Three senior executives at stablecoin issuer, Circle, published a paper outlining a Token Capital Adequacy Framework (TCAF), inspired by the Basel Committee rules for banks. One of the most interesting aspects of the paper is the conclusion that the USDC stablecoin would not have suffered the Silicon Valley Bank (SVB) de-peg event had it followed TCAF guidelines.
A key part of the recommendations is a purely risk-based focus, so the TCAF model uses the concept of Value at Risk. A simplification of the approach is how much money could be lost and what is the confidence level of that happening?
The USDC de-peg event
In March 2023 when there was a run on Silicon Valley Bank, Circle had $3.3 billion of its $40 billion reserves at SVB. Another $1 billion was at Customers Bank and $5.4 billion at BNY Mellon.
Before the announcement of the government bailout, over the counter pricing of SVB deposits was 70-80 cents on the dollar, say 75 cents. Using that data for the risk calculation, a run on SVB or Customers Bank, could cause a loss of a quarter of the assets held at the bank. The authors consider the risk of loss at BNY Mellon at zero because it’s a systemically important bank.
Hence, the authors calculate it would have needed $1.08 billion (a quarter of the deposits) in capital for the level of deposits it held at SVB and Customers Bank.
“Circle would likely not have held $4.3 billion of deposits at SVB and Customers Bank in aggregate if it had been required to have at least $1.08 billion of capital available,” the authors wrote. “This type of proactive risk management and rationing through a risk-sensitive capital framework can be consequential in affecting the long-term success of token issuers.”
They believe it’s not just the size of the capital but making it publicly visible and credible.
Other stablecoins
Besides analyzing USDC, they also explore other stablecoins, such as the impact of the SVB event on the DAI and the collapse of Terra. Plus, they assessed the (significant) capital needed for the new synthetic stablecoin USDe from Ethena Labs ($3 billion market cap).
They don’t mention Tether, other than noting it holds a variety of non cash assets such as crypto, precious metals and corporate bonds. On the one hand, Tether now holds significant equity of $12 billion. On the other hand, earlier this month we highlighted that almost $30 billion of its assets are moderate to high risk.
For arguments sake, if Tether kept $2 billion as a buffer for operational risks, and assuming zero risk (not true) on its cash-like assets, $10 billion would be enough to cover losing a third of the risky assets. Hopefully, it won’t be put to the test.
The guts of the paper
The authors make two moderately controversial arguments in the paper. Firstly, they are keen to adopt a forward looking risk-based approach. Current banking regulation combines risk-based rules with others that are not granularly sensitive to risk.
One example is the U.S. supplementary leverage ratio that calculates a bank’s equity capital as a percentage of its total leverage, with large U.S. banks needing at least 3% equity. Because this ratio is not risk focused, the authors assert it encourages banks to switch holdings of Treasury securities for riskier, more profitable assets. They believe the TCAF achieves the opposite, as demonstrated by the SVB example.
Separate balance sheets
Another argument is they’d like to see stablecoin issuers assessed on two balance sheets. One balance sheet directly relates to the stablecoin reserves, with the equity calculated based on financial risks, including credit and liquidity risks. The other balance sheet is for the corporate issuer, where risks relate to technology, infrastructure and operational risks.
This separation leans on the idea that assets held in custody rarely appear on the balance sheet. That’s apart from the controversial SEC crypto accounting rule, SAB 121, which does not apply to the conventional assets held by most stablecoins.
However, the paper doesn’t mention governance structure in this context. If the custodian is a trust, then there is true legal segregation because the assets are ring-fenced in bankruptcy. But Circle has chosen not to structure itself as a trust. S&P Global Ratings noted that the sort of segregation attempted by Circle would have to be tested in the courts.
Again, fingers crossed that won’t be put to the test.
