Circle + USDC's "Four-Character Classic" of Operation: Transparency First, Income Stability, and Compliance
Compilation of the original text: Bai Ze Research Institute
Compilation of the original text: Bai Ze Research Institute
Which products in the Crypto space are useful and real, and which are hype and Ponzi schemes?
Enthusiasts seem to agree that stablecoins are the most useful, and within stablecoins, the consensus seems to be again: USDC is the most stable of all stablecoins.
Stablecoins are fascinating because they are both adigital currency, another "platform", on which new applications can be built. But to fulfill this promise, they must be stable. Dollar-denominated stablecoins, such as USDC, need to allow users to convert into dollars anytime, anywhere.
If a stablecoin is trustworthy, developers can use it to build financial products, such as DeFi protocols, to replace old, traditional financial infrastructure.
Circle is a case study in compromise. It is a centralized company that issued stablecoin USDC for the development of decentralized financial system, which is widely used by web2, web3 and web2.5 companies. The introduction of USDC will not only make global payments cheaper and faster, third-party developers can also use USDC to build applications.
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USDC Accelerates Growth
This is the market value of USDC since its establishment in October 2018, and it can also represent the total circulation of USDC. At the time of writing, on July 20, 2022, that figure stands at $54.8 billion. After a 25-fold increase between July 2020 and July 2021, USDC in circulation has more than doubled in the past year. Since its price is pegged to $1,An increase in market cap means increased usage of USDC(And vice versa - when people exchange their USDC for USD, the market cap goes down).
This is Circle's first product value proposition - "Digital Dollar", which is also Circle's vision:Promoting global economic prosperity through the frictionless exchange of financial value。
If you’ve heard of Circle, it’s likely because of USDC, as this is the company’s first killer product. Most recently, it announced the launch of a second stablecoin, the Euro Stablecoin (EUROC).
But if you only think of USDC and EUROC as stablecoins, then you are very wrong (doesn't reflect the company's ambitions):
- A platform on which developers can build new financial systems
- Digital currency used by institutional investors for transactions and settlements
- A tool that enables frictionless, borderless exchange of value
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What are stablecoins?
If you’ve been paying attention to the crypto market lately, you probably laughed out loud when you heard the term “stablecoin.” "Stablecoin, eh?" you'll quip, "Not very...stable." It's a funny joke.
In May, UST (Terra’s stablecoin) lost its peg to the dollar (translation: it became less than $1). In addition to disrupting the entire Terra ecosystem, in the end, it also brought down crypto hedge fund Three Arrows Capital (“3AC”), which led to the downfall of BlockFi and other centralized finance (“CeFi”).
The UST situation reveals what should be obvious to anyone: not all stablecoins are...stable.
The goal of a stablecoin is to maintain a peg to its reference asset. For example a dollar stablecoin - a $1 stablecoin - like USDC - should be worth $1. As Alex Danco wrote in 2018:
The key tests for any stablecoin to be trusted by the market are:If users wanted to exchange their stablecoins for real dollars, would they be able to do so under any reasonable circumstances?
“Reasonable”, representing that people should always be able to exchange their stablecoins for real dollars.
Stablecoin issuers typically employ three main models to achieve this:
- Fiat currency support
- Crypto asset support
- algorithm
Algorithmic stablecoins, such as UST, do not have dollars, commodities, or anything as the backing of the stablecoins, but only through automatic smart contracts—the “algorithms” in “algorithmic stablecoins”—regulating supply and demand—and stabilizing prices.
Crypto-asset-backed stablecoins are backed by a basket of crypto-assets and are typically over-collateralized, meaning that the dollar value of the crypto-assets in reserves exceeds the dollar value of the stablecoin in circulation. They do this by requiring each user to stake more crypto assets (BTC, ETH, etc.) than the stablecoin is worth when minting the stablecoin.
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What are the risks of USDC?
Circle's USDC stablecoin is the most straightforward of the mainstream stablecoins: for every additional USDC in circulation, Circle will accumulate $1 worth of USD cash and US Treasury bills in the deepest and most liquid market of any asset in the world.
Dollars are either parked in USDC reserve bank accounts at BNY Mellon and other big banks, or invested in short-term treasuries that are more easily converted into dollars than anything else in the world. Circle publishes weekly reports and monthly testimonials on its website:
In a recent interview, Circle CFO Jeremy Fox-Geen said that Circle customers "can redeem all their USDC within a day. We can process those redemptions, and the only time limit for them to get their dollars back is the fiat currency bank." The limitations of the settlement system of the system itself.”
