many banks all around the world. This was because, during 1920s, the stock market was booming, so  banks invested huge portion of their money in the stock market. However, when the stock market collapsed in 1929, people were all rushing to get their money out of the banks, but the banks cannot do that because they did not have enough cash. That is why, in 1993, US Government established Federal Deposit Insurance Corporation (FDIC) in order to control the deposit money and bank operations.

What happened to Silicon Valley Bank

One of the recent Bank Run is the one happened to Silicon Valley Bank or SVB which was the 16th biggest bank in the US holding more than $200 billion worth of asset. SVB mostly provide the services to the technology companies.

There was a high demand for SVB’s service during the COVID-19 outbreak, especially in 2020, the golden time for startup and technology company because the customers started to rely more on technology and digital services.

Many technology company uses SVB to deposit their cash for business expenses leading SVB to have large amount of money deposited, and just like normal bank, SVB took the portion of that deposit to invest. 

However, the problem occurred because SVB invested large amount of money to bonds from US government that have long maturity, and bonds tends to have negative correlation to the interest rate. If the interest rate increases, the price of the bond will decrease. Therefore, after US Federal Reserve rapidly increased the interest rate in order to control inflation, the value of SVB’s investment port plummeted.

If SVB can hold the bonds for many years until their maturity date, at least they will receive the initial fund back, but due to the recession, the technology company got lots of impact, so SVB’s customers started to withdraw their money. However, SVB did not have enough cash, so they sold a part of their bonds eventhough they make a loss. This created worry to the investors and customers leading to Bank Run situation. US Government had to intervene in order to lessen the impact of this situation.

How Does It Affect Cryptocurrency Market
Not long before Silicon Valley Bank faced Bank Run, Silvergate Bank which is also the main bank for cryptocurrency companies also encountered Bank Run. Moreover, almost half of the startups in US and cryptocurrency-friendly funds kept their cash in SVB.

The most obvious effect happens to cryptocurrencies that are catagorized as stablecoin, especially USDC that Circle, the issuer company, deposited the money that is used to peg the value of USDC with SVB for around $3.3 billion. This makes USDC holders started to worry about the downfall of SVB leading to large amount of USDC being sold. This caused the USDC value to drop lower than $1 while it should be close to $1 because it has real dollar as the reserves.

Jeremy Allaire, CO-Fouder and CEO of Circle, tweeted “$3.3bn of USDC’s cash reserves remain with SVB. As of Thursday, we had initiated transfers of these funds to other banking partners. Though these transfers had not yet been settled as of close of business Friday, we remain confident in the FDIC’s management of the SVB situation and stand ready to receive these funds”

The tweet shows Circle’s confidence in the ability to handle the situation, together with Federal Reserve announcement that they will help SVB by establishing the “Bank Term Funding Program” to protect financial institution. Moreover, US Department of Treasury also assure SVB customers that they will be able to withdraw their money from SVB in full amount causing the USDC value to recover to 1 Dollar.

However, the effect to USDC is just short-term effect. In long-term, it is possible that the collapse of these two cryptocurrency-friendly banks will lead to liquidity problem in term of exchanging fiat with cryptocurrency which could affect the cash flow of the whole industry, not only just digital asset. Therefore, what we should do during the uncertain situation like this is to hold cash in case of emergency, try not to create more debt, and always follow the economics news.

Reference: Bitkub Blog, Investopedia, CNBC



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