The Breakdown - The Next Phase of Stablecoin Competition Begins As Coinbase Invests In Circle

Episode Date: August 23, 2023

Today on The Breakdown, NLW looks at the rearrangement of the arrangement between Circle and Coinbase. The Centre Consortium is being dissolved and Coinbase is investing in Circle directly. The show also features a macro update on bonds and China. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the Big Picture Power Shifts remaking our world. What's going on, guys? It is Tuesday, August 22nd, and today we are talking about updates in the circle and coin-based relationship around USDC, followed by a number of macro updates. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us. on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Hello friends, happy Tuesday. So today we are going big picture and we're starting in the crypto sphere with some updates around one of the biggest stable coins in the space. The TLDR is that Coinbase and Circle are dissolving their center consortium partnership and restructuring

the relationship between the two firms. The center consortium that governs USDC currently will be wound down and Coinbase will take a minority equity stake in The size of the equity stake was not disclosed, but one anonymous source said that no cash had changed hands as part of the deal. Coinbase CEO, Brian Armstrong, and Circle CEO Jeremy Allaire said in their joint blog post that, quote, The nature of the investment means that Coinbase and Circle will now have even greater strategic and economic alignment on the future of the financial system. So let's take a step back for a moment. The Center Consortium was founded by Coinbase and Circle in October 2018 to establish the USDC stable coin. The effort was originally envisioned as an open standards effort which could facilitate additional

USDC issuers and broader industry participation. That said, since the consortium's founding, Circle has remained the sole issuer of USDC, with the Center Consortium acting as a jointly managed self-governance organization. As part of the restructuring, Circle will bring issuance and governance of the Stablecoin completely in-house. In their blog post, the two companies explained that, quote, with growing regulatory clarity for stablecoins in the U.S. and around the world, the requirement of a separate governance body like Center is no one. longer needed. They said the move will, quote, streamline the operations in governance and enhance the direct accountability of Circle as the issuer, including holding all the smart contract keys,

complying with regulations on governance of reserves, and enabling USDC on new blockchains. Alongside the restructuring, the firms announced that USDC would be issued on six additional blockchains, bringing the total number of supported networks to 15. The firms didn't identify the new blockchains, but Circle had previously announced plans to support Pocodot, NIR, Optimism, and Cosmos this year. Coinbase's new base, blockchain would also make sense as one of the remaining additions, but was not formally announced. Now, revenue sharing of the interest earned on USDC reserves has become an increasingly important driver of profits for Coinbase over the past year. Coinbase earned 151 million in interest income

from the revenue sharing agreement in the last quarter alone. The two companies confirmed that revenue sharing would continue under a revised agreement stating that, under the party's new arrangement, this revenue will continue to be shared based on the amount of USDC held on each of our platforms, and additionally, we will now equally share an interest income generated by the broader distribution and usage of USDC. In a tweet, Coinbase said they, quote, do not anticipate these updates to impact our financial outlook. For users, there should be no noticeable changes in how USD functions other than this compatibility with additional blockchains. Executives from the two firms reinforced the idea that additional regulatory clarity and competition drove the decision.

Circle Chief Strategy Officer and Head of Global Policy, Dante Desparte, said, not only are we at a point where we can retire the center consortium, but doing so makes sense because of clarity in the marketplace around regulating stablecoins. Major companies like PayPal are entering the game, and there's sufficient clarity to abandon what was, for lack of a better term, a stablecoin self-regulatory organization structure. Of course, in addition to newly arrived competition from PayPal, USDC has also been under recent pressure from crypto-native rivals. Since the March banking crisis, which briefly threatened a small portion of USDC reserves, the stablecoin has lost more than $17 billion in market cap. In the same period, Tether has

increased its stablecoin market share by over $10 billion and is now more than three times larger than USDC. Discussions on Twitter around this had a lot to do with this idea of regulatory clarifications. Columbia Business School, adjunct professor and former Paxo staffer Austin Campbell wrote, on the topic of the Coinbase Circle News today, there are some elements here that make sense to me. First, while there was the initial idea of a consortium, the reality is that Coinbase and Circle have held tightly to the mint burn control and issuer status rather than expanding into an actual consortium. To some extent, this just validates this is the path forward for this partnership. Second, with more issuers of stablecoins arriving this year, PiUSD, FD, etc., and others on

