Erebor Bank’s Free Stablecoin Plan Failed After Traders Found the Loophole

Erebor Bank, a Silicon Valley‑based startup backed by Anduril co‑founder Palmer Luckey, launched a free conversion service that allowed clients to redeem USDC and USDT for U.S. dollars at a 1:1 rate without fees. The offering was intended to position the bank as a crypto‑friendly partner for firms in the cryptocurrency, AI and defense‑tech sectors.

How the Free Conversion Was Exploited

Stablecoins such as USDT sometimes trade below their $1 peg on secondary markets. Traditional redemption services charge fees—Tether, for example, imposes the greater of $1,000 or 0.1% for direct redemptions. Erebor’s fee‑free policy meant that a trader could purchase USDT at a discount, redeem it at Erebor for a full dollar, and keep the price differential. When executed at scale, the small per‑unit profit accumulated into millions of dollars.

Trading Firms Involved

According to reports, professional firms including Wintermute and Galaxy Digital conducted large‑volume redemption trades using the free conversion service. Wintermute is said to have processed millions of dollars worth of USDT in this manner. Galaxy Digital also performed similar stablecoin redemption trades.

Bank’s Response

After identifying the arbitrage activity, Erebor instructed firms such as Wintermute to cease the practice. The bank subsequently removed the free conversion option for customers without substantial deposits and introduced volume‑based fees and limits on stablecoin redemptions. Despite the incident, a Wintermute representative indicated that the firm continues to maintain a business relationship with Erebor.

Implications for Crypto Banking

The episode highlights the challenges new crypto‑focused banks face when designing fee structures for stablecoin services. Even fractional price differences can become profitable at high volumes, prompting banks to balance attractive offerings with safeguards against arbitrage. Erebor is currently pursuing a $1.5 billion fundraising round at an $8 billion pre‑money valuation, with FDIC approval to serve technology, payments, investment and defense companies, including crypto firms.