Stablecoins have been getting a lot of attention recently with the collapse of Terra’s algorithmic stablecoin UST and the depeg of the stablecoin USDC earlier this month. Stablecoins are digital currencies backed by assets or an algorithm regulating their supply and are core to the crypto infrastructure. They hold stable value and are designed to reduce volatility and facilitate trading in other digital assets. With a market capitalization of almost $130B today, stablecoins are getting increasingly adopted and under growing scrutiny by regulators.

This article is part of the miniseries about Stablecoins in which we will present the four main stablecoins: Tether, USD Coin, Binance USD, and Multi Collateral Dai.

USD Coin

USD Coin (USDC) is a stablecoin pegged to the United States Dollar and managed by a consortium called Centre, which was founded by Circle and includes members from Coinbase and Bitmain. USDC is primarily available as an Ethereum ERC-20 token and is backed by a dollar held in reserve or other approved investments like T-bills (short-term treasury bills). USDC was first announced in May 2018 by Circle and launched in September 2018. Currently, there are 33 billion USDC in circulation; USDC is the second largest stablecoin in the world and can be transacted in 8 different blockchains. In March 2021, Visa announced that it would allow USDC to settle transactions on its payment network, a decision that boosted the popularity of the stablecoin.

Ownership

Circle

Circle Internet Financial Ltd, then Boston Internet Financial Services Ltd, is an American peer-to-peer payments technology company that manages the stablecoin USDC launched by Jeremy Allaire and Sean Neville in October 2013. Its headquarters are in Boston, Massachusetts, but the company is incorporated in Ireland.

Jeremy Allaire

Jeremy Allaire is the founder, CEO, and Chairman of the Board of Circle, the company that manages USDC. He is a well-known entrepreneur and investor with a background in technology and finance. Jeremy has been a vocal advocate for blockchain and cryptocurrency and believes that digital currencies will transform the global financial system. Under his leadership, Circle has become one of the leading players in the stablecoin market, with USDC used by millions worldwide.

Executive Team & Board of Directors

NB: The list of executives and board of directors is not exhaustive.

Li Fan — Executive

Leading Circle’s engineering team, Li Fan has an impressive background in the tech industry. He has previously served as CTO and interim CPO at Lime, SVP of engineering at Pinterest, Senior Director of Engineering at Google Inc., and Vice President of Engineering at Baidu, China.

Michele Burns — Board Member

Michele Burns is a Goldman Sachs and InBev board member, chairing the Audit Committee and serving on other committees. She is also a director at Cisco Systems. Michele held leadership roles as Chairman and ex-CFO of MMC and as CEO at Mercer LLC, which provides human resource consulting and investment services. Previously, she was CFO of Delta Airlines.

Rajeev Date — Board Member

With over 20 years of experience in the financial services industry, Rajeev Date has held various key positions. He was the first-ever Deputy Director of the U.S. Consumer Financial Protection Bureau (CFPB) and a Managing Director in the Financial Institutions Group at Deutsche Bank Securities. Currently, Rajeev serves as the Managing Director of Fenway Summer LLC and FS Venture Capital LLC, and as a board member of the public company bank GreenDot.

The Peg

According to Circle, USDC is a fully-backed digital currency that is pegged to the US Dollar at a 1:1 exchange rate.

A combination of cash and short-term Treasury bills (T-bills) fully back all USDC in circulation, ensuring that each digital dollar of USDC is always redeemable at a 1:1 ratio with the US Dollar. The reserves are held in custody by reputable U.S. financial institutions, including BlackRock and BNY Mellon. Additionally, Circle is unable to lend, borrow against, or utilize its USDC reserves for any purpose other than backing the digital currency, unlike banks.

According to Circle’s website, their reserves are 80% T-bills and 20% cash. The fund that holds all those short-term assets, called Circle Reserve Fund, is managed by BlackRock and custodied at BNY Mellon; 2 mastodons of the financial world.

What’s very impressive is that everything is online, not on a blockchain but displayed on BlackRock’s website, showing details of the T-bills bought along with their face value, yield, and final maturity. It is transparent and allows customers to go and check what they hold by themselves.