Concerns about Circle and USDC have been expressed by many, ranging from "the notion that centralized institutions cannot be trusted" to issues with the structure of its agreement with BlackRock around Circle's reserve fund. Concerns boil down to whether there are always dollars available when customers want to redeem USDC, which breaks down to whether Circle keeps its reserves in what it says are assets (cash and T-bills), and Circle's corporate business operations and USDC reserves Whether to separate.
Many of these claims seem to stem from misunderstandings about how USDC works, how reserves are held today, and the differences between USDC and Circle itself.
Regarding the first point, does Circle actually hold USD cash and T-bills? In the past, Circle held commercial paper, corporate bonds, and municipal bonds, but according to Grant Thornton's 2021 Cycle Check report, Circle will convert all of its USDC reserves into cash and cash equivalents in September 2021.
The company wrote in a blog post that the growth of the stablecoin “has rightfully attracted significant regulatory attention,” so it will hold all USDC cash reserves and short-term U.S. government Treasuries.
In addition to monthly attestations and annual audits, last week, Circle CEO Jeremy Allaire tweeted a breakdown of CUSIP levels of treasury holdings held by the Reserve:
Additionally, he said Circle is working to get permission from its bank partners to disclose how much it holds in reserves at each bank.
The second point is that Circle's business operations are separated from USDC reserves, and Circle itself is providing products that are separated from USDC, such as API, SeedInvest, and Circle Yield. Given the recent debacles of Celsius, BlockFi, Voyager, and other CeFi, investors are most worried about Circle Yield, but Circle's product is different in that it is only available to institutional investors and only offers very low deposit rates.
Importantly, Circle's yield products do not touch USDC reserves. Circle will not lend its USDC reserves to anyone. Circle Yield allows institutional investors to earn income through their own USDC.
Circle has publicly stated that its USDC reserves are held for the benefit of USDC token holders: “Circle does not and will not use USDC holders’ money to operate its business or to repay its debts. These funds are held in separate account."
In addition, Circle is regulated as a money services business and is licensed under the rules and state money transmission licenses that govern U.S. payment institutions, including Stripe, PayPal, and Apple.
Just to be clear though:everything is at risk. In theory, the biggest risk to USDC, in my opinion, is a total collapse of its banking partners or the US government defaulting on its debts, in which case "maybe only God help us".
It should be pointed out that although USDC seems to be the most stable stablecoin, there are risks and people need to watch their money.
Circle and Concord Acquisition Corp.'s S-4 filing with the SEC regarding the proposed SPAC merger transaction lists 23 risks on pages 29 and 30. Written very clearly: this is not investment advice, you should do your own homework.
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Can USDC be transparent?
For years, Tether's stablecoin USDT led the way, but has come under fire for years. One of the most serious allegations against Tether is that its chief financial officer, Giancarlo Devasini, used Tether reserves to fill a hole in the balance sheet of the crypto asset trading platform Bitfinex, which is particularly troubling because it means that Tether has not fully retained USDT. reserves, and Devasini is a large investor in Bitfinex.
Despite lawsuits and government scrutiny, Tether has proven to be the "stablecoin leader," maintaining a market capitalization of $65.9 billion, down significantly from $80 billion before the UST crash.
Tether's legitimacy has been debated and is beyond the scope of this article, but it's worth noting that Tether is currently trading at $1 despite net outflows of $17 billion. Circle CEO Jeremy Allaire said on the blog show,He believes Tether will be around for a long time and have useful applications, especially in Asia。
The core challenge facing Tether is that the company is not transparent and does not disclose where or what its funds are held. Especially in the stablecoin market where trust is required, this is not ideal.
Transparency is where Circle stands out. Trust is fundamental to stablecoins: people need to trust that their digital dollars will bring them fiat dollars. Trust is the main reason USDC has been able to slowly increase its market share, and one of the reasons why fiat-backed stablecoins are still much larger than algorithmic or crypto-asset-backed stablecoins.
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How do stablecoin issuers generate revenue?
Let’s take a quick look at how stablecoin issuers generate revenue. It's weird to think of a digital currency, or any other, as a business, but understanding how it works will help you understand the motivations of different stablecoin issuers.
