SVB Collapse Shows the Rot in U.S. Banking and Dollars

Bank balances and money itself are effectively illusions. Reserve co-founder Nevin Freeman considers an alternative.

AccessTimeIconMar 17, 2023 at 3:15 p.m. UTC
Updated Sep 28, 2023 at 2:23 p.m. UTC
AccessTimeIconMar 17, 2023 at 3:15 p.m. UTCUpdated Sep 28, 2023 at 2:23 p.m. UTC
AccessTimeIconMar 17, 2023 at 3:15 p.m. UTCUpdated Sep 28, 2023 at 2:23 p.m. UTC

It’s common knowledge that banks are the safest place to store your money, but the run on Silicon Valley Bank (SVB) and the collapses of Silvergate and Signature shook that assumption – and rightly so. Initially, many were quick to point fingers at crypto as the culprit for Silvergate and Signature’s failures, but SVB is less tied to digital assets. Instead, something else is to blame entirely: the Federal Reserve’s decision to hike interest rates.

Nevin Freeman is the co-founder of Reserve.

What could have prevented this modern-day bank run? Perhaps different decision-making by the Fed or more conservative investments by the bank. More importantly, these events serve as reminders of the ever-present risks behind fractional-reserve banking and the confusing nature of the dollar itself.

What if money were real?

The U.S. dollar, as it exists today in the digital world, is no longer a store of value. The problem isn’t just the dollar’s loss of purchasing power to inflation; it goes much deeper. The dollar has become a sort of weird accounting trick.

When you give a dollar to a bank, you see the dollar in your account. It feels like it’s there, like it’s yours and like you have full control over whether and when to spend it. You can go to sleep knowing that you have the power to pay for what you need in business or in life.

Or can you?

When banks like Silvergate, Signature and SVB fail (there were 562 U.S. bank failures from 2001 through 2023, about 25 per year) we’re reminded that “dollar” balances in bank accounts are not actually “dollars” in the way we think of them.

If banks kept all of their deposits on hand and backed their customer balances 1:1 with real dollars, this would be fine. Bank customers could all decide to transfer all of their balances, and the bank would have no trouble doing that because it had 100% of the actual dollars.

However, they don’t. Banks often only keep about one real dollar with the Fed for every $10 of deposits they show to their customers. So if you have a balance of $1,000, the bank might only have $100 in real dollars in the background. There used to be minimums, but in 2020 the Fed removed these minimums and left it up to banks to decide how much to hold in reserves.

Think of it this way: Imagine you are the customer and I’m the bank. You deposit $1,000 in physical cash with me. I keep $100, and lend out $900. If you come back and ask for your $1,000 and I can’t get the borrowers to pay back the $900, I can sell that loan to another bank for 900 real dollars so that I can repay your $1,000 in full.

The problem with this is that sometimes those other assets can lose value in dollar terms. Suppose the loans I made are starting to look like they weren’t a good idea, and other banks are only willing to pay $600 for them. Now if you ask for your $1,000 I can only offer you $100 that I had kept in real dollars plus $600 that I can raise from selling the loan to another bank for 700 real dollars.

That’s essentially what happened with Silicon Valley Bank – it held securities that ended up losing value and reached a point where people started to worry it wouldn’t be able to sell those assets for enough real dollars to cover all of its customers’ deposits. Once people realized this, everyone wanted to pull their money out first, causing a bank run.

How FDIC (sort of) fixes this

The Federal Deposit Insurance Corporation (FDIC) maintains a fund in order to insure customer deposits of banks that fail, so that if banks lose money on their loans and investments the account holders can be made whole anyway. They insure up to $250,000 per person or company that has an account with the failing bank, so as long as your balance is less than $250,000 with an FDIC-insured bank, you have less to worry about.

But our economy is powered by businesses, not just people. As businesses grow, they often have more than $250,000 in capital to manage. What do they do? The answer might surprise you.

They lend their money directly to the U.S. government instead of putting it in a bank.

It turns out the safest way for a business to guarantee that it’ll have dollars in the future is to lend those dollars to the U.S. Treasury Department in exchange for special receipts that prove they are owed the money on some particular date. Depending on the duration of the loan, the receipts have different names: Treasury bills (“T-bills”) are four weeks to one year, notes (“T-notes”) are two to10 years and bonds (“T-bonds”) are 20 to 30 years. Since they are all receipts to be paid back by the Treasury, all are often called “Treasurys.”

By holding Treasurys, businesses have no bank between them and the government, they are only depending on the Treasury to make good on its promise to deliver real dollars to the business’s bank account at some future date. If a bunch of banks fail in the meantime, that has no impact on the Treasury or the business, so the promise stands.

Since this is safer than a bank account with more than $250,000 in it, larger businesses pretty much all end up going this route.

Isn’t that strange?

There’s no way for businesses to just hold real dollars. It would be impractical and dangerous to keep piles of physical cash, and nonbank businesses aren’t allowed to have an account with the Fed, which keeps track of all digital dollars, so they play a game of continual lending and re-lending to the government because the receipts for those loans are the closest thing to real digital dollars they are allowed to touch. Loaning money to the government earns you interest as well, but it’s often done just for safety, not for profit.

