‘Stable’ Coins

… or so they are called. Recent events would beg to differ.

On Saturday March 11th, 2023, crypto investors woke to portfolios in the red as USDC fell
violently from its $1 peg to lows of $0.82.

How can a ‘Stable’coin, backed 1:1 by US dollars, fall over 18% from the price it has remained
so close to for the last 5 years in just a matter of hours?

In this report we will answer that very question whilst delving into the analysis behind our highly
profitable USDC trades & take away some crucial lessons for the future that I'm confident will
make you a better crypto investor.

But first, how do stablecoins work?

I’m sure everyone reading this has at some point held some portion of their portfolio in
stablecoins, without truly understanding how the price seems to magically float around $1.

There are three main mechanisms behind stablecoins, it's important you’re familiar with them
all.

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Centralized

This is the simplest, and the most regularly used - a centralized stablecoin is controlled by a
central entity.

USDT is controlled by Tether

BUSD is controlled by Paxos
USDC is controlled by Circle

These three alone account for the majority of the stablecoin market cap, with a combined total
value of over $100Bn.

What does it mean for a stablecoin to be ‘controlled’?

In the case of USDT, Tether controls all of the minting, burning and freezing of the USDT
stablecoin on the blockchain. If Tether for whatever reason wanted to take back control of the
USDT in your Ethereum wallet, they very easily could (even if it is in your cold wallet!)

How does Tether keep the value of the stablecoin at $1?

This is very simple: you can go to Tether with your USDT tokens and they will credit you $1 in
fiat currency (through a wire transfer directly to your bank account). This guarantees that you
will always be able to get $1 for 1 USDT.

For example: if the price of USDT was to fall below $1 on Binance, this opens the potential for
an arbitrage. A trader could come in and swoop up the USDT, send it to Tether in exchange for
a greater fiat value. Profiting on the price difference.

1. USDT @ $0.990 on Binance

2. Purchase 1,000,000 USDT for $990,000
3. Transfer 1M USDT to Tether
4. Receive $1,000,000 to your bank
5. Profit $10,000

This ability to arbitrage means the price of USDT should always remain at $1, as traders buying
tokens sub $1 will cause the price to increase. (As long as Tether continues USDT redemptions
at $1 per USDT)

How can Tether afford this?

In order to mint (create) new USDT tokens, you must send an equal amount of dollars to
Tethers bank account. So every USDT token that exists on the blockchain has $1 in fiat in a
bank account (or in some form of easily liquidatable low risk investment, like a treasury bill)*
*There is a lot of speculation that USDT is not backed 1:1, but that is a different topic for another report.

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These next two stablecoin mechanisms are going to start becoming a lot more important as the
dust settles and the inherent risks of centralized stablecoins & fractionalized banking become
more evident.

Algorithmic

Algorithmic stablecoins are made possible using smart contracts. Whilst a centralized stablecoin
relies on a central entity to keep the peg, an algorithmic stablecoin uses smart contracts to mint
& burn tokens to increase and decrease the supply as required.

This is made possible by a secondary token, which has a free moving market value (for example
LUNA, or FRAX). This token can be minted or burned in order to return the stablecoin to its $1
peg.

Although there are plenty of examples of this technology working, UST & Terra have given this
form of stablecoin consensus a bad name. Most investors are apprehensive about using them.

Overcollateralized

With centralized stablecoins, every token is backed 1:1 with dollars. However, with a
decentralized stablecoin that can’t open a bank account to store dollars, the stablecoin needs to
be backed by something else.

An example of this in action is Djed, an overcollateralized stablecoin on the Cardano blockchain.

Users can deposit their $ADA tokens at a collateralization ratio of 5:1. $5 of ADA backing each
DJED. As an incentive for providing their collateral they generate a yield on their ADA tokens.

We have covered the DJED Stablecoin mechanism in detail during a live session, it's available
to watch in the google drive for mentorship students.

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How does Circle (USDC) work?

Circle operates in a very similar way to Tether, they accept USD in return they will mint you an
equal amount of USDC sent directly to your wallet.

