Recently, mid-sized American banks have been facing a critical situation. Some suffered bank runs, some were forcibly shut down by regulators, and many saw their market capitalization plummet amidst features of systematic collapse. What can we learn from this seemingly abrupt crisis? The traditional banking system may not be as trustworthy as most believe, and protection can be put into place by infusing more decentralization into our financial ecosystem.
What is SVB: The Crisis Facing Small U.S. Banks
The bank failure that started this cascade was a regional Silicon Valley bank. On March 10 2023 SVB collapsed after experiencing a bank run, representing the second-largest American bank failure in history and the most significant since the 2008 financial crisis. Their core problem stemmed from investing deposits into long-term Treasury bonds that yielded relatively low returns, then being faced with a period of interest rate hikes which made such long-term holdings much less attractive. As a result, the bank was forced to sell securities and take a $1.8 billion loss to fulfill deposit obligations.
This downfall highlighted an issue facing other mid-sized regional banks in the United States, as depositor confidence was shaken across the board. This led to spiraling stock prices on many other regional banks. The United States federal government chose to step in and announced that it would cover depositors of failing institutions.
Crypto as a Trustworthy Alternative to TradFi Banks
While bank failures are often caused by an amalgamation of various factors with no primary culprit to blame, the recent situation still showcases some unexpected fragilities within the reputable traditional financial system. Presumably these mid-sized banks and the federal reserve were simply acting in good faith to provide their customers and citizens with healthy economic conditions, yet the system still showed cracks. In many ways, the blockchain and decentralized finance offers a more trustworthy and stable alternative.
Firstly, it’s important to remember that the invention of cryptocurrencies was in response to perceived inadequacies with traditional banking in the first place. Satoshi Nakamoto, the inventor of Bitcoin, witnessed how the 2008 global financial crisis arose from the banks’ irresponsibility of lending depositor funds out to form credit bubbles while keeping little in reserve. In a blog post, Satoshi claimed that the traditional fiat system relied too much on trust, while he sought to replace that dependency with cryptographic proofs. Despite recent price correlation between cryptocurrency and the wider economy, one must not forget that cryptocurrency and traditional banks are not complementary goods and instead substitute goods.
Furthermore, crypto projects in DeFi are almost always overcollateralized whereas traditional banks run on a fractional reserve system. Fractional banking can lead to financial instability in the banking system, as banks can become vulnerable to sudden changes in depositor behavior or shifts in market conditions. On the other hand, efficient and secure cryptocurrency exchanges like Phemex have all deposits in reserve which can be verified on-chain through our Proof-of-Reserve system. The benefit of the blockchain is that all transaction records are wholly transparent because all mechanisms are governed by code. Platforms like Phemex are supporting that transparency while bridging the gap to regular users through top-notch user-friendly interfaces.