Dialogue with Circle's transaction manager: Building a new internet financial system through cryptocurrency

Original Title: “USDC and The Future of the Dollar”

Author: STANFORD BLOCKCHAIN CLUB

Compiled by: Deep Tide TechFlow

An interview was conducted with Heath Tarbert, the Chief Legal Officer and Head of Corporate Affairs at Circle, former Chairman of the Commodity Futures Trading Commission (CFTC), and former Assistant Secretary of the Treasury.

This article is a lengthy exploration of the discussions and ideas from an interview with Jay Yu of the Stanford Blockchain Club in June 2024. Click here to watch the full video.

Introduction

Today, stablecoins are an important part of the cryptocurrency industry, combining the reliability of the dollar as a store of value with the tradability and usability of blockchain tokens. Among them, USDC is Circle's flagship product and one of the most widely adopted stablecoins, ranking as the sixth largest cryptocurrency by market capitalization.

In this article, we will discuss the unique characteristics of USDC as a stablecoin product, its current adoption as a means of payment, the regulatory environment that USDC and other digital assets may face, and the implications of all this for the future of the digital dollar.

Creating Trust and Transparency in Stablecoins

The core of USDC addresses a very simple question: how to purchase digital assets with dollars? Before the advent of stablecoins, the solution was to transfer fiat dollars from the traditional banking system to cryptocurrency exchanges, which was often a slow, cumbersome, and expensive process. USDC solves this "on-chain" problem by creating a "digital dollar," a programmable, tokenized representation of the dollar, backed 1:1 by fiat cash and cash-equivalent assets.

Since its inception in 2018, USDC has grown to become one of the leading stablecoins in the cryptocurrency industry. Perhaps the key factor that distinguishes USDC from other major stablecoins is its emphasis on trust and transparency during the issuance process. Unlike other stablecoin providers that are often located overseas and unregulated, Circle is a fully U.S.-owned and operated company that issues these "digital dollars." Every month, the reserve assets of USDC are independently audited by one of the Big Four accounting firms, and Circle has a public dashboard where anyone can view the composition of USDC's reserves in real-time. For example, as of August 8, 2024, Circle's dashboard recorded $34.5 billion of USDC in circulation.

Circle's reserve composition, accessed on August 8, 2024

So, how are Circle's USDC tokens issued and redeemed from fiat backing? The direct issuance and redemption of USDC is handled through "Circle Mint," an application programming interface (API) provided for institutional traders, fintech companies, exchanges, and other businesses. To receive any amount of USDC, Circle Mint customers initiate a corresponding fiat transfer to Circle's USDC reserve account through its API, and Circle issues an equivalent amount of USDC to the customer's Circle Mint account. Similarly, when Circle Mint customers request to redeem USDC for fiat currency, Circle sends the USDC to a "burn address," and after this "burn event" occurs, the dollars are transferred to the associated bank account of the business.

The asset management process is also designed to foster trust by leveraging the expertise and transparency of traditional asset management companies. Of the current $34.5 billion in USDC reserves, $4.5 billion is held in reserve banks, while the remaining $30.1 billion is held in the Circle Reserve Fund, a SEC-registered government money market fund managed by Blackrock, with a 7-day SEC yield of 5.29%.

Fiat-backed stablecoins like USDC stand in stark contrast to the traditional fractional banking system. In most banks, dollars are only backed by the bank's loan portfolio (which typically consists of relatively illiquid and higher-risk assets), whereas every dollar of USDC is backed by an equivalent amount of highly liquid cash and cash-equivalent dollar assets. In this sense, Circle's USDC paves the way for the future of the dollar in the digital environment. By providing a secure, reliable, and innovative infrastructure framework for the "digital dollar," Circle aims to reimagine one of the most important assets in the financial world.

Adoption of USDC: From DeFi to TradFi

Of course, the true value of stablecoins lies in their use cases. No matter how well-designed or transparent a product is, the real test of a stablecoin is its adoption in everyday use—whether in blockchain environments or traditional payment systems.

