The New Madness of Crowds

USDC and USDT are two well-known stablecoins. USDC is fully backing by safe, liquid assets, which are verified monthly by a major U.S. accounting firm under the scrutiny of U.S. state regulators. USDT (Tether) is an unregulated stablecoin with questionable asset backing and opaque operations, founded by an actor from the Mighty Ducks and supported by a bank established by one of the creators of Inspector Gadget.

Yet, when Silicon Valley Bank (SVB) went into crisis, USDC broke the peg, and people fled to the nutty, opaque, unregulated Inspector Gadget backed coin.

(USDC is in blue and measured on the right axis and spiked below par, USDT is in red and measured on the left axis and spiked over par.)

Now, this is in some sense “explainable”. USDC kept some money at SVB and Tether (probably) did not. Matthew Zeitlin, channeling Matt Levine, put it this way:

One problem with being transparently and fully backed is that sometimes your investors can transparently see how much of your assets are in a bank that went bottom up, Tether does not have this problem.

SVB’s troubles stemmed from its investments in long-term government bonds, which dropped in value as interest rates rose. However, the bank’s fundamentals were not that dire. If no one had panicked, SVB could probably have paid off all its depositors in the ordinary course of business. The problem happened because some investors saw information they thought others might interpret negatively, prompting them to withdraw their funds. This led others to believe the information was indeed bad, validating the initial belief and causing a massive $42 billion withdrawal in a single day. Had transparency been less and transaction costs more, this wouldn’t have happened and, quite possibly, everything would have been fine.

Indeed, in the past, banks probably become insolvent on a mark-to-market basis but few people noticed. Today, a bank dips below the line and depositors are heading to the door.

SVB’s fundamentals may have been worse than I believe, poor management undoubtedly played a role. But fundamentals aren’t driving the boat; the boat is being driven by sunspots, memes, and vibes. Tether’s fundamentals are much worse than SVBs ever were. And USDC was even less imperiled than SVB, yet people ran to Tether. Why? Because there wasn’t a Tether sunspot. But be careful. Tether’s stability doesn’t mean that its fundamentals are strong. Not even close. Stability doesn’t mean good fundamentals and instability doesn’t mean bad fundamentals. The mad crowd is capricious. Tether’s time is coming, but no one knows what will spark the fire.

Greater transparency and lower transaction costs have intensified the madness of the masses and expanded their reach. From finance to politics and culture, no domain remains untouched by the new madness of crowds.

Hat tip: Connor Tabarrok and Max Tabarrok.