Bank turmoil bites crypto sector

Last year’s crypto market meltdown sparked concerns that turmoil in that sector could spread to the traditional financial sector. Now, in the wake of a series of U.S. bank failures, it’s evident that systemic risk spreads in the opposite direction too.

Several of the major stablecoin issuers held deposits or had accounts at banks that have failed or announced plans to wind down this month — Silicon Valley Bank (SVB), Signature Bank and Silvergate Bank — revealing the sorts of risks that these kinds of issuers face from their dependence on traditional banks.

“Although the industry and regulators have been concerned about the risk of crypto-to-traditional finance contagion, the collapse of Silicon Valley Bank demonstrates that contagion risk works in both directions,” Moody’s Investors Service said in a new report.

Amid the turmoil at the traditional banks, several U.S.-dollar stablecoins temporarily lost their currency pegs, Moody’s noted.

When banking regulators stepped in and guaranteed uninsured deposits at the failing banks, they seemingly averted a wider panic.

Without the regulators’ efforts, stablecoins with exposure to SVB and other banks could have been forced to liquidate assets, sparking a run on other banks holding stablecoin reserves, causing other stablecoins to lose their pegs, Moody’s said.

“In other words, the crypto industry might have amplified a shock originating from the traditional economy,” it said.

In a separate report, Fitch Ratings said that, while the immediate risk has receded, these events “highlighted the issuers’ exposure to contagion and counterparty risk.”

Moody’s said the episode exposed the “unpredictability of interlinkages between traditional and decentralized finance,” and revealed that “fiat-backed stablecoins are more volatile than market participants initially believed.”

Additionally, several of the major crypto exchanges temporarily suspended trading in certain stablecoins during last week’s market turmoil, “highlighting redemption risks,” Fitch said.

The recent demise of tech-focused banks will also present other challenges to the crypto sector, the rating agencies suggested.

For instance, crypto issuers could have a harder time finding banks to do business with, Fitch said, which could, in turn, affect stablecoin issuers’ operational costs or deposit earnings, and further intensify their concentration risks.

Stablecoin prices have remained much more volatile than money market funds in the wake of the regulators’ move to backstop deposits, Fitch noted.

“[T]his may reflect lingering risks around reserving practices and transparency, operational risks (including cyber risks), and the legal rights of stablecoin holders — notably around redemption rights,” it said.

This episode may also result in added regulation for stablecoins specifically, and the crypto sector generally, the rating agencies noted.

“Until now, large fiat-backed stablecoins had shown remarkable resilience, having emerged unscathed from past scandals such as the collapse of FTX,” Moody’s said. “However, recent events have shown that the reliance of stablecoin issuers on a relatively small set of off-chain financial institutions limits their stability.”