Previously, I have discussed how stablecoins have gained significant traction over the past five years, showing minimal correlation with Bitcoin’s price fluctuations. In this article, I’ll delve deeper into Circle, the second-largest provider of stablecoins, and explain my thesis on how they’ve developed a unique and highly profitable business model. Circle, a privately held company, has raised over USD 1 billion, with its last Series F round valuing the company at USD 8.2 billion.
What is Circle?
Circle’s stablecoin, USD Coin (USDC), is a cryptocurrency pegged to the US dollar on a 1:1 basis. Issued by Circle, it can be redeemed for one US dollar. USDC operates on the Ethereum blockchain as an ERC-20 token, following Ethereum-based token standards. Developed in collaboration with Coinbase, USDC aims to provide stability and liquidity in the cryptocurrency market, facilitating various digital transactions, including payments, remittances, and trading on cryptocurrency exchanges. Moreover, USDC offers advantages such as fast transaction settlement times and low fees compared to traditional cross-border (SWIFT) payment methods.
Circle’s Largest Competitor: Tether/USDT
USDT is Circle’s primary competitor, boasting nearly a 300% greater market cap than USDC.
While USDT is commonly used for trading and payments, some perceive USDC as a safer stablecoin. This perception stems from Circle’s practice of having its reserves attested to by an independent auditor on a monthly basis, contrasting with Tether’s quarterly attestations. Furthermore, Circle’s reserves for USDC predominantly consist of U.S. Treasury securities and cash, while Tether’s reserves for USDT encompass a broader array of assets, including various investments.
Safety and transparency have been central topics of discussion. Previously, USDT faced scrutiny due to Tether’s reluctance to provide comprehensive updates on its backing. In contrast, Circle, the parent company of USDC, consistently publishes audited reports on their reserves. Despite Tether’s efforts to enhance transparency, organizations like the Commodity Futures Trading Commission have called for a full audit. Conversely, Circle’s USDC has a history of offering detailed information about its reserves, with Circle releasing monthly audits conducted by accounting firm Grant Thornton LLP.
Circle’s Competitive Advantage
Circle holds a competitive edge over Tether, primarily due to its compliance with regulations in the US. With impending stablecoin regulations in the US, Circle is well-positioned to adhere to these rules, making it a preferred partner for institutional clients in the US cryptocurrency sector. Its stablecoin, USDC, is favored for its stability, compliance, and liquidity in digital transactions, further solidifying its standing in the market.
Recent announcements, such as Stripe’s integration of USDC for merchant payments and partnerships with Visa and other major US enterprises, bolster Circle’s position. Additionally, its strategic partnership with Coinbase, which holds a minority stake in Circle, adds to its strength, given Coinbase’s reputation for global compliance standards and active promotion of Circle’s offerings.
These factors, along with Circle’s regulatory compliance, stablecoin leadership, technological innovation, and user-friendly products, contribute to its competitive advantage over Tether in the US cryptocurrency and blockchain industry
How Does Circle Make Money
Circle earns interest income on the reserves backing its stablecoin, USD Coin (USDC). The funds held in reserve (USD) to back USDC may be invested in short and medium-term interest-bearing assets, such as government bonds or money market funds. Circle then retains 100% of the interest earnings on these funds.
Why is this business model revolutionary?
- Interest-Free Deposits: Unlike traditional banks, stablecoin providers like Circle issue digital $1 to depositors without the need to pay them interest. This allows stablecoin providers to lend out deposited money and keep all the income.
- Low Operational Costs: Circle doesn’t need to produce or sell anything like traditional organisations. Their main tasks involve providing technology for USD to USDC exchanges, securely storing USD, and investing it in low-risk assets like treasuries. Similar to SaaS products, operational costs should stabilise, with each sale adding directly to the bottom line. Unlike traditional SaaS companies, Circle’s focus on innovation is primarily on maintaining transparency around assets, investments, security, and compliance.
- Non-Selling Model: While Circle engages in marketing to promote its product, it doesn’t have the obligation to sell anything. Instead, it partners with organisations such as Coinbase, Visa, Mastercard, Stripe, and every crypto exchange, effectively using them as sales channels for Circle’s product.
- Increasing Trust: As Circle expands, it gains trust through its track record, proactive compliance measures, transparency, and US-based operations. This growing trust makes it increasingly difficult for new entrants to compete with Circle.
