Fed’s QT policy drains bank reserves
The U.S. banking landscape is currently navigating a complex financial terrain, marked by a quest for liquidity amidst the Federal Reserve’s quantitative tightening (QT) measures. QT is a policy that involves reducing the size of the Fed’s balance sheet by selling or letting mature some of the assets it acquired during the quantitative easing (QE) program that followed the 2008 financial crisis. QE was a policy that involved buying large amounts of government bonds and other securities to inject money into the economy and lower interest rates.
The Fed’s QT policy, which began in 2017 and ended in 2019, has drained bank reserves by about $800 billion, according to a report by Cryptopolitan. Bank reserves are the deposits that banks hold at the Fed, which they can use to meet their liquidity needs and regulatory requirements. The reduction in bank reserves has made it harder for banks to access cheap and stable funding sources, especially in times of stress.
Bank failures expose fragility of crypto sector
The quest for liquidity has become more urgent after a series of high-profile U.S. bank failures in March 2023, which exposed the fragility of the crypto sector. The banks that failed were Silicon Valley Bank (SVB), Signature Bank, and Silvergate Capital Corp, all of which were known for their crypto-friendly services. These banks provided banking support to many crypto businesses, such as exchanges, lending platforms, and stablecoin issuers.
The bank failures were triggered by different factors, such as a run on deposits, a massive bond loss, and a fraud scandal involving two crypto firms. However, the consequences were similar: crypto businesses faced challenges in accessing U.S. dollar liquidity, forcing many to seek banking support offshore. The bank failures also impacted the stablecoin market, which relies on the backing of fiat currencies to maintain their peg. The most affected stablecoin was Circle USD (USDC), which lost its peg temporarily after SVB’s closure.
Crypto activity contracts in North America
The banking crisis has had a negative impact on the crypto activity in North America, according to a report by Chainalysis. The report, focusing on North American crypto activity, highlights a substantial drop in “institutional” transaction volume, defined as transactions exceeding $10 million, beginning in April 2023. In contrast, smaller-scale “professional” and “retail” trading activities remained relatively constant.
The report noted, “Crypto activity contracted more in the months immediately following the March banking crisis that saw Silicon Valley Bank and crypto-friendly banks Signature and Silvergate close down.” This decline added to the ongoing trend of reduced trading activity since the failures of several crypto exchanges and lending desks, notably FTX and Alameda Research in November of the previous year.
The report also revealed that the share of crypto volume occupied by stablecoins in North America dropped from 70.3% in February to 48.8% in June. The majority of stablecoin inflows to the 50 largest crypto services have shifted from U.S. services to non-U.S. services since the spring of 2023.
Crypto industry seeks alternative solutions
The crypto industry is not giving up on its quest for liquidity, despite the challenges posed by the banking crisis and the Fed’s QT policy. The industry is seeking alternative solutions, such as decentralized finance (DeFi), peer-to-peer (P2P) platforms, and new banking partners.
DeFi is a sector that offers various financial services, such as lending, borrowing, trading, and investing, without intermediaries, using smart contracts and blockchain technology. DeFi has grown rapidly in the past year, reaching a total value locked (TVL) of over $200 billion, according to DeFi Pulse. DeFi offers crypto users more control, transparency, and efficiency, as well as higher returns and lower fees, compared to traditional finance.
P2P platforms are another option for crypto users who want to access liquidity without relying on banks. P2P platforms allow users to trade crypto directly with each other, using various payment methods, such as cash, bank transfers, or mobile money. P2P platforms, such as Paxful and LocalBitcoins, have seen an increase in volume and users in North America, especially in countries with limited banking access, such as Venezuela and Nigeria.
Finally, some crypto businesses are still hopeful of finding new banking partners in the U.S. or elsewhere. Binance.US, the U.S. arm of the world’s largest crypto exchange, is reportedly looking for a new banking partner after the failure of Signature Bank and Silvergate Capital Corp. Binance.US is facing difficulties finding a bank that is willing to work with the company, due to regulatory concerns and scrutiny. However, the company has stated that it works with multiple U.S.-based banking and payment providers and continues to onboard new partners while upgrading its internal systems.