Unlike Tether, Circle is regularly audited by Deloitte. Every dollar is accounted for, either
deposited in Cash in a US bank account, or in short term treasury bills (managed by Blackrock).

Circle holds $43bn in USD, backing the 43bn USDC tokens on the market (as of March 9th,
2023). ~23% of this is held liquid in cash in US bank accounts, ~77% is held in the ‘Circle
Reserve Fund’ which invests the money in short term t-bills.

The liquid cash was split between 7 major US Banks:

Bank of New York Mellon, Citizens Trust Bank, Customers Bank, New York Community Bank,
Signature Bank, Silicon Valley Bank and Silvergate Bank.

Exact distribution between these 7 banks is not made public.

Since their last audit in January, 3 of these 7 banks have closed. (Signature Bank, Silicon Valley
Bank & Silvergate Bank) Meaning the remaining USDC cash reserves is split between 4 US
Banks. Circle plans to add more banking partners soon.

$1.43bn per year is being generated from the ~80% of their liquidity ($31.6bn) in t-bills.

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 Timeline of Events
Friday, 10th March

Silicon Valley Bank (SVB) was taken over by the FDIC, marking the second biggest bank failure
ever in the US. With over $200Bn in assets, it was the 16th biggest bank in the USA. It was
predominantly used by VCs and tech startups.

Investors are quick to notice Circles financials reveal they have exposure to SVB, whilst the
exact amount is unknown but we can decipher from their Public Audit it is less than $11Bn

This caused the initial de-peg of USDC, made worse by it being a Friday so no minting or
redeeming would process until the following Monday (as the banks were shut)

Saturday, 11th March (Morning)

Circle announces on Twitter they have $3.3Bn remaining in SVB bank which was not processed
out of the bank before the week ended.

Market reacted emotionally, sentiment went dark & panic set in. Hundreds of millions of dollars
worth of sell orders hit the books as investors rushed to dump their devalued USDC tokens at a
loss. Flashbacks to UST, the fear of a similar outcome set a precedent of what may happen.
Getting out now at a 10% loss seemed like a better alternative than the fate of UST holders.

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However, the educated, unemotional investor saw opportunity amongst the pandemonium. With
the new information at our disposal we could run some numbers & figure out just how bad the
damage really was.

At this time, around 40bn USDC tokens were in circulation, according to usdc.cool, with 3bn
having been burned already over the weekend.

$40bn - $3.3bn = $36.7bn

$36.7bn / 40bn USDC = 91.75% still liquid

91.75% of Circles cash reserves is untouched, in an absolute worst case scenario a fair market
value of USDC is $0.9175

Anything below $0.9175 was a logical buy.

After running the numbers, then running them again, we posted this analysis into the Mentorship
Network Discord. At the time the price of USDC was $0.885

Some hours later the market calmed and the price found some comfort around $0.9175.

Around this time the narrative had very much changed to align with the math, a general
consensus had been reached and the market had come to agree with the fair market value of
USDC at $0.9175. Investors were happy to buy anything below.

Finding A Best Case Scenario

Beyond that, it would depend on the FDIC & FEDs response. ‘How much of the $3.3Bn would
be returned to Circle?’ was the question we had to ask ourselves.

Most bullish estimates, using historical data, was 94% - leaving a hole of just $198M. Which can
easily be filled by Circle. However the timeline for this could be months, even years.

It was then down to fundamental analysis on Circle as a company, could they realistically fill a
$3.3bn hole in their balance sheet and operate business-as-usual come Monday?

Circles Highly Profitable Business Model

Circle makes a lot of money, with little overhead. As we know from their audits, Circle holds 79%
of their USDC cash reserves in short term t-bills. This is around $31.6bn returning $1.43bn per
year. It would not be difficult to sell off some equity, or even use existing cash reserves, to fill
this hole and keep the company operational - even if just temporarily until the FDIC pays out.

Further supporting this, last year Circle was planning to go public and had the company valued
at $9bn.