This adds a lot of complexity and confusion to a system that could be simple and elegant, and it certainly seems to give the government a lot of borrowed money to play with.

(It’s also noteworthy that the FDIC’s resources aren’t unlimited. Its insurance fund was only about $128 billion as of December 2022, but it's on the hook to cover about $10 trillion to cover all accounts with a max of $250,000. While it’s hard to think about how all $10 trillion in deposits would need to be covered at the same time, to put things in perspective Bank of America has $1.9 trillion in FDIC-insured deposits across all accounts as of last December.)

What a real dollar could look like

If we wanted to, there’s no reason in principle we couldn’t open the database of real dollars to the public. You and I, along with Apple, your local ice cream shop and the government of Argentina could all have accounts with the Fed, which would have no risk of vaporizing, no matter how many dollars we had there.

There’d be no need for FDIC insurance (where does that insurance fund money come from anyway?), and we could decide whether to lend our money out for interest instead of being forced to lend it to a bank any time we wanted it in digital form.

And yes, if we wanted, we could do it on a blockchain. If a real dollar were issued on a real, public blockchain like Ethereum (not a “permissioned chain” that only a few parties can access or administer), the financial infrastructure we could build and automate on top of that would be incredibly efficient and effective. If you don’t know what a smart contract is and have not yet played around with decentralized finance (DeFi), this will sound crazy to you. If you have, you’ll be nodding along. Before too long the majority of the population will start to see these implications.

USDC, the U.S. dollar-pegged stablecoin, is the closest to a real dollar on a blockchain we have today – it’s mostly backed by Treasurys and bank balances. Users wanting to exchange one USDC for a dollar can essentially be sure the money is there.

This past weekend, however, it looked for a moment that USDC might implode. Some of its backing reserves were sitting in SVB bank accounts, so the market priced in the risk the money would be irretrievable or wrapped up in a lengthy bankruptcy process. That is until it became clear all SVB balances would be covered by the FDIC on Monday.

Image courtesy of CoinMarketCap.

USDC’s blip wasn’t a problem with crypto, it was a problem with how bank balances work. Likewise, if the Fed issued a dollar directly to public blockchains – it could issue on many chains, just like USDC – there would be no such risk.

But why stop there?

Asset-backed currency

In a world where we have the technology to create unforgeable digital tokens to represent anything and send them to anyone with very little cost or friction (we are in that world! it’s so cool!), there’s so much more we can do than just a real digital dollar.

Earlier, I waved inflation and purchasing power to the side so we could focus on this more obscure problem, but inflation is still a thing. Fiat currency supplies pretty much all end up being expanded faster than their economies grow, and this leads them to be diluted and lose purchasing power. Sometimes, extreme things happen and they’re devalued really quickly.

Wealthy people and businesses already have a solution for this: Don’t store too much wealth in fiat currencies.

When you have any real wealth, you keep a little in your bank account, a chunk in Treasurys and the rest in a diversified portfolio of stocks, real estate and perhaps some gold or bitcoin.

If we wanted to, we could issue tokens for each and every one of these assets on public blockchains, and we’d get the same incredible transaction properties, programmability and global accessibility we have with USDC today.

Once we had enough tokenized assets we’d get something that’s, in my opinion, more than the sum of its parts: an asset-backed currency. We could take all of those assets and aggregate them together, just like wealthy people and businesses already do, into a single portfolio to create an index of the entire global economy. And that index could then be represented with a single token.

Imagine buying a bag of groceries and paying with a token that represents a tiny slice of the entire world economy. It’s a wild idea, but do we really need it? What does it solve? This kind of money – an asset-backed currency – could be designed not to dilute.

Central banks have an impossible challenge on their hands. They are charged with keeping the economy stimulated and at the same time not inflating the currency. But adding units of currency is the easiest way to stimulate an economy, so they succumb to the pressure. I truly believe it’s a systemic thing, not incompetence or malice – if you or I were in their place, we’d end up making pretty much the same moves they do.

But an asset-backed currency could be independent of governments, with no mandate other than maintaining value.

We are using 1929-level banking systems to manage 2023-level wealth. It's costing us 25 banks a year, plus all the collateral economic dislocation, when we have 2023 technology that would make the leap to a point where it's like we were all banking directly with the Fed. Cutting out the bank layer would cut out the insane leverage that is an accident waiting to happen.

It’s confusing and counterintuitive, but cryptocurrency done right is actually less risky than a Main Street bank. Don’t let the myriad of scams and fraud in the industry get in the way of the good we can do with it.

Exactly how asset-backed currencies on public blockchains will work is yet undetermined. Global crypto penetration is about 5%, which is 1998 in internet penetration – the same year Google launched to compete against 20 established search engines.

The Google of stablecoins likely has not been invented yet and the 2020-2030s look like they’ll be the great unraveling and reorganization of the financial system. Instead of holding “dollar” balances in bank accounts that may or may not be real dollars, we could just … have real money.

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Nevin Freeman

Nevin Freeman is the co-founder of Reserve.