Proof of State is the Wednesday edition of Fortune Crypto where Leo Schwartz delivers insider insights on policy and regulation.
For the past month, I've been trying to answer one question: Why is Circle losing to Tether?
On first blush, Circle's U.S. dollar-backed stablecoin, USDC, seems like it should be the clear winner. Unlike Tether, which chooses to operate offshores without any pretense of regulation or transparency, Circle is upfront about its reserves, its operations, and its attempts to push oversight discussions forward in the U.S. and beyond.
And yet, USDC's market cap has been precipitously falling, now hovering around $26 billion, while Tether keeps creeping north of $82 billion. One clear reason is USDC's brief depeg in March, after Circle revealed that it had $3.3 billion in reserves stuck at the failing Silicon Valley Bank. As one competitor told me, "It's an impaired product." But after speaking with more than two dozen executives, regulators, former employees, and crypto leaders, I learned the answer goes much deeper.
My new feature explores USDC's struggles and aspirations, and how they mirror its parent company. The Jeremy Allaire-led Circle turns 10 this year, which I thought was a good opportunity to look back at its pre-USDC history of OTC trading and Poloniex, the birth and demise of the Centre Consortium, and the growth of stablecoins. That all brings us to the past six months, when it seemed that USDC was poised to conquer the world until Silicon Valley Bank came tumbling down and the White House put the brakes on stablecoin legislation.
Despite Circle's tumultuous year, USDC still occupies an enviable position in the crypto industry. Amid the bear market, stablecoins are still a favorite curiosity for lawmakers and traditional finance firms, representing a relatively safe entry point into the sector. In Allaire's ideal future, stablecoins will become the rails for global payment settlement, just as Visa is piloting with several companies.
Perhaps my bias is showing given the theme of this newsletter, but the key for that dream to be realized is regulation. Institutions are still dipping their toes into stablecoins, but they're waiting for the blessing of an oversight regime—a reality that seems further and further away, as Congress bickers over questions like Fed vs. OCC supervision.
In the absence of clarity, the sole stablecoin regulator remains the New York Department of Financial Services, which demonstrated its influence last February when it kneecapped another USDC competitor, the Binance and Paxos joint project BUSD. BUSD represented 95% of Paxos's revenue, demonstrating the power of regulators in the space. Paxos, of course, has moved on to its PayPal-branded stablecoin.
While Circle often touts its relationship with regulators as its differentiator from the wildcat Tether, I found that the reality is more complicated. Unlike Paxos and the Winklevoss-led Gemini, Circle doesn't issue USDC under DFS supervision, likely due to its business model of issuing across a variety of blockchains, which DFS is wary about. “It’s weird,” a former DFS regulator told me about the relationship between Circle and DFS. “It’s almost a metaphysical distinction.”
As USDC remains trapped behind Tether, the question for Circle is what comes next. The company is still pulling in hefty profits, although with over 99% of its revenue coming from interest income, that financial cushion is not a given. And while the company’s reserves are in a much more stable place post-Silicon Valley Bank, Allaire's proposal of having an account directly with the Federal Reserve doesn't seem to be winning many fans in Congress. Meanwhile, Tether continues to serve as an attractive option to global stablecoin users, with the future of the U.S. crypto industry in flux. As Allaire told me, "We still haven’t reached the 1.0 vision of the company."
You can read my full feature here.
Leo Schwartz
leo.schwartz@fortune.com
@leomschwartz
