For USDC to become the undisputed king of stablecoins, a number of factors must come together in the proper way for this to happen.
USDC, the stablecoin that Circle operates, and its CEO, Jeremy Allaire, have ambitious goals for their respective companies and for USDC. Allaire noted in a blog post this week that Circle plans to become a federal bank and that he anticipates USDC to “grow into hundreds of billions of dollars in circulation.”
Allaire’s remarks come at a time when stablecoins—digital tokens that are tethered to a national currency—are experiencing a resurgence in popularity. Stablecoins, which have long been popular among cryptocurrency traders as a way to enter and exit risky positions, have recently gained acceptance in the traditional banking system as a more efficient means of moving money around.
Tether, a stablecoin, continues to be the dominant player on the market for the time being. However, there are several competitors, and Allaire believes that USDC, which is presently ranked second in terms of market capitalization, has a potential to take the lead at a time when U.S. regulators are probing Tether’s unique accounting practises.
In contrast, Circle is dealing with its own set of regulatory and business concerns, which makes Allaire’s intentions to make USDC the undisputed monarch of stablecoins much more precarious than they appear.
Stablecoins are popular among users because they provide the same simplicity as other blockchain-based currencies such as Bitcoin while avoiding the volatility associated with those currencies. Stablecoins also provide a simple means of making money for the dozens of companies who issue and trade them.
Whenever customers spend their dollars to purchase stablecoins, organisations such as Tether and Circle do not pay interest on the purchases.
It is these dollars that are used to establish stablecoin reserves, which result in a return for the corporations holding the reserves. Circle, for example, plans to earn $40 million this year from its USDC operations, according to the company.
A dilemma arises, however, as a result of this opportunity: how aggressively should a stablecoin corporation invest those reserves? While investing in items like bonds or commercial paper can result in better returns, it can also result in a stablecoin that is less stable than the corporation claims.
When Circle revealed last month that USDC was not backed by cash on a one-to-one basis, as the business had promised for years, competitors pounced like vultures. Dollar Coin (USDC) is not a true stablecoin, according to a blog post published by Paxos, a smaller competitor.
As the graph illustrates, Circle is partially securing its stablecoin using assets such as bonds and commercial paper that are not cash or cash equivalents, such as bonds and commercial paper.
“They are seeking the highest possible yield. The question is are they putting consumer assets at risk by pursuing that yield?” Paxos’ top lawyer, Dan Burnstein, told Decrypt.
Dante Disparte, the Chief Strategy Officer of Circle, responded with a retort. According to a recent interview, Disparte dismissed the Paxos assertions as a worthless “purity test,” and stated, “We’re not going to dignify the Paxos article with a response.”
In the words of Disparte, the entire stablecoin business is on the verge of becoming highly regulated, and Circle will make certain that USDC complies with any rules imposed by the United States Treasury Department or other government agencies. He will not say, though, whether Circle intends to alter its reserve mix in the future.
Burstein claims that Circle is putting consumer assets at danger, which raises the question of whether this is indeed the case. It appears that Burstein may be exaggerating the situation at first glance. Circumstance is employing relatively safe non-cash assets to back USDC—they are not junk bonds, alt-coins, or anything else that could go bust at any time.
However, this does not rule out the possibility of danger. As JP Koning, a former bank analyst and writer on stablecoins, points out, the question is what would happen in the event of a banking crisis such as those experienced by the United States in March 2020 or November 2008.
In the event of a crisis, consumers may rush to convert their USDC back to cash, putting Circle in the position of having to sell its assets in order to meet redemption requests.
According to Koning, if this occurs, Circle may be obliged to sell such assets at a discount to their fair market worth, or it may be unable to sell them at all. It is possible that USDC’s price will fall below $1 as a result of this, causing Circle’s stablecoin to become unstable.
A run on stablecoins would almost certainly be faster and more severe than a run on traditional markets if there is a new crisis, according to the experts. According to a recent research, this is due to the fact that a rush to redemption in the case of stablecoins would occur in hours or minutes rather than over a period of several days.
Meanwhile, a crisis could be precipitated by broader events or by something specific to stablecoins—for example, the revelation of a defect in a stablecoin’s protocol—and could last for weeks or months.
As far as we know, these are just theoretical worries, but it’s interesting to note that Circle’s partner Coinbase has discreetly changed verbiage from its website that indicated each USDC was backed by “one US dollar, which is held in a bank account.” It is possible that Coinbase is changing the wording in order to avoid lawsuits, but it also reflects the fact that USDC is not the fail-safe investment Circle had promised.
Due to the fact that Circle is in the process of becoming public, it needs convince investors that its USDC business is secure and expanding. This is most likely why the company announced its ambition to become a federally licenced bank, a status that would assist alleviate potential investors’ concerns about regulatory risk in the financial sector.
At the moment, Circle operates under the authority of state-based money transmitter licences, a model that is also used by a large number of other financial institutions, including PayPal. Some other stablecoin issuers have chosen various legal tactics.
For example, Paxos and Gemini are relying on a stablecoin regime designed by the state of New York, but Tether has pursued a wildcat approach that entails operating in multiple jurisdictions throughout the world.
Circle’s journey to become a national full-reserve
digital currency commercial bank: https://t.co/3aNQ0bKPyr
— Jeremy Allaire (@jerallaire) August 9, 2021Circle’s hard road ahead
All of these models have one thing in common: they require stablecoin issuers to carry only a small amount of additional capital on top of their reserves in order to operate. This is in stark contrast to traditional banks, which are required to maintain a “capital cushion” of at least 8 percent, and in certain cases much more.
With a cushion, banks can suffer a loss on part of their assets while still having more than enough cash on hand to meet redemption demands in the case of a financial catastrophe, according to the concept.
If Circle follows ahead with its plans to become a national bank, it may find itself in the position of having to carry a similar capital buffer. This could prove to be a difficult task, especially if the Fed is also required to replace the commercial paper and bonds in its reserves with Treasury Bills, which yield close to zero interest.
Where would Circle acquire the money to set up an 8 percent reserve? Outside investment totaled $440 million for the company this spring, with a portion of the funds earmarked for the establishment of a capital cushion.
However, in the long run, it is unclear how Circle will generate enough revenue from its stablecoin activities to retain that cushion while still covering the costs of its day-to-day operations.
Despite the fact that USDC is only one of Circle’s money makers, Disparte, the company’s chief executive, expressed confidence in the company’s future business prospects, noting that the company also operates a “transaction and treasury” business that it expects to bring in $60 million this year, as well as a profitable crowdfunding platform called Seed Invest.
Disparte also pointed out that having a bank charter would grant Circle access to the Federal Reserve’s discount window, which would provide the company with a consistent source of low-cost liquidity.
Furthermore, Circle already has relationships with payment giants Visa and Mastercard, which demonstrates the kind of traction the company has gained in the mainstream financial industry.
However, uncertainty continues to lurk over Circle, particularly given the fact that its plan to become a bank is still just that: a plan.
The corporation has only proclaimed its intentions; it has not yet filed any paperwork to support those intentions. A key report on stablecoins will be released by the Federal Reserve next month, which has the potential to significantly alter how Circle and other stablecoin issuers operate—perhaps by requiring them to alter the structure of their reserves.
This does not rule out the possibility that Circle will be successful in its efforts to win the stablecoin battles. Only that a slew of factors will need to come together in order for that to occur.