Supportive Trends for Circle & Stablecoins
Integration by US-Based Companies:
The recent integration of USDC payments by US-based companies like Stripe for merchants and PayPal’s money transfer service, Xoom, enabling US customers to make stablecoin transfers to approximately 160 countries without transaction fees, signifies a positive trend for stablecoins. This development is particularly significant given the lucrative nature of the remittance market, which is valued at $781 billion globally, with Americans spending nearly $12 billion annually on remittance fees. These integrations enhance the utility of stablecoins like USDC for streamlining cross-border transactions.
Growing User Base and Transaction Volume:
Stablecoins have gained traction, with nearly 30 million monthly users on average, processing a significant volume of transactions annually, comparable to Visa. Notably, Circle’s USDC token has witnessed a surge in market share since the beginning of 2024, representing 50% of total transactions despite accounting for only about 20% of circulating stablecoins. The substantial transaction volume, amounting to $456 billion recorded in the last week of April alone, underscores USDC’s dominance in the stablecoin market. This trend reflects the increasing adoption and utility of stablecoins in facilitating global transactions.
Valuing Circle: A Complex Endeavour
Valuing Circle presents unique challenges due to its position in a niche and emerging sector, compounded by the private nature of the company and its competitors. The lack of disclosure regarding revenues and profits, along with the absence of exits or listed entities for comparison, further complicates the valuation process.
However, despite these challenges, there are approaches to estimate Circle’s value. One method involves comparing it to traditional banking models, albeit with modifications to suit the stablecoin industry. Both Circle and Tether operate on similar models, receiving deposits from individuals and institutions, and then lending out these funds to earn interest.
Drawing parallels with US-listed banks, which typically have PE ratios exceeding 12, using a conservative PE ratio of 10 for stablecoin providers like Tether and Circle seems reasonable.
Recent transparency efforts by Tether, such as the release of their Q1 2024 numbers, shed light on their operations, revealing a net operating profit of USD 1 billion derived from their substantial deposits in US treasuries. Applying a similar framework to Circle, with its approximately USD 30 billion in reserves, suggests an estimated quarterly operating profit of around USD 300 million, or USD 1.2 billion annually. Using the PE ratio of 10, this translates to a valuation of USD 12 billion for Circle.
Risks Associated with Investing in Circle
Regulatory Risk:
There’s always a risk associated with regulations that could impact the business model. For Circle, the most significant regulatory risk would involve any regulations prohibiting Circle from earning yield or income from the deposited funds. Such regulations could potentially disrupt their entire business model.
USDC De-pegging from the USD:
This occurs when people start redeeming USDC at a discount to $1 due to a loss of confidence in the cryptocurrency. An example of this was seen on March 10, 2023, when the failure of three US banks—Silicon Valley Bank (SVB), Signature Bank, and Silvergate Bank—led to the depegging of both USDC and DAI stablecoins. USDC de-pegged by 13% below its $1 peg after Circle confirmed that $3.3 billion of cash reserves backing USDC were held at SVB. Additionally, Circle relied partly on Signature Bank and Silvergate Bank for operations related to USDC and fiat US dollars. DAI’s value closely mirrored that of USDC as USDC holdings and related instruments constituted over half of the collateral reserves backing DAI. Both stablecoins recovered to their peg levels after the Federal Reserve announced its support for the banks’ creditors.
Third-Party Loan Risks:
USDC’s de-pegging was partly due to third parties it had deposited or lent money to collapsing. It’s essential for Circle to have a stringent process regarding where they deposit their cash and whom they invest in. As seen in the events of March 2023, leaving the cash in the US is essentially risk-free, as the US government will always act as a backstop.
Smart Contract Risk:
Since USDC operates on the Ethereum blockchain, any failures of Ethereum or the code used to execute USDC could potentially lead to failures for USDC.
Conclusion
We were fortunate to acquire secondary shares in Circle at a valuation of USD 7.2 billion, representing a significant discount of 40% compared to their anticipated valuation in the public markets. While this investment comes with inherent risks, particularly regarding Circle’s transition from private to public markets, I see substantial potential upside.
My confidence in Circle’s future stems from its unique business model, which I believe has yet to find a comparable counterpart among publicly listed companies. This distinctive position, coupled with the certainty surrounding its revenue and profit margins, leads me to anticipate significant growth upon Circle’s entry into the public markets.
TheBucket 