According to BlackRock’s website, $28,88 billion are held in the Circle Reserve Fund, when their reserve is $34,6 billion, making their T-bills reserve equivalent to 83.46%. Circle today holds around 80% of very safe and liquid assets in an SEC-regulated money market fund and the rest as cash in commercial banks.

It is also important to note that Circle is the only owner of this fund. According to Circle’s January 2023 Monthly Report, Circle Internet Financial Ltd “owns one hundred percent of the equity interests in the Fund represented by the Fund’s Net Asset Value (the “NAV”), held on behalf of USDC holders”.

The Report also lists the banks that hold USDC’s cash reserves. In the latest January 2023 Report, Circle had seven custodian banks, of which Signature Bank, Silicon Valley Bank (SVB), and Silvergate.

The Depeg of March

So, what happened?

On the 8th of March

Circle’s first banking partner Silvergate Bank gets liquidated.

On March 10th

The FDIC closes SVB after a bank run, which caused panic amongst investors who had deposited their funds with the bank. One of the notable depositors was Circle, with $3.3 billion deposited at SVB. This news created a wave of uncertainty and concern among investors holding USDC. As a result of this event, USDC’s value began to drop and ultimately depegged from its $1 value, causing further panic in the market, reaching as low as $0.86. Between Monday the 13th and Wednesday the 15th of March, it’s a whopping $3 billion that was redeemed by USDC holders.

On the 12th of March

It’s Signature Bank’s turn to get shut down by US regulators.

On the 12th of March at night

After the US government intervention to ensure all SVB and Signature Banks depositors would get their whole deposit back on Sunday, the USDC peg was back to $1 by Monday.

“We are heartened to see the U.S. government and financial regulators take crucial steps to mitigate risks extending from the banking system. We’ve long advocated for full-reserve digital currency banking that insulates our base layer of internet money and payment systems from fractional reserve banking risk” said Circle’s CEO.

In a blog post dated the 14th of March on their website, Circle stated that they now hold most of their cash at BNY Mellon. BNY Mellon is a systemically important bank with around $45 billion in assets under custody, according to the Financial Stability Board Report of 2022.

The depeg lasted 3 days, long enough for USDC to lose $10 billion in market capitalization to competitor Tether.

The closure of Silicon Valley Bank has had a significant impact on the cryptocurrency market, highlighting the risks associated with holding funds in centralized financial institutions that use fractional reserves and the importance of high liquidity and redeemability.

Regulations

USDC reserves are regularly attested, every month, and have recently been conducted by Deloitte & Touche LLP. Circle also gets its financial statements audited annually and reviewed by the SEC.

On its website, Circle explains that “the audits for 2021 and 2020 have been filed publicly with the SEC as we prepare to become a public company listed on the New York Stock Exchange. Circle expects to continue to publish quarterly financial statements (reviewed by our auditors) and annual audited financial statements.”

According to their latest financial statements, Circle has licenses with majority of US state regulatory agencies, but also outside of the US with the Financial Conduct Authority (FCA) in the UK, the Bermuda Monetary Authority (“BMA”), and an in-principle approval as a Major Payments Institution License holder in Singapore.

Circle is well-regulated and licensed under state money transmission licenses, just like other major U.S. payment institutions such as Stripe, PayPal, and Apple. Circle is also registered as a money services business (MSB) with the U.S. Department of the Treasury and adhere to Know Your Business (KYB)/Anti Money Laundering (AML) and financial crimes compliance requirements.

What’s a money transmitter license?

In the US legal code, a money transmitter or money transfer service is a business that provides money transfer services or payment instruments, regulated by the Financial Crimes Enforcement Network (FinCEN) of the US Treasury Department. Money transmitters are part of a larger group of entities called money service businesses or MSBs and are required to register for a money transmitter license under federal law.

Forty-nine US states regulate money transmitters, with varying laws that require licensure, surety bonds, and minimum capital requirements. The Money Transfer Regulators Association seeks to create uniformity and common practices in regulation, while the Money Services Business Association and other industry associations promote innovation and development in the payments industry while communicating with US federal and state regulators.

