How Erebor Bank’s Sweet Stablecoin Deal Backfired

When Palmer Luckey’s Erebor Bank launched earlier this year, it made an attractive pitch to lure new crypto customers: It would convert their stablecoins to cash for free.

But Erebor wound up pulling the offer after several months, after sophisticated crypto trading firms sniffed out a way to make an easy profit out of the offer—at a cost to Erebor. The episode demonstrates that the young bank is still figuring out how to manage the risks of serving the cryptocurrency industry, a world of fast-moving financial flows, colorful characters and unusual business models.

Erebor is part of a new cohort of stablecoin-friendly banks, which popped up after getting bank charters under the Trump administration. While Erebor has won plaudits from defense tech startups and novel businesses that other banks have turned away, the company is still in its early stages and is refining how it serves customers, according to people who have dealt with the bank.

Erebor, which is soon to close a $1.5 billion fundraising at a $8 billion valuation, was awarded a national bank charter by the Office of the Comptroller of the Currency in February, the first newly created bank to receive a license under the second Trump administration. The bank, backed by billionaire Anduril co-founder Luckey, Peter Thiel’s Founders Fund and Andreessen Horowitz, received its charter roughly four months after its application—one of the fastest-approved startup charters in modern U.S. banking.

This is how the arbitrage play worked: Erebor promised customers it would convert Tether’s and Circle’s stablecoins to U.S. dollars at face value without charging a fee, people familiar with the offer said. And yet stablecoins often trade at a slight discount to their $1 face value in the open market, thanks in part to the fees major stablecoin issuers like Tether and Circle charge to convert tokens into cash.

The disconnect meant traders could profit by buying large numbers of stablecoins in the open market and redeeming them with Erebor at full face value, with the bank eating the difference in costs.

One firm that quickly took advantage of Erebor’s offer was Wintermute, a crypto-focused high-frequency trading firm backed by investors such as Lightspeed Venture Partners. It made money swapping millions of dollars’ worth of tether stablecoins it had purchased at a discount for their full face value of $1 each with Erebor, the bank discovered earlier this year, according to people briefed on the matter.

For Wintermute, the trade was business as usual. The firm makes money by eyeing tiny fractions of market mispricing across millions of daily trades, and it is known for having profited handsomely during the 2022 collapse of stablecoin terraUSD, when it bought mountains of the collapsing token and traded them for their sibling currency, luna.

Galaxy Digital, a crypto-focused financial firm with a big trading operation, also engaged in a stablecoin-redemption trade with Erebor, according to people familiar with the matter. Galaxy declined to comment on its counterparty relationships.

Erebor, realizing it was losing money due to the high-volume arbitrage, told firms including Wintermute to stop the trading and withdrew the offer of free stablecoin conversion for customers that didn’t have sizable deposits at the bank, people familiar with the situation said.

A representative for Wintermute said the company “continues to do business with Erebor, and we value our relationship. We don’t comment on the details of commercial arrangements.”

Since then, Erebor has changed some of its contract terms regarding the settlement of stablecoins into the bank. It introduced a range of volume-based fees and limits, according to its clients. The changes have upset some clients who were drawn to the upstart bank because of its promise that it would treat stablecoins the same way as cash, a crypto-friendly stance that in the past was uncommon among banks.

Erebor’s original offer was important to the industry because the cost of converting stablecoins to cash was significant enough to undermine their adoption.

An array of financial institutions, such as Stripe, Visa, Mastercard and Coinbase, are planning to launch a new stablecoin, Open USD, with no charges on converting dollars into the digital currency and vice versa. But Jeremy Allaire, founder and CEO of Circle, which issues the USDC stablecoin, has questioned whether Open USD’s plan could succeed.

U.S. regulators are also working on rules specifying how stablecoin issuers should process redemptions following the passage of the Genius Act last year to ensure holders can exit stablecoins promptly and smoothly.