The tale of a whale who took Solend’s money

DeFi stands for decentralized finance, but don’t let the “decentralized” part fool you. These protocols are almost always controlled by a central party who calls the shots.

When you hand them your money, they can do whatever they want with it, when they want. Offshore crypto exchanges exhibit similar behavior.

On Sunday, Solend, a “decentralized” lending platform on the Solana blockchain, passed a proposal that would give them permission to take over the account of a “whale” — a large holder — who posed a threat to the price of SOL, the native token of Solana. 

The whale had deposited a large amount of SOL into Solend in exchange for a “loan” of USDC and USDT, two popular stablecoins, and then disappeared. Make no mistake: this was an exit, not a loan. The whale essentially sold a huge amount of SOL for a two highly liquid assets — at a substantial discount, granted, but that amount of SOL would have crashed the market otherwise.

The problem was that if the price of SOL dropped below a certain point, the Solend platform would auto-liquidate his funds, selling off a large chunk on a decentralized exchange. This would create cascading liquidations across the books of the decentralized exchanges, potentially driving the price of SOL to zero. 

Solend Labs made a bad loan and overpaid for the SOL. To fix this, they came up with a solution: set up a sham DAO and conduct a sham vote to take over the whale’s account and sell the coins over the counter (OTC) to avoid crashing the market. “Code is law” only applies until the big boys might lose money.

How DeFi works

In October, Solend raised $6.5 million from Coinbase Ventures, Solana Ventures, and Alameda Research, among others. The following month, the firm raised another $26 million worth of USDC in an initial coin offering, selling its SLND token. Investors and insiders got a percentage of SLND. [Crunchbase; SLND distribution]

Solend is one of the largest DeFi lending protocols on Solana. You deposit assets as collateral and take out loans against those assets, generally in the form of stablecoins.  

This isn’t true lending. True lending involves giving money to people who don’t have money in exchange for illiquid collateral, such as a car or a house, or something that is liquid but the lender cannot or does not want to sell, such as controlling shares in a company. In contrast, DeFi lending is giving people money against collateral that is a larger amount of fungible money. Another crucial distinction is that with true lending, you keep possession of the home, car or stock; whereas, in DeFi lending, the lender takes possession of the collateral, which you then cannot use in any way, not even for POS staking.

Traders use DeFi lending platforms to leverage long or short positions. It’s a form of gambling. If your bet goes south, you lose your collateral. Everything in DeFi is done with smart contracts, which are just simple and dumb computer programs, so liquidations are automatic — unless they’re not. 

In the case of Solend, a whale took out a large margin position. They parked 5.7 million SOL (currently worth $170 million) onto the platform to withdraw $108 million in USDC and USDT. The whale then vanished, and would not pay down the loan or respond to tweets from Solend’s pseudonymous founder Rooter. [Tweet]

This is one of the reasons we’ve seen such a proliferation of stablecoins in 2021 — they are used in DeFi lending. Retailers (the public) buy stablecoins and stake them on DeFi platforms hoping to earn higher interest than they can from traditional banks. The market cap of USDC was 4 billion in early 2021. Today, it is 56 billion.

The whale’s position represented 95% of all Solana deposits on Solend and 88% of all USDC the platform had lent out. If Solana dropped to $22.30, the whale risked partial liquidation — about $21 million worth of SOL — even though they didn’t seem to care. And the retail stakers risked losing their USDC. 

SOL is currently trading at $35, according to Coin Gecko. It still has a way to fall, but in the current market, the value of all cryptos only seems to be going down. 

Let’s let the DAO decide

To get itself out of this sticky situation, Solend Labs spun up a decentralized autonomous organization. The purpose of a DAO is to allow the community to vote on proposals. Solend’s governance token is SLND. The more SLND you hold, the larger influence you have on a proposal passing. DAOs typically aren’t created on-demand, but this one was. 

On June 19, Solend put the first proposal to its DAO: “SLND1: Mitigate Risk From Whale.” [Proposal, Solend blog]

“DEX liquidity isn’t deep enough to handle a sale of this size and could cause cascading effects. Additionally, liquidators will be incentivized to spam the network to win very lucrative liquidations. This has been known to cause load issues for Solana in the past which would exacerbate the problems at hand.”

… It’d be difficult for the market to absorb such an impact since liquidators generally market sell on DEXes. In the worst case, Solend could end up with bad debt.”

That last line is misleading. Solend already had bad debt. It was simply trying to fumble its way out of a horrible situation of its own making.  

