In conversation with Morten Christorp Nielsen, TradFi veteran and leading DeFi exponent on SVB’s downfall and how his innovative stablecoin business ARYZE is contributing to financial stability in these most challenging of times.
Over the last few months, we have watched the crypto sector endure a massive bank-run-style implosion, and now the traditional banking industry is facing an even more seismic shakeout of its own. We have seen crypto exchanges collapse, tokens go to zero, and stablecoins become unstable, untrustworthy, and now nearly unusable.
The most recent shock was the closure of Signature Bank, Silvergate, and Silicon Valley Bank (SVB), the latter now considered to be the largest bank failure in the United States since the global financial crisis of 2008.
At the end of 2022, 93% of SVB’s deposits were uninsured under the terms of the Federal Deposit Insurance Corporation (FDIC) program, the second highest ratio amongst large US banks. After its downfall just over a week ago, the FDIC has taken over SVB, and the Federal government (and ultimately the US taxpayers) are on the hook to guarantee all depositors. There are potential bank runs aplenty waiting in the wings across the US regional banking sector, all of which have large ratios of uninsured deposits and are all under strain against a backdrop of mass deposit withdrawals.
It is really a crisis of trust and confidence affecting everyone with a bank account and a business to run. Total US bank deposits are estimated to be $19 trillion, with well less than half within the notional scope of the current FDIC guarantee. Add to that the fact that, based on the information from the end of 2022, FDIC also only has around $128.2 billion to set against the nearly $8 trillion of so-called guaranteed deposits, and you can begin to see that there is a serious problem. In addition, SVB – as well as fellow failed US banks Silvergate and Signature – all had interconnectivity with crypto exchanges, stablecoins, and FinTech businesses further compounding the ramifications of what had happened.
Back in 2008, AIG was bailed out in a massive USD 150BN deal with the US government after a spectacular failure of the insurance giant believed by many to be a company that could never fail, but it did as the insurance losses from especially mortgage liabilities grew and grew.
In this interview, ARYZE Co-founder and CFO Morten Christorp Nielsen weighs in on the latest developments in banking and cryptocurrency, their mutual connection, and our trust in both.
Q: What do you believe lies at the core of the issues plaguing the banking system today?
Morten: In the simplest of terms, traditional finance today is based on a fractional reserve banking model. It is a system that not only permits, but also encourages, banks to take risks with their depositors’ hard-earned money, especially taking into consideration that a US bank only needs to keep about 10% of liquid reserves on hand when compared to total deposits.
The current financial system we have in place today offers traditional banks a profit motive and a regulatory environment that supports taking depositors’ money and investing it in all manner of financial products, all while never anticipating that depositors will need access to more than just a fraction of their money at any one time – and hence creating the opportunity for bank runs when they do.
Habits need to change. Best practices need to be hard-coded. As well-intentioned as SVB executives may have been, they placed enormous bets with depositors’ funds in an attempt to make more money not in loans, but in yield curve risk.
❞In light of the rapid developments in Web 3.0, it is essential to examine the underlying strength and stability of the traditional banking system that we have become accustomed to. At the end of the day, one has to wonder just how robust these financial institutions truly are. How effective is the current regulatory framework in overseeing and controlling these financial institutions, and do they have proper management practices in place to handle potential defaults as banks evolve into financial supermarkets?
At ARYZE, we understand the impact that some of the biggest problems in the financial sphere have on our daily lives, and since 2017 we have been working hard on providing the answer by adopting a full reserve banking modelwith a guarantee of solvency and liquidity.
To elaborate further, our recently launched suite of ARYZE Digital Cash stablecoins is backed 1-to-1 in a full reserve model where at least 85% is invested in short-term, government-issued bonds or bills, and the rest is kept in liquid assets to be used for market stabilization interactions as required.
Digital Cash is also over-collateralized by 2.5 percent to manage market-to-market issues with the underlying government assets. The over-collateralization for each stablecoin is “solidaric” with other ARYZE stablecoin over-collateralization. This means that over-collateralization in one currency can temporarily beused in exceptional situationsto ensure that the minimum 1-to-1 collateralization is always kept in one or more ARYZE stablecoins. We have all seen how other stablecoins have been struggling to maintain 1-to-1 parity, even the biggest, including USDC and USDT, and that is because they are not correctly collateralized – much like traditional bank deposits.
In your view, what are some of the key takeaways regarding Silicon Valley Bank’s downfall?
