Transparency Among FUD

Photo by Riccardo Annandale on Unsplash

There has been a lot of FUD in the crypto world lately. Some of it is justified. Some of it is not. Some of it is genuinely just confused.

I’ve been asked at least 5+ times today what is going on with BUSD, why USDC withdrawals were halted, what wrapped/pegged/bridged BUSD is, why [insert stablecoin here] is going to zero, and other increasingly hysterical questions.

This is my attempt to answer most of them. If you have more after reading it, ask. Feel free to repost this anywhere.

Why did Binance stop USDC withdrawals?

Would you believe me if I told you the problem is actually traditional banks and the interactions between stablecoins?

It is.

Part 1: Stablecoin Reserve Liquidity During Off Hours

To explain this, we have to talk about how a stablecoin works. As a general statement, a properly designed fiat backed stablecoin should take customer money and put that money in safe reserves(1) in the traditional financial system. The problem is those reserves run on the rails of the traditional financial system. This means if you own treasuries, they settle T+1. If you have overnight reverse repo, that settles T+0. If you own money market funds, they settle T+2 (but often faster, thanks money managers). And all of those T mean business days, during banking hours (9–5pm, New York time), on days where banks are open (so not weekends and not holidays).

Great. This is normal bank stuff (everyone reading this from tradfi is nodding, and everyone reading this from crypto is puking in their mouth a bit).

Now what if someone wants to mint or burn a bunch of stablecoins at 3am NY time on Saturday?

Yeah. About that.

As a result, most stablecoin issuers (at least Paxos and Circle that I can personally confirm) keep money at US banks with fast payments networks. These are internal networks that can do 24/7 fast payments, using a private ledger or blockchain. Some of the luminaries in this space who can also bank crypto have historically included Silvergate and Signature.

However, you’d be a crazy person to keep ALL your deposits at a single bank, especially as they get large. You can’t keep $20B in uninsured deposits and be a stablecoin. Thus, all the stablecoins manage their liquidity and leave some millions to hundreds of millions to billions at these banks, and the rest of the reserves in tradfi instruments.

So let us say a stablecoin, we will call it CUSD for Canonical USD as our example, has $10B of assets. Maybe CUSD keeps $500mm at these fast payments banks, or 5% of total assets.

What that means is that CUSD can burn $500mm of the $10B during off hours, but if a $1B redemption comes in at our previous 3am Saturday NY time, you have to wait until NY banking hours to fulfill the remainder of it.

Is there an issue with the assets of CUSD? No. It’s just a timing issue. But this timing issue can break pegs temporarily and is consistently a source of stablecoin FUD because people do not understand how settlement works in traditional financial markets. The question of is a coin solvent (e.g. are there enough assets) vs. do you have adequate liquidity outside market hours are not the same (and, in fact, probably anti-correlated, because to have that liquidity you take bank credit risk).

Part 2: Autoconversion

Binance engages in something called auto-conversion when there are deposits onto their platform. This means if a user deposits USDC, TUSD, or USDP to Binance, Binance will take those tokens, redeem them for fiat, and use that fiat to mint BUSD through Paxos.

So if Binance receives $1B in USDC deposits, how much USDC does Binance hold?

$0. They hold $1B BUSD instead.

The complication here is that Binance also allows users to withdraw back to other coins, so if Binance receives $1B of withdrawal requests for USDC, they need to do the following:

1 — Redeem BUSD against the BUSD trust

2 — Mint USDC with the proceeds from the BUSD redemption

3 — Sent the USDC to the user

This is a trivial thing to do during NY banking hours, but when you are off hours, as discussed above, things can break if the redemption activity is large.

As a result, if you are trying to evaluate the ongoing stablecoin operations from an outsider’s perspective, you should be evaluating withdrawal rate vs. banking hours to get a sense of what is going on. In the case of Binance suspending withdrawals for USDC, I will say I can personally confirm that lack of off-hours liquidity was in fact the culprit for this action.

Source: I am literally the guy who oversees those reserves at Paxos.

What is going on with BUSD on other chains? Is it fake? Was our money stolen?

The NYDFS, which is the regulator overseeing Paxos, has only given approval to issue BUSD on the Ethereum blockchain.

However, as many who use ETH know, it’s expensive, clunky, and old. There are other blockchains (BSC, AVAX, TRON, SOL, Polygon, etc.) that are used, some of which are faster and cheaper (even if there are other tradeoffs).

Given the lack of native issuance, Binance themselves have taken the step to bridge BUSD privately onto those chains. That token is the BUSD pegged or wrapped token. If you want to see the on-chain reserves held for these tokens, you can find them here by searching for BUSD.

This should allow users to confirm there is adequate Ethereum BUSD to back each of the BUSD pegged/wrapped tokens Binance has bridge to other chains. The time you should grow concerned as a user is if the Ethereum BUSD < BUSD pegged/wrapped, as that means there’s not enough to redeem it back across the bridge. If the ETH BUSD is equal or greater than the bridged amounts, you have adequate reserves.

The other thing to note here is that the bridged token is backed by the Ethereum tokens, but it’s not explicitly that. If the Binance bridge breaks or they stop redeeming BUSD from other chains to Ethereum, you can’t redeem the bridged token to Paxos. Thus, like wBTC vs. BTC, you are taking additional risk using the bridge, to be fully transparent.

Is USDC / BUSD / USDP / TUSD / USDT / GUSD / etc. going to zero?

Listen, I don’t give financial advice. I’m not going to give predictions here. But as a general framework, you should ask the following:

  1. Can I see the reserves? This is a yes for BUSD, USDP, and USDC in unequivocal fashion, and varying degrees for GUSD, TUSD, and USDT.
  2. Are the reserves in safe assets? I would define these as low/no credit risk, highly liquid stuff of the sort you would typically find in money market funds, and if you want maximum safety, government money market funds: t-bills, ON repo/reverse repo secured by USTs (treasuries, not the Terra stablecoin, for you degens out there), and agency debt.
  3. Are the reserves bankruptcy remote? This is probably too complex for the scope of this article, but it’s a core point — make sure if something happens the money in the reserve is actually, you know, for the coinholders.
  4. Is there a track record of liquidity, redemptions, and strong operations? The longer something has been done and the more professional the operation behind it in terms of risk management, the better. Obviously, this can change over time. As a general heuristic, it has value.

Are runs on stablecoins going to cause massive contagion that crashes the financial system?

No. Also stop.

There are ~$150B of t-bills, bank deposits, and ON reverse repo in these things total (and maybe some other small allocations to riskier things in USDT).

While a total wipeout there would be bad, the reality is it’s not system-defining. You’d have short-term rates back up some as all of this paper was sold, assuming people were leaving dollars entirely.

If they are literally just selling stablecoins to go buy money market funds or deposit in banks, it will be completely circular flow that serves little to no purpose.

Compare this to the estimate ~$5 trillion (not a typo) of money market funds, and you can see stablecoins are a rounding error on purely cash management in that space, much less once you start factoring in all other holders of t-bills.

So, yes, there could be an impact on short-term rates, but no, it’s not going to break things. Especially as the stablecoins are unlevered and thus don’t have contagion effects with failures.

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Austin Campbell

Austin is a Columbia Business School professor, has run one of the top 3 stablecoins, and has decades of experience trading profoundly weird financial stuff