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Circle Stablecoin’s Wild Weekend Raises Risk of Regulatory Scrutiny

Circle Stablecoin’s Wild Weekend Raises Risk of Regulatory Scrutiny

(Bloomberg) -- Circle’s stablecoin needed about 36 hours to repair its peg with the dollar amid a liquidity panic. Fixing its reputation with regulators will take longer.

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Market overseers, their hands already full with the biggest US bank failure in a decade, were forced over the weekend to contend with a drama playing out in a section of finance that has been trying their patience for months: crypto. That’s where USD Coin’s supposedly immutable bond with the dollar came asunder, when it was revealed about 8% of the reserves backing it were stuck at the collapsed lender.

It’s particularly awful timing for Circle, which had been piling up earnings and cash and was set to feast on the travails of key rivals. Now its risk management practices are in the spotlight at a moment when regulators have been paying close attention to stablecoins and the companies behind them. “They were the clear winner in the centralized stablecoin space. Now they have hard work to do to win confidence back,” said Campbell Harvey, a finance professor at Duke University.

USD Coin is the world’s second-biggest stablecoin — a kind of crypto token whose value is supposed to be pegged to $1 due to the implication it can be redeemed for a dollar of cash. Most of the reserves backing it are invested in a money market fund holding short-term Treasury bills and cash, but a portion has been kept in several different banks — including Silicon Valley Bank. On Friday, that bank collapsed into receivership after there was a run on deposits.

Circle’s business had been on a roll. The company ended the third quarter of 2022 with total revenue and reserve interest income of $274 million and net income of $43 million — and ended 2022 profitable, according to company documents and interviews. Circle also ended the quarter with close to $400 million in unrestricted cash.

It benefited in part from rising usage, but also from the increase in interest rates. USD Coin tokens don’t pay their holders interest, while Circle was able to earn money from its reserves. Currently Circle Reserve Fund, the BlackRock Inc.-managed money fund that holds most of the money backing USD Coin, shows a seven-day yield of about 4.5%.

On Friday evening, Circle disclosed that about $3.3 billion of USD Coin’s roughly $40 billion in reserves were with the bank. In a tweet, Circle’s Chief Strategy Officer Dante Disparte called SVB’s collapse “a black swan failure”—a common finance metaphor for a highly unusual and hard-to-foresee event.

Anxious crypto traders began selling USD Coin so quickly that it lost its peg to the dollar, falling below 85 cents. By Sunday night, the token had largely recovered as the market reacted to Circle’s statement that it would cover any potential shortfalls and the promise by the government to make all bank depositors whole.

Circle was in “active” conversations over the weekend with US regulators seeking assurance about USD Coin’s path to recovery, Chief Executive Officer Jeremy Allaire said in an interview with Bloomberg News on Tuesday, without giving details on the talks.

“You would expect that we would obviously be keeping very good open lines of communication,” said Allaire. “Everyone wants to make sure that operationally, things are strong, that things are functioning as required from a statutory perspective.”

The company was able to access deposits at SVB as of Monday, Allaire said.

Circle had a good 2022, but it hadn’t been consistently profitable for much of its life since its founding in 2013, according to documents and executive interviews. It raised a total of $1.1 billion in funding over the years, according to Crunchbase, thought it’s unclear how much of that funding is left. The company has a staff of more than 900 people.

Stablecoins like Circle’s provide traders with a way to get in and of out of more volatile coins like Bitcoin or Ether without also having to switch between crypto and normal cash. Securities and Exchange Commission Chairman Gary Gensler once called stablecoins “the poker chip” powering speculative crypto casinos.

  • Read: If Stablecoins Are Stable, Why Are Regulators Tense?: QuickTake

Last year, a stablecoin called TerraUSD collapsed spectacularly, prompting the SEC in February to sue the company behind it and its co-founder for fraud. Although TerraUSD was a so-called “algorithmic” stablecoin with a different design from asset-backed tokens like USD Coin, the move suggested that the regulator thinks stablecoins are within its authority to regulate.

The agency in February also notified stablecoin issuer Paxos Trust Co. that it was considering action against it regarding its Binance-branded BUSD token. The agency alleged that BUSD was an unregistered security, an assessment with which Paxos said it disagreed and intended to litigate if necessary. Circle has said its stablecoin is different from BUSD, and that it is a mechanism for payment, not a security.

“I don’t think the SEC is the regulator for stablecoins,” Allaire told Bloomberg during an interview in February. “There is a reason why everywhere in the world, including the US, the government is specifically saying payment stablecoins are a payment system and banking regulator activity,” Allaire said.

  • Listen: Circle CEO Jeremy Allaire on US Crypto Regulation (Podcast)

But it’s an unsettled issue. “We’ve seen that the SEC does not care” about the differences between the stablecoins, said Christopher LaVigne, who chairs Withersworldwide’s global digital-asset practice of about 180 lawyers. “In their view the definition of a security is very broad, and most things in this space in their view fit into that definition.”

Regulators like the New York State Department of Financial Services also care about the one-to-one backing of stablecoin reserves. Despite the save provided by regulators late on Sunday, recent events may raise questions about the way Circle manages its assets and vets its financial partners, according to Todd White, managing partner of Rulon & White Governance Strategies.

A fixture in some proposals to regulate stablecoins is to treat them more like banks, offering some kind of deposit insurance protection. But that looks unlikely to gain traction—it’s unappealing both to those in crypto who resist additional regulation and to those who think crypto is so unstable it should be kept at a distance from the traditional finance system.

“Stablecoins do nothing but facilitate speculation in the crypto ecosystem,” said Hilary Allen, a law professor at American University. “You are not using it to buy eggs. You are using it to buy other crypto. Do we want the government guaranteeing crypto speculation? For me the answer is, no. It’s a pivotal moment, it will supercharge discussions about regulating stablecoins.”

--With assistance from Chris Nagi, Edward Dufner and Emily Nicolle.

(Updates with comment from CEO Allaire in ninth paragraph.)

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