Circle, the company behind the USD Coin (USDC) stablecoin, is expanding its operations in Asia with the view that, over time, Asia and emerging markets will contribute more liquidity to digital dollars that exist on blockchain rails than the United States.
One inexact comparison is with the Eurodollar system. Eurodollars are US dollar-denominated bank deposits and related instruments, such as corporate derivative positions and USD-denominated bonds issued by non-US companies, held in non-US bank accounts.
The Eurodollar system has nothing to do with the euro; it got its start in the late 1950s as a form of regulatory arbitrage, as UK banks could offer a higher interest rate on local US dollar deposits than could be found in the US.
From there mushroomed a gigantic dollar-based system of fractionalized banking beyond the purview of US regulation (or deposit insurance). Estimates vary, but today the Eurodollar system is around $60 trillion in deposits and derivative positions, about three times the size of the domestic M2 money supply (cash, bank deposits, money market funds), which was $21 trillion as of January 2023.
Circle goes global
Similarly, USDC is used globally to transact in digital dollars. The offshore market for digital dollars is likely to eclipse US domestic demand, both as Asia and emerging markets embrace blockchain-based finance, and as a US regulatory crackdown drives activity offshore.
Raagulan Pathy, Circle’s vice president for Asia Pacific, joined the company last year to establish its presence in Singapore, where Circle has received an in-principle approval for a license under the Payment Services Act. This lets it provide cross-border and domestic payments services.
He is now keen to open shop in Hong Kong too, although the company is still trying to convince a commercial bank to give it an account – a chicken-and-egg situation related to obtaining a license.
“Asia and emerging markets are likely to become the biggest sources of liquidity,” he told DigFin. “We see an incredible demand for digital dollars.”
Activity in blockchain-based financial markets resembles that of traditional finance: regardless of a user’s domicile or provenance, transactions are greased in USD denominations.
That makes stablecoins the main engines of liquidity within the crypto world. Often, market participants will park their crypto holdings in the form of stablecoins because crypto is ultimately tied to the dollar. Stablecoins therefore also serve as a useful form of collateral, although their issuers, such as Circle, say they do not touch staking, lending, or other activities.
The largest by far issuer of US dollar-denominated stablecoins is Tether, affiliated with the Bitfinex exchange. Despite its well-publicized problems with incomplete audit information about its reserves, Tether is the crypto industry’s giant. According to CoinMarketCap, daily average volumes of Tether are $30 billion, with a circulating supply of $79 billion.
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Circle’s USDC is a distant number two, with average 24-hour trading volumes of $4.2 billion and a market cap of $33 billion.
(Binance USD is third; all three issuers claim to fully back their stablecoins with liquid US dollar reserves; the number-four player is Dai, an algorithmic stablecoin.)
Assuming blockchain-based finance grows, therefore, demand for “digital dollars” is likely to rise.
Behind the scenes
Each operator of a fully reserved token is meant to have an audited US dollar in cash or cash equivalent for every stablecoin. Circle, as well as Tether and Binance, are meant to manage the creation and redemption of stablecoins whenever a customer gives them dollars or wants to cash back into dollars. In return, Circle gives customers the equivalent in USDC, which is a smart contract that operates across multiple public blockchains.
Circle is not technically a bank. It has no banking license and it does not regard its minting and burning of USDC as a form of deposit. It does not lend. It makes money by accruing interest on the US dollars it holds in exchange for providing users with USDC. These assets, worth about $33 billion, are mostly invested in US Treasuries (in a special-purpose fund managed by BlackRock), with a fifth of the total held on deposit with banks in the US, Singapore, and elsewhere.
“We’re a utility token, providing infrastructure technology to move money,” Pathy said.
To that extent, he says the Eurodollar example is not accurate, as Eurodollars were born out of the fractional-reserve banking industry, and USDC is a fully reserved asset.
Regulatory risks on the rise
Pathy argues as well that, as a utility token, USDC is not a security.
However, regulators in the US may not agree. This could be one reason why Circle is eager to take root in other markets.
The US Securities and Exchange Commission has already told Binance that it considers BUSD a security, akin to a money-market fund that invests in short-term bonds and other instruments to deliver a higher return than a bank deposit.
If Circle keeps 80 percent of its US dollar holdings in Treasuries, it too could fall under the SEC’s definition of a money-market fund.
If the SEC pursues this argument, the impact would be painful for Circle, which since the FTX collapse has experienced net outflows: some inside crypto to the perceived safety of Bitcoin, and others cashing out into dollars.
Silicon Valley banking blues
USDC also “broke the buck” (lost its US dollar peg) in March because most of its US dollar deposits are held at the now-defunct Silicon Valley Bank. When SVB suffered a bank run among its depositors, crypto users of USDC also panicked and sold. The peg was restored only after US authorities stepped in and guaranteed the deposits of SVB customers.
This amounted to an inadvertent bailout of USDC by Washington. The irony is that Circle’s deposits at SVB are now very reliably safe, yet USDC has lost ground to Tether, whose reserves remain unclear.
Pathy says the inherent nature of Circle’s business is to be tied to the US dollar, for better or worse. “Our risk is we are attached to the dollar. It’s the risk we want, because the dollar is the global currency.”
The company launched a euro stablecoin last year but this is small beer: “The global [crypto] market is something like 99 percent digital dollar.”
Circling the Fed
Being tied to the dollar is one thing; does Circle need to be tied to the US banking system?
The answer, at least for now, is yes. The company was founded in 2013 in Boston. It has been primarily a US company, and its reserves are in the US financial system. “Unlike our competitors, we’ve wanted to be regulated from the outset,” Pathy said.
Ideally the company would like the Federal Reserve to grant it access to an account and Fed payment rails, so that it could put 100 percent of its reserves with the central bank – although there is no sign that the Fed would do this.
It is possible that the Fed might view Circle as a useful way to outsource management of digital dollars; on the other hand, it might look at the unregulated Eurodollar market and decide this is a risk. Or it might develop an official Digital Dollar while allowing Circle and others to pursue their own businesses, just as it’s allowed foreign banks to hold US dollar deposits, as well as leaving trading in the dollar to market forces.
Partnership, competition, or symbiosis between the Fed and stablecoin providers all remain on the table.
The world beyond the US is increasingly important, however. In addition to operating in Singapore, Circle is applying for licenses in France, and Pathy is keen to open doors in Hong Kong.
This is to tap customer liquidity, as well as to provide a better service, particularly around redemptions. Circle has already added some treasury functions to its Singapore office.
Crypto markets may trade 24/7, but a customer’s redemption order can be processed only as fast as the bank that provides the USDC/USD exchange. More bank coverage gives Circle more options and makes it easier to manage business around the clock. “We want to redeem and mint tokens as fast as possible,” Pathy said.
Another attraction in Asia is the emergence of crypto hubs such as Singapore, Hong Kong and Dubai. These markets are not just sources of liquidity. They are also where governments seem keen to experiment with central-bank digital currencies, primarily to enable real-time cross-border payments.
Pathy says Circle could become the exchange instrument of choice among CBDCs. Each market is likely to see a local player emerge as the major stablecoin operator. As in traditional foreign-exchange markets, operators in a given market will not find liquid ways to transact directly with others (ie, will someone in Brazil find any liquidity to exchange eReal for eHKD?).
Therefore they will use USD-denominated swaps to trade with one another. Pathy reckons the same trend will emerge in blockchain finance, as more local-currency stablecoins or CBDCs come on line.
“We want to be the central swaps market, when the market becomes big enough, because USDC will have liquid pairs with all of these others,” Pathy said.