Circle will earn $2.3 billion in interest alone: explained
As interest rates rise, Circle and its USDC earn billions!
The US Federal Reserve (Fed) has recently announced an increase in interest rates. Against all expectations, this increase particularly benefits a category of players: cryptocurrency startups.
Note that the Federal Reserve is the central bank of the United States. It comes to tackle inflation by raising the projection from 2.6% to 4.3% , almost unheard of. In this movement, the Federal Reserve has also announced 6 new increases in the key interest rate just for the year 2022.
Costings, rates, interest and different rules can quickly lead to confusion. Here is a summary of the main information to take away from this news:
- Why such an increase in interest rates?
- Correlation between Stablecoins and US Dollar
- Circle’s revenge on a laborious 2019
Why Such An Increase In Interest Rates?
First, be aware that the increase in interest rates has been planned for a long time. By the end of 2018 , the leaders of the American central bank had already analyzed and programmed it.
It now corresponds to a rise of a quarter of a percentage point, with the corresponding rate reaching a value between 0.25% and 0.50%. By the end of 2022, the key rate could reach up to 2%. This forecast rate of 2% is impressive, because it would imply the gain of a quarter of a point at each of the famous 6 major economic meetings remaining.
And it is on this point that the startups of cryptocurrencies draw their pin from the game…
Circle for its part issues new coins in USD when customers send it a corresponding dollar amount. Circle then invests those dollars in a portfolio of cash and short-term government securities. This is to ensure the convertibility of USDC. With approximately $53 billion of USDC in circulation, the reserves portfolio managed by Circle is thus as large as a mid-sized US bank.
Like a bank, Circle therefore earns a return on its portfolio of assets. This yield tends to increase when interest rates rise. In Circle’s case, it expects to earn an additional $2.3 billion in interest income alone over the next two years.
The origin of this phenomenon is much easier to understand than it seems. In a context of particularly intense inflation, the Fed affirms its determination to fight against the consequences of inflation, with the ultimate goal of regaining control.
To accomplish this ambitious goal, the Fed has deployed several strategies. Among the latter, it plans to reach its neutral rate of 2.4% from 2023, or even exceed it by going up to 2.8%. In this way, it hopes to create the ideal monetary conditions to act as a brake on economic activity. Such a situation would then be maintained as far as possible until 2025.
However, this objective may be impacted by certain events, such as the war in Ukraine. These events are likely to affect inflationary pressures in the short and medium term, and upset the figures.
Correlation Between Stablecoins And US Dollar
What is a Stablecoin? Nothing could be simpler: it is a cryptocurrency considered “stable.” To be more exhaustive, we can add that a stablecoin is a reliable response to the high volatility of cryptocurrency prices.
In this sense, the potential for variation in value of a stablecoin is much lower than that of a classic cryptocurrency. For example, the price of a traditional crypto is capable of swinging 100-200% in just one day.
The operating system of a stablecoin is to back its value to a classic currency, thus ensuring its back. In this case, the US Dollar serves as a reference. For example, in the case where the price of Bitcoin (BTC) corresponds to 6,000 dollars, it is enough to exchange 1 BTC against 6,000 stablecoins. Thanks to this, in the event that the price of Bitcoin drops, you will always have 6,000 Stablecoins in your possession. Stablecoins thus act as a kind of insurance against losses .
Conversely, if BTC gained in value or even exploded, the limits of the Stablecoin would be reached. Despite the rise in value of BTC, you will still only hold 6,000 stablecoins and therefore will not benefit from this gain in valuation.
The correlation between Stablecoins and US Dollar is thus obvious: support the value of Stablecoins on that of the dollar , all to obtain a stable and reliable cryptocurrency price.
Circle’s Revenge On A Laborious 2019
$179 million: This is the net loss recorded by Circle in 2019.
It all started a year before that when Circle acquired Poloniex, a struggling cryptocurrency exchange. To contextualize, Poloniex had been fined for violating investor protection laws and also opened accounts for people located in countries considered sensitive, such as Iran or North Korea.
Subsequently, Circle focused on developing its own stablecoin, USDC.
Soon after, Circle hired investment bank FT Partners to help raise funds. Within its partnerships, FT Partners always applies two conditions: to be selected for any future transaction, and that the client pays the bank charges which increase as a percentage of the sale prices and the collections of funds that he recovers.
At the time, Circle thus accepted these two conditions, without suspecting the complications that this would cause. The investment bank originally advised Circle on its initial merger with Concord, at a valuation of $4.5 billion. The problem is that FT Partners said its engagement letter with Circle entitles it to about 9% of the deal’s value, or more than $400 million.
Circle directly challenged this reading of the engagement letter.
Circle directly challenged this reading of the engagement letter. Despite this, FT Partners emerged as the big winner. With a Circle-Concord transaction valuation having reached 9 billion instead of the 4.5 initially expected. Thus, the remuneration due to FT Partners has doubled and exceeded 800 million dollars.