Circle’s Mounting List of Woes

The big news this week has been stablecoin issuer Circle’s decision to scrap its plans for a public listing through a merger with a Special Purpose Acquisition Company (SPAC). The Securities Exchange Commission (SEC) played spoilsport to the company’s plans by withholding its approval for the deal. Circle CEO Jeremy Allaire put on a brave front and released a statement that held out hope for a future public listing.

But the chances of that happening in this bear market are slim.

Out of the three pegs of revenue that the company outlined in its balance sheet last year, one has disappeared and the other two are wobbling due to extraordinary conditions in the US economy and crypto markets.

Meanwhile, the operating environment for its business has become rough. Its customers have declared bankruptcies in the current crypto meltdown and the company has been forced to shutter products that could have brought in additional revenue. Even its banking partners seem to be abandoning ship.

In other words, the runway for Circle to prove itself as a bridge between traditional finance and cryptocurrencies has become much shorter with its latest setback.     

An Unstable Stablecoin Business

According to Circle’s previous SEC filings, its total revenue figure is a sum of money from three sources – fees from transactions and services relating to USDC, interest income from investments made using money from reserves to back up USDC, and takings from SeedInvest – an equity crowdfunding platform it acquired in 2019. 

SeedInvest was the biggest contributor to Circle’s revenues in 2020. But it had been trying to get rid of it for the last two years to focus exclusively on its stablecoin business. It finally found a buyer this past October and offloaded most of its stake to become a minority shareholder in the startup.

Circle does not seem to have made much from the deal. According to the SEC filing, the all-share transaction was valued at $24 million. That figure is less than the approximately $34 million total – also equal to half of total compensation expenses – that Circle shelled out for its three highest paid executives last year.

The Interest Income Party  

Interest income from investments made using its reserve funds for USDC is the second biggest contributor to Circle’s top line. In 2021, as USDC use exploded at crypto exchanges, Circle made more money in this revenue category and its income jumped to $28.4 million from $4.4 million a year earlier.

Not all that money accrued to the company because it has income-sharing agreement with crypto exchanges that tokenize and hold USDC on their platforms. In 2019, the company paid out approximately 79% of its interest income to exchanges. The next year, as the Fed dramatically lowered its interest rate to resuscitate economic activity, Circle’s interest income fell by almost 30% and it paid out 64% of the total figure. Last year, it handed over 41% of its interest income to exchanges.

While figures for this year are unavailable, one can be sure that the Fed’s strategy of pursuing high interest rates to tamp inflation must have netted Circle substantial income that likely contributed to its stated profit figures.

But the interest rate hike party in Treasury Bills, which comprise the biggest holdings in Circle’s reserves to back its stablecoin, will likely pause next quarter onwards because the Fed is waiting for data to measure the impact of its policy before taking further steps. This means that Circle’s interest income will decline even as exchanges that custody USDC continue to demand their cut of the overall pie.

Circle and Crypto’s Record Year

The share of interest income and crowdfunding platforms to Circle’s top line pales in comparison to the business drummed up by its Transaction and Treasury services division. The business, which provides an assortment of services related to USDC, including settlement and portability of the stablecoin across various blockchains through Application Programming Interface (API) access, accounted for 56% of the company’s $84.87 million revenues last year.

Much of that figure was derived from skyrocketing trading volumes – a consequence of increased investor appetite for risk due to low interest rates – last year. New investors, retail and institutional, came to crypto and pumped bitcoin price to record highs twice in the same year. In the ensuing melee, USDC wrested market share from Tether – the world’s most heavily-traded stablecoin – and its market capitalization leapt to more than $45 billion from $4.7 billion at the start of the year. 

A Jump In Operating Costs

Expensive operating costs accompanied those hefty gains. The company’s general and administrative expenses shot up by 124% to $31 million between 2020 and 2021. It went on a hiring spree and grew its headcount to 800 employees by August 2022. Employee compensation expenses, the biggest line item on its balance sheet, grew by 260% to more than $68 million in 2021. And it jumped its marketing spend by an astounding 3324% jump to $13.6 million.  

