Despite assurances by Circle Internet Financial Ltd.’s chief financial officer Jeremy Fox-Geen that reserves backing USD Coin (USDC) were ring-fenced, concerns over the state of the collateral backing the so-called stablecoin continue to weigh on the coin, which had a market capitalization of more than US$55 billion on Thursday.

Speaking in an exclusive interview with Forkast Editor-in-Chief Angie Lau, Fox-Geen said being regulated under state money transmission laws in the U.S. meant the company does not have any right on the USDC reserves that are held in segregated accounts with financial institutions.

Watch Jeremy Fox-Geen’s interview here

“The institutions that hold the USDC reserve aren’t lending it out in any way to grow USDC,” Fox-Geen said. “They’re just holding fiat currency within the banking system and holding U.S. Treasuries in custody on behalf of USDC holders, so there’s no lending out of USDC to grow USDC,” he added. “All USDC growth is driven by customer activity.” 

Circle has US$10 billion to US$15 billion of cash at hand to satisfy immediate demands with Treasurys, which make up for roughly three-fourths of the reserves, being the most “price stable liquid assets in the world,” Fox-Geen said. 

According to Circle’s latest weekly reserves breakdown, US$42.5 billion of the stated US$55.5 billion USDC reserves were Treasurys dated three months or less, with cash making up for the rest. However, as highlighted in the Forkast interview, the snapshot provided by Circle has not been verified by any independent third-party auditor, including Grant Thornton LLP. The auditor did not respond to a request for comment by Forkast.

See related article: Circle says customers could redeem all of USDC in one day

This comes amid intense speculation, mostly on social media, over the state of the reserves that remain unaudited. 

These were stoked by an article published on Saturday by American author and journalist Matt Taibbi where he alleged Circle did not disclose how much of the reserves are stored where. 

Early on Friday Hong Kong time, Circle published an unaudited breakdown of its reserve assets worth US$55.7 billion in a bid to increase transparency.

The document showed that Circle held US$13.58 billion in cash and US$42.12 billion in U.S. Treasurys with a weighted average maturity of 43.9 days, as of June 30. The company also published a list of its reserve cash custodians, which includes Bank of New York Mellon, Citizens Trust Bank, Customers Bank, New York Community Bank, Signature Bank, Silicon Valley Bank, Silvergate Bank, and US Bancorp.

Fox-Geen said that the Circle is working on daily disclosure of reserve assets and trying to secure permission to reveal the amount of cash held by each custodian.

He also said that Circle “cannot use the USDC reserve in any way,” the article questioned how the stablecoin issuer projected earnings of US$438 million for the full year of 2022 from interest generated by USDC reserves. The company expects to earn another US$2.19 billion in interest from the reserves, the outlook shared in February showed. 

“We make a conservative rate of return on the reserve,” on Treasurys and cash denominated in greenback, and held directly with financial institutions and custodians within the U.S. regulatory perimeter, Fox-Geen said. 

The annualized yield received for investing in Treasurys with a three-month maturity was at 2.2% in late evening trade in Asia on Thursday. Even if coupled with next to no returns on cash holdings, and any possible split in earnings, the lowered average return on Circle’s stated reserves of US$54.01 billion is well above the projected earnings for 2022.    

Meanwhile, a spokesperson told Forkast on Wednesday that Circle does not and will not use USDC holders’ money to run its business or pay its debts.

“Circle does not and will not use USDC holders’ money to run its business or pay its debts.”

– Circle spokesperson

The Reserve

In March, Circle agreed to a US$400 million funding round with investments from BlackRock, Inc., Fidelity Management and Research, Marshall Wace LLP and Fin Capital. 

As part of the deal, BlackRock also “entered into a broader strategic partnership with Circle which includes exploring capital market applications for USDC,” ending with the world’s largest asset manager managing the USDC cash reserves through the Circle Reserve Fund. But the fund’s prospectus filed with the Securities and Exchange Commission showed only Circle could purchase shares in the fund. 

Read more: Financial Stability Board calls for high regulatory standards for stablecoins

“If Circle is to be the sole counterparty to a reserve fund, that would mean reserves would belong to the company, not its users,” Taibbi wrote in his article. The report further questioned the provision that allowed the Reserve Fund to invest up to one-third of its assets in reverse repurchase agreements. 

“We cannot comment on the details of the fund at this time as we wait for approval,” a spokesperson told Forkast on Wednesday.

Taibbi also questioned whether investors in Wisconsin, Minnesota, and Wyoming would be protected, as Circle operates in these states without licenses and the protection offered by state money transmission laws. However, the company’s website showed it has a money transmitter license in Minnesota with no licenses required in the other two states along with Montana.