the way, scale is going to become increasingly important, so these firms binding together to leverage that also matters. Third, I don't know what the public pathway is for Circle, but a purchase by Coinbase, which this ultimately sets up, is one pathway to get to that, and essentially allows Coinbase to have more control over cash on platform and cash management. Tommy Shanisi from Delphi Digital also brought up this idea of this as sort of a pre-merger. He wrote, wondering the odds of a Coinbase Circle merger versus a Circle IPO. Investors can bid up the most legit U.S. Exchange that has full control over the expansion of U.S.D. merger of the two most reputable U.S. firms. Coinbase just invested and they have a U.S.D.C. interest-sharing

arrangement. Now, the flip-side interpretation is almost exactly the opposite, that Coinbase might have been coming up against regulatory pressure because of its vertically integrated regulated financial services. There has been a lot of scuttlebutt about how the crypto industry does away with distinctions that exist in traditional markets, such as separating brokerage and custody, and how part of the path forward from a regulatory perspective might be to reimpose those barriers. Bitwise researcher Ryan Rasmussen said, my guess, pressure from regulators to separate and dissolve the 50-50 relationship between Coinbase and Circle. So it's a really interesting one in the sense that people are interpreting it in two totally different and in fact some ways opposite ways.

Now, one thing to speak briefly to the decoupling of Tether and USDC over the last few months, this is something I've talked about before on this show, but I think has far less to do with a vote of no confidence in Circle and USC, and far more to do with a vote of no confidence in the United States regulatory apparatus. Circle and USC have gone to pains to be as compliant as possible when it comes to issuing a stable coin in the U.S. and the fact that they had a decoupling event and almost got screwed by the failure of a major U.S. bank, even as the U.S. government was putting undue pressure on the crypto industry via Operation Chokepoint 2.0, I think, increased the risk profile of U.S.D.C., not because of anything that Circle did, other than try to comply with U.S.

regulations. The move towards tether and away from U.S.D.C. is, I think, a reflection of the lack of regulatory clarity that we have. Overall, though, I also agree with the point that this just formalizes what has effectively been the case for some time now. And that sort of streamlining usually does make sense. Now, next up, let's move over to a macro update. The U.S. bond market continued to sell off on Monday as long-dated yields hit fresh multi-decade highs. The 10-year treasury yield climbed to nearly 10 basis points to 4.35%, a level not seen since

2007. Meanwhile, the 30-year notched up by seven basis points to reach 4.45%. 10-year inflation-protected treasuries reached 2% for the first time since 2008, and the two-year yield, which is sensitive to changes in Fed policy, moved up to 5% coming close to previous peaks in March and July. The overwhelming sense in bond markets is that traders are positioning for continued tightness in central bank policy and potentially a re-acceleration in inflation. Recent macro data indicated the risk of another pulse of inflation with GDP estimates coming in scorching hot. Last week, the Atlanta Fed published the results of its GDP-now modeling,

which forecast third-quarter GDP growth coming in at an annualized rate of 5.8%. We haven't seen growth that strong since the final quarter of 2021 when the data came in at 7%. This is a complete reversal from economic concerns over the first half of the year, where below-trend growth and the risk of recession was front of mind. Zachary Griffith's senior fixed income strategist at credit site said, the continued better than expected economic data has made it like we are almost contemplating a new reality that we haven't had for quite some time, where rates could potentially be quite higher for quite longer. That's the big thing driving real yields. Now, of course, one of the underlying narratives of the past 18 months of Fed policy is that the central bank is seeking to

close the door on post-GFC zero interest rate policy, returning to most historically normal policy settings. These bond market movements could be a ratification of the Fed strategy, signaling a growing belief that a return to the zero lower bound won't be required at the conclusion of this hiking cycle. Now, it's also worth putting this in context of upcoming comments. The bond market route comes just ahead of Fed Chair Jerome Powell's speech at Jackson Hole, which is scheduled for Friday. Jackson Hole is the annual Fed Symposium for the discussion of longer-term monetary policy strategy among central bankers and interested parties. Last year, the conference was punctuated by a brief and terse speech from Powell that had been apparently rewritten just before the event. At the time, the stock market was in the midst of a strong relief rally, and according to reporting, the Fed Chair threw his prepared notes in the trash shortly before the speech.