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Finding An Edge
Our previous assumption works on the basis of a fair distribution, that every USDC holder is
going to get a fair piece of the pie. This was my biggest concern behind this trade, the hole in
Circles balance sheet becomes proportionally bigger as more tokens are redeemed.

$3.3bn loss against $40bn = 8.25%

$3.3bn loss against $20bn = 16.5%

This is where our edge comes in, we have a direct means of redeeming USDC through our
Circle account. This gives us the best chance of redeeming USDC at $1, or above market value.

We sent all USDC to Circle to queue up for redemptions come Monday.

Due to the requirements to open a Circle account, a registered company & a minimum yearly
turnover, I know most USDC holders do not have an account. This gave me further confidence
in taking this trade (and also on the eventual repegging of USDC, it's harder to have a USDC
bank run if most holders don't have a bank account.)

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Saturday, 11th March (Afternoon)

A tweet came later Saturday from the CEO of Circle, Jeremy Allaire, confirming that Circle
would continue to honor USDC redemptions come Monday for the standard 1:1 rate.

He also spoke on the scenario in which the $3.3bn is not immediately returned from the FDIC.
Circle would cover any expenses using company reserves or by seeking external investment, as
we had predicted.

This instilled confidence into the market and led to a price increase for USDC up to $0.975.

Price continued to be volatile, falling and finding comfort at $0.95. At this point we initiated
further buys with the intention of sending to Circle for redemption.

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Sunday, 12th March

The next notable update came on Sunday, from the FED, they confirmed that depositors of SVB
would be returned in their entirety from Monday. Meaning the $3.3bn would be accessible to
Circle on Monday, and no longer was there a hole in the USDC reserves.

Even after this announcement, it still remained a 1.5% off-peg due to huge selling pressure from
investors who are happy to take a small loss even when there is no need to do so. One last
opportunity to arbitrage (or run a leveraged position if you’re in a region where that is possible
[or through AAVE, but the borrowing APR negated a lot of the profits]).

In Conclusion

USDC will regain the peg due to arbitrageurs redeeming USDC tokens on Circle, this may still
take a few days as we can expect large selling pressure on all markets from investors who are
still selling $1 lower than $1.

Our three trades netted us 11.5%, 5% & 1.5%

There is always a way to win if you can ignore the hysteria & focus on the facts. The level
headed investor will come out on top.

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 The Takeaways
The problem laid deeper than we looked.

USDC’s regular audits made it the golden child of stablecoins, the safe-investors pick. In a room
full of sketchy backgrounds, SEC investigations and explosive algorithmic shitcoins, USDC
seemed like the obvious choice. And objectively, it was.

The problem was not Circle, they had every token backed with fiat. The problem is the
fractionalized banking system that the world is built on. Circle may have everything backed, but
the bank they’re using to keep it ‘safe’ doesn’t. How ironic.

If a year ago you’d have asked any seasoned crypto investor ‘What was the biggest risk to
USDC’ I would be willing to bet not a single person would say ‘Fractionalized Banking’.

We take it for granted that these systems work as intended, 2008 was a long time ago, long
enough ago for near enough everyone to forget about it.

Hopefully we are all more vigilant moving forward.

Enter the mind of a retail investor, understand what they are thinking

I attribute a lot of my success as an investor to two main things, one of which is being able to
understand the psychology of a typical crypto investor. Rationality is delayed, emotionality takes
the driving seat.

Crypto is the epitome of emotional investing, as the markets are driven by retail investors.

The profile of a retail investor: fast moving, emotionally driven & overinvested.

‘Predictable Irrationality’ sounds like a juxtaposition, but I believe it encapsulates the crypto
markets perfectly.

You need to be able to mentally transpose yourself into their mind, and see the scenario through
their eyes. Understand the panic, feel the pressure to act quickly.

Drawing Incorrect Comparisons

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The biggest mistake I saw being made throughout this entire ordeal was the false comparisons.

“X failed over here, so X over here must face the same fate.”