Circle is not licensed in these states as they do not require one for the company to operate, a spokesperson said. However, the company is also registered as a money services business (MSB) with the U.S. Department of the Treasury, which requires adherence to know-your-business (KYB), anti-money laundering (AML) and financial crimes compliance requirements, the spokesperson added. 

“Circle, then, is not just relying on state law for bankruptcy protection but also the federal Bankruptcy Code for what assets are considered assets of the estate (and subject to creditors) and what is not,” the spokesperson said. 

However, in the event of a Circle bankruptcy, the company makes no representations or warranties as to whether all supported digital currencies held in hosted wallets will be returned to users, its legal documentation showed on late Thursday. The company’s Circle Account wallet service allows customers to deposit, withdraw, send, receive, store and allocate funds to invest in digital currency, Circle said on its website. 

“Yes, USDC reserves are treated differently in bankruptcy from digital assets we custody for Circle Account holders,” said a company spokesperson, noting that Circle Accounts are only available to sophisticated, accredited investors and businesses.  

“USDC reserves are treated differently in bankruptcy from digital assets we custody.”

– Circle spokesperson

See related article: CFTC Commissioner Pham suggests regulators stay tech-neutral on stablecoins

Meanwhile, former banker and financial journalist Frances Coppola pointed out that maintaining a 1:1 liquid dollar reserve would limit stablecoin issuance to the ability of an issuer to obtain such reserves. 

Unless the issuer is a bank, the ability to get dollars from the U.S. Federal Reserve is limited, forcing an issuer to buy on the open market, said Coppola.  

“This explains why it (USDC) de-pegged during the May market panic,” Coppola said. “It could not obtain reserves fast enough to issue the quantity of USDC that investors were demanding, so the price rose sharply,” she added.

And while an “obvious solution is for the stablecoin issuer to become a bank,” it will need “sufficient high-quality collateral” such as short-term government debt such as Treasurys, which need to be bought from the market, said Coppola.

“If a stablecoin issuer couldn’t obtain sufficient T-bills to maintain 100% reserves in a market panic, how would it obtain sufficient T-bills to borrow those reserves from the Fed?” Coppola said. 

“If a stablecoin issuer couldn’t obtain sufficient T-bills to maintain 100% reserves in a market panic, how would it obtain sufficient T-bills to borrow those reserves from the Fed?”

– Frances Coppola

“I’m not sure those who argue that stablecoin issuers should become 100% reserve banks have quite thought this through,” Coppola said. “If a stablecoin issuer with a Fed master account must obtain collateral from markets in order to borrow the reserves it needs to hold its peg, then it cannot guarantee its peg.”  

The audit

Over the past week, several people have questioned the status of Circle’s audited reports, alleging financial information in these submissions were unaudited after December 2020. 

A Circle spokesperson said the S-4A filing made on July 11 contains audited financial statements for 2021 and 2020. It also contains quarterly interim financial statements for the first quarter which are not subject to audit as is standard practice for any Securities and Exchange Commission (SEC) filing, the spokesperson added. 

The S-4A filed on May 6 also contains the same audited financial statements, the spokesperson said, adding that “the USDC reserve has been audited pursuant to Public Company Accounting Oversight Board (PCAOB) standards as part of Circle’s financial statement audit, which have been filed publicly with the SEC.”

“The USDC reserves are reported as a component of Circle’s financial statements,” the company said. “The balances, financial statement classification and disclosures in connection with the reserves are subject to review on a quarterly basis and audit on an annual basis by a top five accounting firm,” it added. “The audit verifies the completeness, accuracy and composition of the reserves.”

“The annual audit opinion issued is on a PCAOB basis as consistent with Circle’s plan to become a public company and the audited financial statements are included in Circle’s periodic SEC Filings,” the spokesperson said. 

These filings were submitted as part of Circle’s deal with former Barclays head Bob Diamond’s blank-check firm (SPAC), Concord Acquisition Corp., which valued it at US$9 billion in February, double the original deal value of US$4.5 billion in July 2021.

Forkast found the deal would help Circle qualify as an “emerging growth company,” making it eligible for certain exemptions from various reporting requirements applicable to other public companies, including being exempt from the auditor attestation requirements with respect to internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act.

But a Circle spokesperson said the “emerging growth company” categorization doesn’t change the fact that any public company still must publish audited statements. 

In its last attestation on USDC reserves in May available on the company’s website, Grant Thornton said it wasn’t expressing an opinion on the effectiveness of Circle’s internal controls related to the reserve. The auditor “obtained an understanding” of the procedures related to information on reserve accounts, it said.

“Our external accounting firm is not expressing an opinion on Circle’s internal controls — that is not part of this attestation process,” a spokesperson told Forkast. “They are validating Circle’s assertion that U.S. dollar denominated assets held in segregated accounts are at least equal to the USDC in circulation at a designated date.”

The story has been updated to reflect Circle’s breakdown of USDC reserves that the company made public on Friday.