Introduction
Investors were assured by top figures that the U.S. federal entities have no intentions of banning digital assets. Securities and Exchange Commission (SEC) Chair, Gary Gensler, said that rather than prohibiting digital assets, the government's priority is to ensure that the industry follows investor and consumer protection standards, anti-money laundering regulations, and tax laws. According to Federal Reserve Chairman Jerome Powell, the U.S. government does not intend to prohibit Bitcoin (BTC-USD) or cryptocurrencies. Furthermore, the Federal Deposit Insurance Corporation (FDIC) is said to be evaluating whether or not it may expand its services to include stablecoins.
This sets the landscape for the crypto industry to thrive. Of the many projects and businesses to invest, Circle should be on crypto bulls' radar. After all, the company developed the USD Coin (USDC-USD) that we use extensively today.
The company is expected to go public via a SPAC merger with Concord Acquisition Corp. (CND) at a $4.5bn valuation. In this article, we aim to examine Circle's business model and valuation.
Circle's Business Model
According to Circle,
In our founding documents, we envisioned that we could build a global digital currency bank, one that enabled frictionless, instant and nearly free payments that combined fiat reserve currencies with open, permissionless blockchains, and eventually building on these open networks to support new forms of capital formation and intermediation.
To become a "full-reverse national commercial bank" has always been the vision of Circle. The company is true to its vision. Not only that the domain expertise of Circle's and CND's top management (Figure 1) very much align with its vision, Circle's business model is also very similar to that of a bank. That vision may be realized sooner than expected as Circle is applying for recognition as a national digital currency bank.
A bank derives its earnings from interest income from loans, transaction fees, treasury services, etc. The higher the utility of those services, the higher a bank's earnings.
We can observe that Circle's business model behaves similarly (Figure 2), which is not a surprise given its vision. Therefore, its business model is relatively easy to understand. Circle derives income from interest on reserves deposited by users, provides transactions and treasury services (TTS) to individuals and corporations, and provides a platform for funding businesses.
Circle has three highly synergistic products: USD Coin, Suites for Transaction and Treasury Service (TTS), and SeedInvest (Equity Crowdfunding Platform). What ties together these products is the USDC. The higher the adoption of USDC, the higher the utility of Circle's services, the higher the earnings potential of Circle.
USDC And Its Reserve Income
Since we find that USDC serves as entry to the utility of other services, let's examine this segment first.
USDC is a digital currency introduced by Centre Consortium, an organization co-founded by Circle and Coinbase (COIN). USDC is pegged to the USD. It now runs on Ethereum (ETH-USD), Stellar (XLM-USD), Algorand (ALGO-USD), Solana (SOL-USD), Tron (TRON-USD), etc. This means that it enjoys all the benefits of a cryptocurrency, such as almost instantaneous and low-cost transactions across the globe.
The creation of a new USDC coin is beyond the scope of this article. Since USDC runs on several blockchains, the mechanism of minting and burning USDC differs. What is important to know is that the company assures that each USDC is redeemable 1:1 for the USD as USDC is backed by cash and equivalents and short-term Treasuries. Unlike Tether (USDT-USD), Circle publishes attestation reports monthly regarding reserve balances.
As a consumer of USDC, you might say, "It is not 100% USD cash-backed!". However, as an investor, we're thrilled because the reserves are "working." Circle is entitled to a share of the generated interest from the reserves, and this interest income scales proportionally to the size of the reserves.
There are already more than $32bn USDC in circulation (Table 1), behind only USDT. The company expects it to scale to $200bn in the next two years. The company claims that USDC has been the fastest-growing stablecoin in the market over the past three years (130x). This claim is valid when compared to the growth of USDT (36x), Figure 3.
With $200bn in reserves, the company only expects to earn an income of $196mil. This interest income is susceptible to changes in the prevailing interest rates. It is estimated that 2023 interest income will increase by $555mil for every 50bps increase in interest rates before sharing. We could not estimate the actual income for Circle as the share rate isn't disclosed.
Although it is not as much as we would like, we find that USDC adoption better serves as an entry to other higher-margin services (e.g., TTS).
Suites Of Transaction And Treasury Services
According to Circle's projection, this segment is projected to generate the most revenue compared to the other two segments. These services are provided through Circle Accounts and APIs to individuals and corporations.
It is estimated that TTS will generate the majority of Circle's revenue ($622mil or 75% of total revenue). This figure is not surprising when looking at its marketed marquee partners, including Coinbase, Visa (V), U.S. Bancorp (USB), and TopShot.
