Abstract

To what extent does the collapse of a commercial bank spread contagion across cryptocurrency markets? How do markets behave around bankruptcy if digital assets remain stuck within the bank and cannot be withdrawn? We use a BEKK model to examine contagion effects across major digital assets during the Silicon Valley Bank (SVB) collapse period in early March 2023. We find evidence of contagion across major stablecoins and Bitcoin. We also examine the price action when nearly all withdrawals at SVB were prohibited. We find substantial abnormal movements in stablecoin cumulative returns and traded volumes, indicating a “flight to safety” from less to more authoritative and trusted stablecoins. The implications for practitioners and policymakers are discussed.

Introduction

Cryptocurrencies are gradually gaining traction in trading and becoming a notable segment of the financial landscape, providing new investment avenues. However, their inherent volatility continues to hinder their broader acceptance. Among cryptocurrencies, a subset known as stablecoins, which is intended to maintain a “stable” peg to a reference currency, is crucial to the market as it allows traders to work around the volatility issue and keep money in a form equal to US dollars (De Blasis et al., 2023). Access to those digital assets is typically given by new financial technologies (also called Fintech) such as digital wallets or Centralized cryptocurrency Exchanges (CEXs), with the aim of decentralizing finance through innovative offers of financial services. However, due to the high costs associated with the trading of cryptocurrencies in US dollars, the impossibility of using US dollars on cryptocurrency exchanges,1 and the simplicity and speed of transferring those virtual assets between exchanges, stablecoins occasionally trade at a premium2 to the underlying asset they imitate (De Blasis et al., 2023). The recent bankruptcy of Silicon Valley Bank (SVB), the largest commercial bank for nearly half of all venture-backed tech startups in Silicon Valley,3 in March 2023 tied up $3.3 out of $40 billions of stablecoins in its financial statement, making this exogenous shock a significant event to study.

Thus, the aim of this research is to examine the impact of bank failure on the stability of stablecoin markets. Specifically, we examine the question of whether halting access to digital assets through the bankruptcy procedure of a traditional finance institution spills over contagion effects across those innovative instruments. Answering this question is important as the March 2023 collapse of SVB, together with the ensuing instability in a number of major stablecoins, demonstrated the importance of the interlinks between traditional and digital financial systems. The results of this research are therefore relevant to policymakers in both the traditional and modern financial systems interested in avoiding the risk of financial contagion, as well as investors willing to defend their savings and balance their portfolios against market uncertainty.

Conclusion

This study examined the extent to which the collapse of a commercial bank spread contagion across cryptocurrency markets and how those markets behave around the failure when asset withdrawals are halted. We use a BEKK-GARCH multivariate model to test for financial contagion around the Silicon Valley Bank collapse across multiple digital assets. Arguably, this is the second-largest bank run after the global financial crises experienced in history. We find evidence of volatility spillover effects across major stablecoins and Bitcoin, with a “flight to safety” from less to more stable virtual currencies.

Hence, this study provides important evidence of the ways the traditional and cryptocurrency financial systems are interlinked. Arguably, it links centralized and decentralized finance, showing the ways in which spillovers can occur between what seem to be separate realms of finance. Academics, practitioners, and policymakers alike interested in destabilizing risk in the digital finance ecosystem should pay attention to the connections with traditional finance and thus to the results of this research. A limitation of this study is that it focuses on the most liquid stablecoins and cryptocurrencies. Future studies may, therefore, further explore the links between centralized and decentralized finance, including stablecoins and other means of digital value exchange.