In a nutshell, the revenue formula for a stablecoin issuer isReserve Dollar* Reserve Dollar Yield。
There are two main ways that stablecoin issuers can increase revenue:
- increase reserve
- generate higher reserve income
Adding reserves is simple. As the stablecoin issuer issues more stablecoins, it exchanges $1 from customers for the $1-denominated stablecoins it creates. It holds $1 as a reserve. If someone redeems, they return $1 in exchange for 1 stablecoin. So you can think of this growth lever like most companies do: increasing usage of your product.
Generating higher reserve yields is a bit more complicated, and this is where stablecoin issuers can run into trouble. Stablecoin issuers need to generate some revenue, that's how the business works.
Keeping every dollar in reserve guarantees that there will always be dollars available (assuming the bank where the deposit is made doesn't fail), but the bank account yields next to nothing.
The next least risky are short-term US Treasury bonds, such as 1-month and 3-month T-bills. The yield on the 3-month Treasury bill is often referred to as the "risk-free rate." Something really bad needs to happen to not get your money back from the US Treasury.
Today, the 3-month Treasury bill pays 2.29%, which means that a $1 billion reserve invested in 3-month bills would generate $22.9 million in "risk-free interest" income per year, not bad! . (Nothing is truly risk-free.)
But for some, just sitting there and earning a risk-free rate is too boring. There is still a lot of money to be made! For them, there are many different ways to generate higher reserve yields, including:
- A fractional reserve model (like a bank) means you can lend money multiple times.
- Investing reserves in riskier assets should yield higher returns. Riskier assets may include longer-dated treasury bonds (such as 10-year treasury bonds), commercial paper, DeFi, crypto loans, and even equity or fund investments.
Putting a 25% reserve in debt that even incurs a risk of around 4% means an additional $4.275 million in annual interest income.
But clearly, every basis point of extra yield comes with extra risk.
Over a long enough time frame, increasing reserve yields is antithetical to increasing reserves, because increasing yields reduces the chances that users will want to redeem their dollars, which ultimately reduces trust. For pegged stablecoins, trust is critical. Whoever earns the most trust among investors through their actions and transparency will win from the growth.
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History of Circle: From Bitcoin to USDC
Circle co-founder and CEO Jeremy Allaire started the company back in 2013 to help investors "convert, store, send and receive digital currencies like bitcoin more easily." .
Jeremy was already a technology veteran at the time, having founded Brightcove, an online video service provider, before founding Circle.
In any case, with Jeremy's background and early enthusiasm for Bitcoin, he was able to raise funds without much trouble:
- 2013: $9 million in Series A funding from Breyer Capital, Accel and General Catalyst
- 2014: $17M Series B round led by the same investors as Pantera Capital
- 2015: $50 million Series C round led by Goldman Sachs and IDG Capital at a valuation of $250 million
- 2016: $60 million in Series D financing, led by IDG Capital, with a valuation of $480 million
- 2018: $110 million in Series E financing, led by Bitmain, at a valuation of $3 billion
Amazingly, it raised $246 million before announcing its USDC offering in May 2018.
Joao Reginatto, Circle's vice president of product, told me that when he joined the company seven years ago, he was signed on to be a product manager for Circle's payments app, Circle Pay.
Circle Pay plans to build a product for people looking to move money over the blockchain, while removing complexity and providing a familiar experience. People are most familiar and comfortable with fiat currencies, so they enable balances and transfers in USD, EUR, and GBP for Bitcoin payments. In the background, they handle all liquidity and funding operations, such as converting USD to BTC and back.
But by 2016, the transfer speed of Bitcoin had become too slow, and the Bitcoin network was built for P2P money, not to support building applications on it. Then they tried ethereum, but it wasn't quite viable either. They are even considering launching their own settlement token. In the end, they realized that what they needed was fiat money running on the blockchain.
They looked at Tether, but decided they couldn't build on top of it, so the team realized they needed to create their own stablecoin.
In September 2018, Circle and Coinbase jointly launched USDC, and it began to circulate in October 2018. By the first day of 2019, the circulation was 288 million US dollars. Today, USDC is jointly owned by Circle and Coinbase, with Coinbase helping to set the direction of the protocol and Circle being the issuer.
andSupervisionandcomplianceThe stance sets the tone.
As Jeremy explained, one of the first questions he asked about running financial services on the blockchain was, “Is this legal?” He has built a reputation as a company, and he wants to do it well.
So, out of pocket, he hired one of the top regulatory consulting firms in the US, and they found that while there wasn't a lot of precedent or guidance, there was some. In March 2013, the U.S. Department of the Treasury issued a six-page memorandum titled "Application of FinCEN Regulations to Persons Who Manage, Exchange, or Use Cryptoassets." Essentially, if you act as a money changer from the banking system to digital currency, then you must be registered as a money transmitter, comply with anti-money laundering (AML) and anti-terrorism policies, and obtain all appropriate licenses.