Instead, he opted to deliver the simple message that the inflation fight is not over and that it would involve pain to households and businesses. Andrew Brenner of Natalian Securities thinks that expectations around Powell's speech could already be providing tailwind for bond traders betting on higher yields. He said, The technicals are with the bond bears. In a slow August, a liquid holiday week, they have nothing to fear as the world expects Powell to be hawkish.

Now lastly today, a brief China update. For more background on this, go listen to my episode from last week, where we did a bit of a primer on the China economic situation, which is increasingly coming to dominate macro conversations in the U.S. as well. Chinese banks have held a key interest rate steady this week in a move that surprised economists. The five-year loan prime rate was held at 4.2% on Monday, according to data from the People's Bank of China. Economists had expected a 15 basis point cut to the rate which prices retail mortgages.

The choice to keep rate steady represents lenders choosing not to pass last week's cut to central bank policy rates onto borrowers. Now, the decision is highlighting the dilemma facing Beijing. Policymakers are seeking to drive borrowing in an attempt to combat deflation, while at the same time needing to preserve financial stability in the banking sector. Allowing banks to capture a little more of the interest rate spread should preserve banks' revenue and profitability. This concern was highlighted in a report from the PBOC last week, which said banks need to maintain, quote, reasonable profits and net interest margins in order to serve the real economy and prevent financial risks.

Goldman Sachs economist wrote in a note, Protecting banks net interest margins is the main motivation behind the smaller than expected cuts to LPR in our view. Having said that, confidence remains key to an economic recovery, and the disappointing cut to the prime loan rate would not help with building confidence. Chinese stocks continue to fall on Monday, with the I-share's China-large-cap ETF now reflecting a full retracement of price action dating back to 2006. Offshore yuan pricing also softened by 0.3%. Ten-year bond yields fell to 2.55% the lowest yield since 2020. The Chinese government has signaled more urgency in shoring up lending, urging banks to expand credit growth amidst a slump in borrowing

demand. Deflation pressures also continue to mount, with simultaneous trouble in the housing sector and an as-yet-unresolved liquidity crisis at major shadow bank, Zhang Xi. And really the big theme is the continued lack of decisive action out of Beijing. This policy of cutting central bank rates while allowing mortgage rates to stay flat at commercial banks kind of continues that weirdness. Bloomberg economist Eric Zhu said, the surprise hold on China's five-year loan prime rate conveys two messages. First, there may be doubts that slashing rates for new mortgage loans, which are already at a record low, is the best way to shore up the housing market. Second, it could be a signal that other non-monetary policy support is in the pipeline. Now, these policy settings might indicate that Beijing is

attempting to navigate the economic downturn without taking measures that would re-accelerate housing prices. China already has some of the most overpriced property on Earth, and President Xi has been clear that he wants to put an end to excessive housing speculation. Bruce Pang, chief economist for Greater China at Jones-Lang LaSalle said that the policy actions send a signal that, quote, authorities don't want the property market to overheat. There has been speculation on whether the government will completely let loose property policies after the Politburo meeting omitted the pledge that housing is not for speculation. The signal now is that there will still be policy controls on the property sector, just that they will be optimized. End quote. Now, in some ways,

this more moderate intervention could represent a transition away from the infrastructure-heavy growth at any cost mindset of a pre-pandemic China. In remarks released over the summer, President Xi expanded the scope of national success outside of growth, emphasizing national security, risk preparation, and lower pollution. Michael Herson, a former U.S. Treasury attesche in Beijing, commented that, she has emphasized at several key points this year that local officials should stay disciplined against financial risks and not chase short-term goals. But now they are also being told to support growth. Many officials are thus likely to see the safe course of actions as taking modest efforts at stimulus, but nothing particularly bold. So taken altogether, this really

still leaves us in a very liminal in-between moment. In crypto, we've got USDC and Coinbase preparing for an anticipated regulatory clarity coming down the pipeline, but which still isn't there. Fed policy watchers are trying to grapple with what might come next, and different and conflicting signals in again another wait-and-see period. And then in China, they continue to thread a needle between political goals and economic goals, while all around continued global realignment is happening. A quiet August may be in some ways, but with it seems, a lot of change building under the surface. Anyways, friends, that is going to do it for today's breakdown. I hope you enjoyed, and until tomorrow, be safe and take care of each other. Peace.