The Consumer Financial Protection Bureau extends its regulation to remittance institutions defined as consumer-to-consumer transfers of low monetary value, made via money transmitters, banks or credit unions, through wire transfers or Automated Clearing House transactions, to businesses as well as to individuals in foreign countries.

Risks

Liquidity & “Bank” Run

Regulators have identified the potential threat of a “run” on stablecoins as a major policy concern that requires attention. This refers to the risk of a sudden loss of faith in a stablecoin that is backed by fiat currency, which could lead to a sell-off of reserve assets and have a ripple effect on the wider financial system, posing a risk to its stability. To assess this risk, it is necessary to analyze both the risk profile of the asset reserves held by stablecoins and the behavior of the liabilities associated with the broader on-chain ecosystem and its use cases.

A bank run starts with a lack of confidence, in trust in the asset. The thing with stablecoins like USDC is that with blockchain we’re able to verify (“don’t trust, verify!”). Everything is on chain, and if the company (here Circle) is strictly regulated and provides regular attestations and audits, something would have to happen for holders to lose TRUST.

In his paper, Gordon Liao, Circle’s Chief Economist, calculates USDC’s liquidity ratio, showing that it is two to seven times bigger than a global systemic bank; it is therefore safer and much more stable. As shown in the table below, the liquidity ratio of USDC is greater than 196% while systemic banks like Bank of New York Mellon(111%) or Goldman Sachs (125%) have much lower ratios. I encourage you to read his paper which analyzes the potential systemic risks linked to tokenized cash, a category of stablecoins backed entirely by cash and cash equivalents.

Privacy/ Data Security

One issue people raise when told that stablecoin is better than cash is that cash is untraceable, while one of the major points of cryptocurrency is that all the transactions are publicly recorded on the blockchain. However technology is evolving rapidly, and one of the solutions that has emerged to address the issue is Zero Knowledge (ZK) technology. Vertex is an example of a new decentralized identity protocol that utilizes this technology. With ZK technology, companies or governments can verify an individual’s identity without directly accessing the identity itself. This is accomplished through zero-knowledge proof, which allows the validation of a statement without revealing the statement itself.

Circle has recently launched an institutional digital identity system that uses Verite, an open-source decentralized identity credential framework. This allows eligible institutions to request KYB credentials, enabling web and mobile apps and smart contracts to verify user authorizations for on-chain activity.

Companies will have complete control over their identity attributes, with no personally identifiable information sent or stored on-chain. Circle has partnered with TrueFi to support Verite KYB credentials and access to their permission lending platform. Verite enables identity claims to be verified without revealing sensitive personal data, using a simple credential check.

Trust

Since the March events, USDC lost almost $10 billion in market capitalization. Does it mean that people have lost confidence in the stablecoin?

Coinbase, Circle’s partner and major cryptocurrency exchange, recently announced plans to launch “inflation-protected” stablecoins.

According to Bloomberg, Coinbase’s new stablecoins will be pegged to the Consumer Price Index (CPI), which is a measure of inflation. This means that the value of the stablecoins will adjust automatically to reflect changes in inflation, so they will remain relatively stable in real purchasing power over time.

Coinbase’s announcement comes as other stablecoins, such as USDC, have come under scrutiny due to concerns about their potential risks to financial stability; Coinbase is positioning its new stablecoins as a more reliable alternative.

Coinbase’s move to launch inflation-protected stablecoins reflects ongoing efforts to create more reliable and trustworthy cryptocurrency options that can gain wider acceptance in the mainstream financial world.

Circle Wants Safer Cash, Globally

The End of Physical Cash

Circle has great ambitions. One of them is to completely replace physical cash, as Circle’s Chief Economist mentioned in an interview last week. Cash represents multi-trillion dollars worldwide; in the US alone it represents $2 trillion. In G. Liao’s opinion, banks and government should welcome this idea with arms open as it would mean more deposits into banks.

It is not crazy to think that we could get rid of physical cash; after all, you only need a mobile phone to carry crypto.

Our Current Banking System is Failing

A Revisit of the Chicago Plan

Jeremy Allaire asks for a separation between the payment & deposit management system and the lending & credit services banks offer, arguing that those 2 services cannot and shouldn’t cohabit.