Jeremy put it more bluntly: "The reality is that if you want to build a business at the intersection of traditional finance and blockchain, you have to be regulated or go to jail." But Jeremy is not disappointed by this, but A great deal of research has been done on policy areas:
New things that change society and pose risks require new policies—self-driving cars, artificial intelligence, spacecraft, genetics. It is difficult to operate in a regulated field because it has a great impact on society.
So from day one, Circle has "entered through the front door". The firm's first hire was its General Counsel/Chief Compliance Officer.
Starting in late 2013, Jeremy said, “We secured every possible license and became the most licensed and regulated company in the crypto industry at the time.”
Circle was the first company to receive the New York crypto license BitLicense and helped shape it by providing feedback.
From the early days of the crypto industry, all the way to today, "doing this in a regulated way is going to get a lot of 'boo' from the crypto community, but if you want this to go mainstream, you have to do it," Jeremy explain.
From the beginning, Circle's position has been to work with regulators, engage in dialogue and educate.
Second, the company's early attempts at creating payment products on the blockchain meant that when Circle created USDC, they built it as a platform on which other developers could build applications.
From the beginning of USDC development, Joao "wanted to build with an API in mind, and consider scalability from a developer's perspective." They needed an API from the beginning to handle issuance and redemption. After the team brought USDC to market in 2018, most of it immediately turned to building APIs and developer tools, documentation.
The adoption of USDC by third-party developers has fueled Circle's meteoric rise. In May 2021, with USDC's market capitalization just over $20 billion, Circle announced it had raised $440 million in funding from Fidelity, FTX, Digital Currency Group, and others. Later that year, it signed a SPAC deal with Concord Acquisition Corp. to take it public for $4 billion. In February, it announced that it had more than doubled its SPAC valuation to $9 billion, and in April it announced a $400 million funding round led by BlackRock and Fidelity as USDC's market cap grew to $51 billion .
What kind of platform are USDC and Circle?
As it turns out, it's weird to think of a digital currency as a platform, but it works.
I was talking to Fairmint founder Joris Delanoue the other day. The company, which provides issuance services for crypto-native securities, is a typical web2.5 company—the front end of the product feels very web2, but on the back end, it uses USDC and smart contracts to facilitate smoother, faster, and cheaper transactions.
“The USDC stablecoin is definitely the key to bridging on-chain and off-chain,” Joris explained to me. “It’s reliable and gives us 10x faster processing of transactions.”
That talk was the first time USDC's role as a platform came to mind, but Fairmint is just one example of the many companies building on USDC today.
Established companies such as Visa, MoneyGram, Twitter, and Stripe are also working with USDC to facilitate crypto payments.
In March 2021, Visa announced that it had become the first major payment network to settle transactions in USDC, writing:
Visa's standard settlement process requires partners to settle in traditional fiat currencies, which can add cost and complexity to businesses built using digital currencies. The ability to settle in USDC could ultimately help crypto-native companies evaluate entirely new business models without requiring traditional fiat currencies in their financial and settlement workflows.
Visa's partnership is an important sign of USDC's approval.
Summarize
Summarize
There is a popular saying among web3 skeptics that we don’t need cryptoassets because banks and fintechs work just fine. Why would you need a stablecoin to send money abroad when a cross-border payment network like Wise exists?
But the skeptic's belief is essentially,When it comes to financial innovation, we've reached a dead end。
But I don't think stablecoins will replace banks or fintechs, they will co-exist.As has already happened, fintechs will increasingly build smoother, faster, cheaper, more global products on USDC with the necessary guardrails, compliance, interfaces, and what fintechs do best various other things.
Not just fintech.
As money and banking become embedded in more of the products we use every day, and new technologies create new categories of products, I expect USDC to become a core part of more and more companies' technology stacks.
According to the "Notice on Further Preventing and Dealing with the Risk of Hype in Virtual Currency Transactions" issued by the central bank and other departments, the content of this article is only for information sharing, and does not promote or endorse any operation and investment behavior. Participate in any illegal financial practice.
risk warning:
According to the "Notice on Further Preventing and Dealing with the Risk of Hype in Virtual Currency Transactions" issued by the central bank and other departments, the content of this article is only for information sharing, and does not promote or endorse any operation and investment behavior. Participate in any illegal financial practice.