To start with, I think we should ask ourselves what was the reasoning behind such urgency to sell the assets, and what is it that we don’t know? Normally when you close down an entity, the insolvency practitioners and institutional authorities who must take over the assets for a proper wind-down of the bank would have to do so in the interest of shareholders, depositors, and employees as well. And when you sell the UK entity for one pound in less than 48 hours, have you actually done that?
❞What is it we don’t know, and why is this being handled in such a way that it has a huge impact on the market?
It sounds strange and potentially very unprofessional, as they are putting themselves at risk by being subject to lawsuits left, right, and center from other depositors in whose interest it has not been to wind down the bank that fast. Why is it not an institution with experience in winding banks down rather than FDIC that takes over the bank, and then closes it down properly? Much like the standard wind down process that usually occurs in a situation like this.
What lessons can be learned from the situation with SVB in terms of risk management and regulatory oversight?
I do find it interesting that Silicon Valley Bank was not warned by regulators to change their risk management policies. Taking too much exposure to long-term securities instead of short term bonds meant that SVB could not liquidate these assets without taking a significant loss.
Why were they not supervised to such an extent that the authorities and bank regulators were seeing that, and warning them to change their practices in the face of rising interest rates?
❞Regulators must look at these things on a constant basis to make sure that banks are not taking more risk than they should be allowed to.
All this occurred under the not-so-watchful eye of a regulator hamstring by their own ineptitude and outdated convention, meaning that they did not even look closely enough at what SVB was up to. Even though the Kansas City Fed and the world’s biggest investor BLACKROCK had tried to raise the alarm bells months ago. This is not the way to bank and regulate the banking of other people’s money.
❞In addition, why didn’t the CFO, and maybe also the CEO, of Silicon Valley Bank see this coming – that they were taking too much market risk? It’s not like we haven’t known for a long time, probably since the summer of 2021, that interest rates were only going to go one way, which was up.
So, why did they not see that? And why did they make it as not pointed out to the bank that they were taking too much risk?
In hindsight, what could have been done differently to prevent this situation from occurring?
I would like to emphasize the fact that all this happened on a Friday afternoon. Surely the regulators have been looking at who were the biggest creditors in the bank, and whether it could have implications for other markets given that all this was happening on Friday afternoon. They knew, for example, or should have known, that Circle had up to $3.3 billion of their USDC stablecoin reserve deposits held at Silicon Valley Bank.
❞As a consequence, it could have an impact on not being able to wind down the bank correctly in the best interest of the depositors, who incidentally were mostly not covered by FDIC insurance on a Friday afternoon. In addition, it also impacts their ability to stabilize their own cryptocurrency and stablecoins in the market, because they cannot get liquidity through to the market fast enough if it happens right before the weekend.
Why not wait until Monday? Then the problem would have never even occurred – Circle would have had instant liquidity in the market and stabilized the stablecoins. Very strange timing, and it sounds like it’s not coincidental. It was all very, very, poorly managed from my perspective.
Can you elaborate on the FDIC’s involvement in this?
When you take into consideration that only 7% of the deposits with SVBwere actually FDIC-insured, then their involvement sounds even more strange. Why is it that the FDIC is taking over the practice of unwinding the bank, and what kind of experience do they have in winding this down?
❞What precedence do we have for FDIC to be the authority responsible for winding down the bank and not the SEC itself, or the FED, or anybody else? It sounds completely mismatched between their capabilities and the actual execution by FDIC.
93% of SVB deposits had nothing to do with the FDIC, and therefore why are they not winding the bank down in the interest of the 93% and not the 7%? Completely mismatched indeed. And I think it opens them up for lawsuits left, right, and center because they did not act in the interest of other depositors, shareholders, or employees.
Is there any final advice or perspective you’d like to share with our readers?
There are always risks which needs to be managed in banking and financial services, and from time-to-time bad things happen which we need to be prepared for. With non-fractional, lending-based stablecoins being available in crypto, i.e., stablecoins that are backed one-to-one with risk-free assets (bank deposits to be kept at an absolute minimum and only for instant liquidity purposes), the question is whether we should not once and for all move core money away from the risky fractional lending banking system and away from traditional banks, like it was suggested in The Chicago Plan after the Great Depression. Surely the combination of holding cash in a credit risk-free manner combined with instant settlement and finality on payments and core money becoming fully programable, unleashing a wave of financial innovation, have significant merits, proving once and for all with the current SVB et al crises. I am quite certain that none insured corporate depositors would agree with this.