In his paper, G. Liao argues that “a recent revisit of the earlier narrow banking plan, often known as the Chicago Plan, by Benes and Kumhof (2012) shows that the separation between monetary and credit functions of banks would reduce business cycle fluctuations, eliminate bank runs, and increase output by around 10%. “

Death of Banks and the Birth of a New Type of Bank

To avoid risks caused by the intermediation of commercial banks, Circle is working with the government and regulators in order to create a charter, specific to stablecoins or tokenized cash. With a charter, Circle would get access to the Federal government and an account at the Federal Reserve. Circle would become a bank…a fully reserved bank, not a fractionally reserved bank.

During a chat with Circle’s Chief Economist G. Liao at Paris Blockchain Week, Circle’s CEO talked at length about credit explaining why stablecoins can ease and make credit intermediation safer:

“If you have this base layer of money on the internet that is straight through government obligation money in a digital form that can be tokenized and works on these blockchain networks, you actually have an incredible material to build with and for the first time ever credit intermediation can actually become something that is in many ways safer than it is in the existing banking system.

Source: youtube

[…] you can have blockchain-based software which provides credit intermediation mechanics, risk mitigation that’s provable, auditable in real-time,” and allow a global “market access” […] to participate in these credit pools.

Jeremy Allaire is clear: the current banking system is too opaque and obsolete; a change is needed and has already started to happen, and Circle wants to be at the center of it.

Europe and the Euro Coin EUROC

In June 2022, Circle got to grips with the second largest fiat currency in the world: the Euro, as it launched its digital Euro stablecoin called EUROC, backed by Euro 1-to-1.

Circle chose Paris for its future European headquarters and recently applied in France to become both a licensed Electronic Money Institution (demande d’agrément en qualité d’établissement de monnaie électronique) and a registered Digital Asset Service Provider (DASP) (demande d’enregistrement en qualité de prestataire de services sur actifs numériques) under the rigorous requirements set out by the Autorité de Contrôle Prudentiel et de Résolution (ACPR) and Autorité des Marchés Financiers (AMF). Circle’s intent to pursue full approval from the AMF could make it the first company to receive full authorization under the DASP regulatory regime.

According to the Cointelegraph, “every EUROC token in circulation will have an equivalent euro-denominated reserve held in custody at financial institutions regulated by the United States.” The token has launched as an ERC-20 token on the Ethereum network.

In 2019, France established a regulatory framework for cryptocurrencies, which included a straightforward registration process for companies. As part of this process, companies were required to demonstrate that their managers possessed appropriate skills and reputation, and to establish measures to prevent money laundering.

France is one of the few forward-looking countries in terms of crypto (and more broadly Web3) regulations. After becoming the European hub for Fintech companies, France has the ambition to become a Web3 European hub with the PACTE law (“Plan d’Action pour la Croissance et la Transformation des Entreprises” or Action Plan for Business Growth and Transformation) passed in 2019. PACTE has become a template for the European MiCA regulation, but it’s still at the draft stage. French regulatory framework for the digital assets sector attracts innovative companies like Circle but also Crypto.com, and Binance and also helps create local Web3 unicorns like Ledger or Sorare.

Conclusion

The team behind USDC has done a great job at trying to mitigate risks and being transparent. There is not much more they can do without the help of the regulators.

The recent events in the banking sector including the closure of a few major US banks as well as the forced merger between the 2 biggest Swiss banks show that we haven’t solved the issues that led to the banking crisis of 2008. The banking system is opaque and risky, and the fractional reserve model is one of the reasons why banks are still risky.

USDC could be part of the solution; it is fully backed by safe assets of which 80% are T-bills. However, the cash held in commercial banks is a risk and needs to be addressed if USDC grows.

We believe the march events will make them take even more precautions in the future when it comes to the safety of their reserves, and it’s something we will be able to follow and check on in their monthly reports.

To be able to transform the financial system, crypto companies need clear regulations and they will go where regulators create clear regulatory frameworks for them.

The US is lagging behind in establishing comprehensive regulatory frameworks for the crypto industry. This has led companies such as Circle to seek out proactive, forward-looking, and innovative-driven locales like France to expand and establish their businesses.