Dune stablecoin trading volume dashboard in DeFi

Circle's USDC remains the largest regulated digital dollar globally, natively supporting 16 different blockchains and seeing significant use as the preferred stablecoin in DeFi protocols. The largest trading volumes occur on Solana and Ethereum, with primary use cases including trading and other activities within the crypto ecosystem. To ensure compatibility across different supported blockchains, USDC has developed a native interoperability infrastructure for cross-chain transfers called the Cross-Chain Transfer Protocol (CCTP).

The interoperability mechanism in CCTP is very similar to the fiat-to-token infrastructure of Circle Mint. Currently, CCTP supports eight different chains: Arbitrum, Avalanche, Base, Ethereum, Noble, OP Mainnet, Polygon PoS, and Solana. To transfer USDC from one chain to another, for example from Ethereum to Solana, three main steps are required:

1. First, USDC is burned on Ethereum (the source chain).

2. Then, the user obtains a signed proof from Circle of the burn event as a receipt for the "burn event."

3. Circle uses that proof to authorize the minting of USDC on Solana.

One advantage of this burn-and-mint mechanism is that it allows for compatibility between blockchains running different virtual machines—such as Ethereum's EVM and Solana's SVM—enabling use cases like cross-chain swaps, deposits, and purchases in decentralized finance (DeFi) systems.

But perhaps the most exciting area of growth for USDC lies in its adoption beyond crypto trading and DeFi products. Traditionally, money has three main functions: (1) as a store of value, (2) as a unit of account, and (3) as a medium of exchange. The adoption of USDC for these three monetary functions in the real world is steadily increasing.

As a "store of value," USDC has become a natural solution for people in developing countries without reliable dollar or dollar-denominated bank accounts. In Argentina, where the annual inflation rate exceeds 200%, stablecoins have become an important way for citizens to preserve wealth. In 2023, 60% of cryptocurrency purchases in Argentina were made using USDC and other dollar-denominated stablecoins, ranking the country 15th globally in cryptocurrency adoption. In December 2023, Circle also announced a partnership with Brazil's Nubank to provide access to "digital dollars" for its 85 million customers.

As a "unit of account," USDC has also made significant strides in recent years, with Circle conducting extensive pilots with the two largest payment processing companies, Visa and Mastercard. For example, since 2021, Visa has partnered with Crypto.com to pilot the use of USDC as a settlement mechanism, and in 2023, Visa announced it would increase support for USDC settlements in collaboration with new merchant acquirers Worldpay and Nuvei, utilizing the Solana blockchain. Similarly, in 2021, Mastercard announced it would enable crypto companies to launch branded cards that settle using stablecoins like USDC.

As a "medium of exchange," USDC can now be used at any Visa terminal through the Coinbase Visa card. This debit card was launched in 2020 for U.S. consumers, allowing them to pay directly with USDC at any Visa terminal, providing a payment experience similar to fiat currency while earning rewards in cryptocurrency.

The Coinbase Visa card allows customers to spend USDC at any Visa terminal

Another example of USDC as a "medium of exchange" is the Grab app, headquartered in Singapore, which is a comprehensive app with over 180 million users in Southeast Asia, offering ride-hailing, food delivery, and grocery services. In September 2023, Grab announced a partnership with Circle to create a web3 wallet that supports USDC payments as well as NFT government vouchers and food vouchers. Today, consumers can use USDC to top up their Grab wallets on Ethereum and Solana.

Thus, we see that USDC is gaining increasing support and integration in traditional payment systems, bridging internet financial systems with traditional financial services. But how does stablecoin as a payment method compare to existing digital payment systems like the Automated Clearing House (ACH)?

In many existing systems (like ACH), funds and messages move separately through centralized ledgers. If Alice transacts with Bob via ACH or credit card, the transaction is first marked as "pending," which may take days to finalize. This is because at the moment the transaction occurs, the system only issues a "message" indicating that the transaction has occurred, while the funds are not immediately transferred. The arrival of funds is asynchronous and can sometimes be delayed for days.

A key advantage of stablecoin payments compared to these traditional systems is that funds and messages move simultaneously. Therefore, when Alice conducts a stablecoin transaction with Bob, Bob receives the full amount immediately upon the issuance of the transaction message, just like a cash payment. In this way, stablecoins represent a technological leap in many existing settlement solutions, making them more suitable for playing the role of a "digital dollar" in the future.