The result of all this spending was that, despite a banner year in crypto trading volumes and prices, Circle swung from a profit of $3.8 million in 2020 to $508 million in losses last year. 

The company has continued to spend this year but market conditions are different.

Valuations for major coins have crashed by double digits and transaction volumes are heading south. USDC seems to have increased its share of overall stablecoin transaction volumes. But bitcoin volumes are down, meaning the share of altcoins using USDC as a trading pair has increased.  

The nature and veracity of those volumes is suspect because such coins have mostly illiquid markets. What’s more, crypto exchanges are infamous for architecting fake volumes on their platforms. This means that, even with increased volumes, Circle’s USDC may not bring in much money to offset its operational costs which, based on available public information, remain similar to last year.

More Pain Ahead

The pain of a crypto winter is exacerbated by a rapidly falling crypto house of cards. The fall has claimed prominent victims, some of whom were Circle partners and customers.

A 2021 investor presentation by the company prominently mentioned FTX and Genesis – the former has filed for bankruptcy and the latter’s loan book is threatened by one – among marquee accounts and partnerships at the exchange.

Circle CEO Allaire stated last month that his company had “no material exposure” to FTX’s collateral or tokens. It was a “tiny equity holder” – to the tune of $10.6 million – in the bankrupt exchange. That amount may be small, but the company’s management deemed FTX’s collapse to be serious enough to revise its estimated revenue projections and make them “materially lower” in an SEC filing.   

Circle’s exposure to Genesis is well-documented through Circle Yield – a product that offered yield and lending services for USDC. The two companies entered into a $25 million agreement in 2020 to launch the product. Back then, Genesis was a behemoth in crypto lending and backstopped high interest rates offered at prominent lending platforms.

But its exposure to Three Arrows Capital and FTX has dramatically reversed that position.

Circle put the brakes on Circle Yield last month after marking down its yield to zero. It has also stopped new loans on the platform and claims that it has repaid customers loan amounts and interest. It did not divulge the exact repayment number, but a November 16 tweet stated it had $2.6 million in outstanding customer loans on its platform.

A Difficult Operating Environment

The current climate of distrust and suspicion around crypto has also made Circle’s operating environment difficult.  

Signature Bank, which held a portion of Circle’s USDC reserve funds, announced yesterday that it was planning to cut down its deposits tied to crypto by between $8 billion to $10 billion in a bid to dissociate its reputation from the tarnished industry.

The announcement is expected to be especially heavy on Circle because the two companies were planning to partner on integrating USDC into Signet, the bank’s real-time payment network, and launch new products and services.    

Crypto regulation, which is expected to be fast tracked after the current turmoil, could also turn out to be a double-edged sword for the company in its current state. Regulatory pincers that force stablecoin issuers to be regulated like banks and hold adequate capital reserves can become another overhang to its operations. They could increase business expenses at the wrong time. In the past, the company has shut down operations in unfriendly jurisdictions, like Hawaii, in response to the considerable costs involved in operating there.

A ‘Doubtful’ Future?

In an SEC filing last year, Circle stated that there was “substantial doubt” about its ability to continue as a concern in March 2021. It resolved this problem by issuing $441 million worth of convertible debt to various parties. The company said the amount was sufficient to help it operate for 12 months from the date of issuance. [Only one of those parties, Intersection Fintech CIF Partners, is named in the filing]. The notes were issued in May 2021, meaning Circle should have used up available funds by May 2022.

But the company hasn’t ceased operations. It raised $400 million from a group of investors that includes investment managers BlackRock Inc. and Fidelity Management LLC., this past April. With estimated business expenses that may be in excess of $400 million (based on its submission to the SEC), it is important for Circle’s balance sheet that the current crypto winter does not last long.

A public listing would have provided the company with a fresh infusion of cash to continue operations and an exit to investors, who have put more than a billion dollars into it over the past ten years. But that does not seem to be on the cards for Circle investors.

In fact, one of its investors, Goldman Sachs, resigned as financial advisor to the SPAC deal earlier this year without providing an explanation. It is reported to be hunting around for bargains in the crypto carnage. Perhaps, it might want to start in its own backyard.

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