This is delusional, twitter is ripe with this sort of fear mongering. Unfortunately you do not need
knowledge to speak with authority, so many terrible & factually incorrect opinions which
appeared to be from a place of expertise became high-engaging tweets.

The most apparent of which was comparison between UST & USDC

UST & USDC are not comparable, other than them being pegged to a dollar. The underlying
technology is totally different. Anyone with any technical knowledge would know this.

However, this fear of this alone drove many investors to sell their USDC at huge discounts.

This is like selling your car because your friend died in a boating accident.

The worst case of this I saw was a page with over 250K followers tweeting ‘The USDC crash is
giving me UST vibes’, this since deleted tweet received huge engagement - i can’t imagine how
much money was lost as a result of this awful take.

The Market Reacts With Emotion, That Emotion is Contagious.

Your mind molds to the information it consumes.

This was one of the very first lessons I teach in the mentoring program because it is so
important to understand, not only about yourself, but also everyone around you.

Fear is one of the most contagious emotions, if you are constantly consuming information that is
fear inducing you’re going to become fearful - then you will make decisions as a result of that
fear.

Think back to the bull market, the sentiment was overwhelmingly positive, to the end that many
investors believed this euphoria would never end and prices would go up indefinitely. They had
their minds molded by the moonboys.

We’re all human, so no one of us is immune to this. Some may be more easily persuaded than
others, but eventually everyone's mind will mold.

The solution is not abstinence, but self-aware de-biasing. If you only have opinions that support
one side of an argument, you don't have an opinion, you’ve been subconsciously programmed.

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The Masses are Often Wrong, You Can’t Rely on Group Thought.

‘Be greedy when others are fearful, fearful when others are greedy’

This principle relies on the underlying understanding that at critical, high intensity moments the
majority are usually incorrect.

No better recent example of this exists than last weekend.

I counted 50 USDC-focused tweets on a fresh twitter timeline (to remove any algorithmic bias),
42 out of the 50 suggested the USDC situation was in some way negative. Only 8 out of the 50
presented this as an opportunity.

I watched investors with large audiences crack under pressure and panic sell, VC funds
dumping USDC at million dollar losses on-chain, research firms posting terrible fear mongering
analysis, comment sections being flooded with doomsday predictions.

If you can only make decisions with the comfort of everyone around you agreeing, and not on
the conviction of your own analysis, you won't be able to separate from the crowd.

Become comfortable with the potential discomforts of individualism.

But be aware when you begin changing your surroundings. Your consensus of what the majority
are thinking is typically divulged from the perspective you hear most frequently, as in the early
stages of your investor career this is what you will be primarily surrounded with. When the
perspective you hear most regularly flips to the minority of highly-profitable investors, you need
to shift your consensus manually.

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No Trust in Corporate Entities.

Many people do not believe a word that is said by corporate or government entities, whilst i
have sympathy because it is undeniable that we are being constantly misled, this frame of mind
stopped a lot of traders from taking this position they otherwise would have.

Your mind molds, if you pay too much attention to deception you start to believe everyone is
deceiving you. Crypto enthusiasts are generally untrusting, they create ‘trustless protocols’ and
‘decentralized governance’ - but you must be able to separate the frame of an enthusiast from
an investor. Conduct rational analysis to decipher if someone can be believed or not, leaving
preconceived biases at the door.

Diversify Risk, Always

Finally, and most importantly, are the principles of risk management. Everything principle i teach
is with this in mind:

● Split your investing capital between multiple altcoins, across different niches, between
multiple risk categories with long-term entry strategies

● Diversify your passive income streams across multiple protocols, using different products
on a range of blockchains.

● And most importantly right now, spreading your on-chain liquidity between multiple
stablecoins to avoid over-exposure if one fails.

This last point alone saved me thousands of dollars in temporary losses – which if the situation
was different could have easily been permanent losses.

In a high risk industry like crypto, any step you can take to substantially reduce risk is a step
worth taking. Moving forward I'm going to be taking more steps to further reduce risk of holding
large amounts of capital on chain, more on this to come.

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