Introduction
This is a hypothetical scenario all DAOs have entertained. It is time for the SiloDAO to examine it and prepare for it.
The crypto market is in turmoil now following the FTX debacle. We are witnessing the systemic failure of many funds in the process. We don’t know the impact it will have on the centralized industry backing DeFi.
We have been hearing rumors about entities like Silvergate facing a bank run - or will soon. Silvergate and a handful of banks providing banking services to the crypto industry maintain fractional reserves and as such there is a realistic possibility for bank runs that may lead to their failure.
How does that impact our DAO?
DeFi has grown incredibly big due to the centralized stablecoins, USDT and USDC. Combined, they account for over $100B. While Circle, the company behind USDC, appears to be in a solid position, the bank that custodies the assets backing USDC might not be. There is a risk that the bank custodying the assets behind USDC may either become illiquid or insolvent.
If there are two lessons to learn from current and past insolvency events, they are 1) we should not trust the “everything is fine” reports provided by centralized entities when rumors start circulating and 2) it’s always best to be first out the door any time the solvency of a counterparty is in question.
What is the worst scenario that can happen?
Hypothetically, if there is a bank run on the bank that custodies the assets that back USDC, USDC may break its hard peg to $1. As these rumors increase, we may see a flood of capital looking to leave USDC such that either redemptions at the $1 peg are suspended or USDC is frozen during bankruptcy proceedings. The same can happen to USDT.
The scenario puts the treasury of our DAO at a tremendous risk given almost the entire development fund is denominated in USDC.
What can we do in case USDC is at risk of depeg?
- Sell USDC for ETH: This is risky because USDC imploding will have a systemic shock to all of crypto, which means that ETH will likely lose value. ETH may potentially lose so much value that SiloDAO cannot fund ongoing operations for a long period of time.
- Sell USDC for other decentralized stablecoins: All stablecoins are either backed by USDC or correlated to USDC. The problem is that these other decentralized stable coins are either significantly backed by USDC (DAI), have high costs of carry (RAI), or face meaningful liquidity and stability risks in periods of market illiquidity (LUSD).
- Sell USDC to USD: This option is the most feasible one but it requires a trusted custodian given that we would be moving the development fund offchain to a traditional bank. Having funds in USD preserves token holder’s funds and provides DAO with many options should contagion within crypto spread. .
Path forward
The DAO should discuss the best path to preserve the DAO’s treasury funds in advance of a possibly severe downfall happening.
The third option mentioned above might be the safest to activate, but it will take time to set up properly. If the DAO finds it to be the safest, the execution can look like the following:
- Authorize the core team to custody the funds: Today, the core team provides services to SiloDAO through a company based in the USA, including paying for technology infrastructure, security services, contributors payouts, among many other services. While the SiloDAO is being formed in the Cayman islands, the DAO can authorize the core team’s company to be a temporary custodian of the USD amounts until it is safe to return the amount to the DAO.
- Sell USDC to USD: When needed, the core team can transfer USDC to its company’s Coinbase account, and sell the entire amount to USD, and transfer it to its bank account.
- The DAO can then decide what to do with the money, for example, sending it back to the DAO’s treasury in any digital currency at any time.