Legal and Regulatory Perspectives on Stablecoins

Like any emerging technology, stablecoins raise many legal and regulatory issues. As stablecoins like USDC gradually enter the mainstream, a key concern is that they may become tools for malicious actors to engage in money laundering, terrorism financing, and evading sanctions. This is particularly important as the connection between traditional financial services and stablecoins matures over time, establishing a new internet-based financial system; thus, there is a need to focus on advancing the compliance of stablecoin products.

In this article, we emphasize that Circle aims to make USDC a regulated, transparent stablecoin issued by an issuer that prioritizes compliance. As a regulated money transfer company, Circle adheres to relevant FINCEN guidelines and state money transfer laws, and all U.S. users of Circle Mint must comply with anti-money laundering and know-your-customer regulations, such as the Patriot Act.

However, while introducing compliance to prevent malicious actors from abusing stablecoins like USDC is necessary, this regulation should also be more nuanced and sophisticated to protect the interests of ordinary consumers who wish to use USDC; creating a regulatory framework that excludes ordinary consumers—especially those who are already marginalized in the existing financial system—does not serve the interests of the United States.

Currently, the two main regulatory bodies attempting to regulate stablecoins in the U.S.—the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC)—were established before the invention of the modern internet, let alone digital assets like cryptocurrencies and stablecoins. Today's regulators are using tools that are over 90 years old; while certain guidelines may still be useful in some cases, regulators need to be particularly cautious about how to apply existing rules to this emerging industry and to formulate new rules to effectively regulate new activities based on blockchain technology innovations.

While the blockchain industry can undertake some technological innovations, such as decentralized digital identity systems, making it easier to balance end-user privacy needs with regulatory requirements, these alone are not enough to fill the regulatory gap. Congress must take action to increase regulatory transparency for stablecoins and digital assets as a whole, and new legislation such as the draft "Stablecoin Transparency Act" represents a step in the right direction.

In this regard, several other regions, including the European Union, are far ahead of the United States. Recently, the EU launched the Markets in Crypto-Assets Regulation (MiCA), which is expected to be fully implemented by December 2024. The core innovation of MiCA is that it aims to create a brand new regulatory framework for digital assets, stipulating requirements for stablecoin issuers to hold liquid reserves, restricting non-euro-denominated stablecoins, and providing a unified authorization mechanism for the EU's 450 million citizens. MiCA represents an important step toward increasing regulatory transparency in the regulation of stablecoins and digital assets, and Circle's stablecoin is among the first globally compliant with MiCA. Based on its work to comply with MiCA, Circle's products have good prospects for adoption in the EU, positioning it as a leading compliant stablecoin.

The largest foreign holder of U.S. Treasury securities

Therefore, there is a strong impetus for Congress to take action on stablecoin legislation. Regulated dollar-denominated stablecoins like USDC can significantly advance U.S. interests in the digital asset space. The reserve requirements of USDC mean that demand for U.S. Treasury securities will always exist. As of June 2024, stablecoins are the 18th largest creditor of U.S. debt, holding more Treasury bills than South Korea or Germany. As demand for stablecoins and digital assets continues to grow, this number will only increase. In other words, the demand for dollar-denominated stablecoins directly translates into demand for dollars and U.S. Treasury securities. Therefore, Congress must increase regulatory transparency in the digital asset space to further enhance the dollar's strength in the digital age.

Conclusion

Stablecoins like USDC have come a long way since their inception a few years ago, becoming one of the most compelling use cases for blockchain technology. The core idea of stablecoins is to bring the internet's interoperability, composability, and accessibility into traditional monetary institutions, and USDC is at the forefront of building a secure and transparent "digital dollar."

In the coming years, as stablecoin products, adoption, and regulation mature and develop, we can expect millions of businesses and individuals to adopt a new open standard for financial transactions. In this sense, Circle's mission is to fulfill the internet's unfinished promise—bringing the openness and transparency of the internet into the realm of money, ultimately establishing an internet financial system.