Coinbase (top 2 crypto spot exchange) and FTX (the top 4 largest spot and derivative crypto exchange) partnered with Circle to allow users to fund and withdraw their accounts directly with USDC. Dapper Labs partnered with Circle to allow payments directly via USDC.
The partnership between Circle and these partners usually come in the form of using USDC as a means of settlement, withdrawals, deposits (funding accounts), payments, transmittal, and etc. That is why we find that the adoption of USDC serves as the entry to Circle's services.
Circle stands to gain much from the future mass adoption of cryptocurrencies where demands for settlements between cryptos and stablecoins or stablecoins to fiat increases.
SeedInvest isn't expected to contribute much (8%) to Circle's revenue, but it could be used as a channel for funds and incubators for complimentary products in the crypto industry. Hence, we won't discuss it here.
Regulation As Barrier To Entry
According to Circle,
Circle, in partnership with Coinbase and through the Centre Consortium, designed USDC to conform with stringent U.S. money transmission supervisory and regulatory standards.
What we like about Circle is that it is a regulation-conscious company, much like Coinbase. Circle's products are developed with regulation in mind. Hence, regulation is more of an advantage towards Circle because the barrier to entry is higher.
According to BIS, stablecoins are promoted to provide faster cross-border payments and deeper financial inclusion. They may, however, fracture the monetary system by creating closed ecosystems. They augment the already significant market power of big techs and challenge existing regulatory practices.
But it paints an entirely new picture if these firms are supervised directly under federal regulatory bodies. Circle has announced plans to become a "full-reserve national commercial bank" that is directly supervised under the Federal Reserve, U.S. Treasury, Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC).
We can already observe that both Circle and the regulatory bodies are moving in the right direction for the crypto community. One aspect of that is insurance. FDIC insurance is a form of deposit insurance, which typically provides ample coverage/safeguards to customer accounts against the potential loss of funds. Recently, FDIC is said to be evaluating whether or not it may expand its services to include stablecoins. Any positive development in this event will greatly benefit Circle.
Circle was recently issued an investigative subpoena by the SEC, and documents pertaining to Circle's holdings, customer programs, and operations were requested. The investigation is believed to be related to an interest-bearing product known as "Circle Yield." Although there is no further information about this investigation, we believe that Circle will be able to cooperate and handle these regulations well.
Although these regulatory challenges may hinder Circle's progress, we have to remember that competitors that come after Circle will need to face similar challenges. We also think that regulatory compliances will also go a long way for Circle since their vision is to be able to serve businesses in the U.S. and worldwide in a reputable and trustworthy manner.
Valuations
Currently, Concord Acquisition Corp. is trading near its $10 floor. This means that investors have the opportunity to invest in Circle at its base $4.5bn valuation or 5.8x 2023 projected revenue sales. We could not conduct further analysis into its financial performance as no historical figures were provided.
We find that a 6x growth in USDC adoption in just two years is rather ambitious, but Figure 3 would beg to differ. Several catalysts could spark further USDC adoption. These catalysts include the launch of the first U.S. Bitcoin ETF (not futures), FDIC insurance coverage on reserves, Circle's official recognition as a national bank operating under the supervision of federal entities, and any form of further adoption of cryptocurrencies in general.
However, a very important thing to note is that the Crypto-SPAC combo has not fared at the time of writing. MoneyLion Inc. (ML), a digital bank and crypto trading platform, plunged up to 40% days after going public (Figure 8). Its valuation stands at around 13.8x current revenue, far lower than Circle's 47x current 2021 expected revenue.
There are several other Crypto-SPAC plays expected to go public in 2021Q4 (Figure 9). All of them are trading near the $10 floor. Figure 10 shows the performance of Crypto-SPAC plays after the merger, notice that they're trading below their floor value despite Bitcoin's recovery to its all-time high (Figure 11).
Source: Circle
Figure 9: Crypto-SPAC plays
Figure 10: Crypto-SPAC plays after merger
Figure 11: Bitcoin Price Nearing All-Time-High
Source: YCharts
Verdict
The prospect of being able to invest in the first-of-its-kind (potentially) crypto national bank with global reach in this early stage presents a desirable investment proposition. Given the upside of the crypto industry, a 5.8x 2023 revenue isn't unreasonable.
This is one company we want to invest in alongside Coinbase, given their partnership in developing USDC and their direction of providing compliant crypto and financial services.
However, given the performances of past Crypto-SPAC plays after the merger (Figure 10), it is reasonable to expect that Circle will trade below its $10 floor after the merger. Therefore, we have allocated enough reserves to buy the dip.
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Analyst’s Disclosure: I/we have a beneficial long position in the shares of COIN, BTC-USD, BITF, CND either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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