SLND holders could vote as follows:

Vote Yes: Enact special margin requirements for large whales that represent over 20% of borrows and grant emergency power to Solend Labs to temporarily take over the whale’s account so the liquidation can be executed OTC.

Vote No: Do nothing.”

One yea voter (a SLND whale) provided 1 million votes out of the 1.15 million votes in favor. In fact, they moved a million governance tokens into their account, voted, and moved them back out again — not the greatest example of corporate governance. Users had only six hours to vote, and the voting site was down for three hours during the voting. Solend claims the Solend core team did not vote. Just some random person who borrowed 98 percent voting power. [Twitter; Twitter]

The Solend community was livid and Solend was getting all kinds of bad press over the incident, so Solend submitted a second proposal to invalidate the first and start over: “SLND2: Invalidate SLND1 and Increase Voting Time. [Proposal; Solend blog]

“We propose to: Invalidate the last proposal, Increase governance voting time to 1 day, Work on a new proposal that does not involve emergency powers to take over an account.”

This second proposal was also passed, largely due to the same SLND whale. 

The ‘future of finance’

Solend is currently experiencing a bank run, as lenders rush to get their deposits off the platform. If the money is borrowed, Solend can’t pay it back. The whale has almost completely drained Solend of any actual value and left it filled with assets that cannot be sold. [Tweet; Reddit; Solend dashboard]

The Solend platform did exactly what it was designed to do — lend money. The problem was that Solend massively overpaid for SOL. Put simply: the whale had trouble offloading a huge amount of SOL, so he offloaded it onto Solend, and they, in turn, are struggling to offload the SOL. 

DAOs are corporate governance but with a concussion. Automated voting is a terrible idea. Being able to borrow an overwhelming number of votes just for the vote is extremely dumb. This is exactly what happed to Beanstalk. 

Crypto boosters and VCs, such as Andreessen Horowitz, have been promoting DeFi as “the future of finance” and the foundation of “Web3,” which is nothing more than a way for people to create money out of thin air in the form of tokens, and for investors to cash out by dumping those tokens on the public.

Retailers deposited their stablecoins on Solend in the hope of making high returns. What they got instead was a whale that took off to sea with all of their money.

Updated to include the bit about the bank run.

Additional reporting by David Gerard.

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The Latecomer’s Guide to Crypto Crashing — a quick map of where we are and what’s ahead

Since November 2021, when Bitcoin hit its all-time high of $69,000, the original cryptocurrency has lost 70 percent of its face value. And when Bitcoin falters, it takes everything else in crypto down with it. 

The entire crypto space has been a Jenga stack of interconnected time bombs for months now, getting ever more interdependent as the companies find new ways to prop each other up.

Which company blew out first was more a question of minor detail than the fact that a blow-out was obviously going to happen. The other blocks in the Jenga stack will have a hard time not following suit. 

Here’s a quick handy guide to the crypto crash — the systemic risks in play as of June 2022. When Bitcoin slips below $20,000, we’ll officially call that the end of the 2021 bubble.

Recent disasters

TerraUSD collapse — Since stablecoins — substitutes for dollars — are unregulated, we don’t know what’s backing them. In the case of TerraUSD (UST), which was supposed to represent $18 billion … nothing was backing it. UST crashed, and it brought down a cascade of other stuff. [David Gerard; Foreign Policy; Chainalysis Report]

Celsius crumbles — Celsius was the largest crypto lender in the space, promising ridiculously high yields from implausible sources. It was only a matter of time before this Ponzi collapsed. We wrote up the inevitable implosion of Celsius yesterday. [David Gerard]

Exchange layoffs — Coinbase, Gemini, Crypto.com, and BlockFi have all announced staff layoffs. Crypto exchanges make money from trades. In a bear market, fewer people are trading, so profits go downhill. Coinbase in particular had been living high on the hog, as if there would never be a tomorrow. Reality is a tough pill. [Bloomberg; Gemini; The Verge]

Stock prices down — Coinbase $COIN, now trading at $50 a share, has lost 80% of its value since the firm went public in June 2021. The company was overhyped and overvalued.

US crypto mining stocks are all down — Bitfarms ($BITF), Hut 8 Mining ($HUT), Bit Digital ($BTBT), Canaan ($CAN), and Riot Blockchain ($RIOT). Miners have been borrowing cash as fast as possible, and are finding the loans hard to pay back because Bitcoin has gone down.

UnTethering

Crypto trading needs a dollar substitute — hence the rise of UST, even as its claims of algorithmic backing literally didn’t make sense. What are the other options?

Tether — We’ve been watching Tether, the most popular and widely used stablecoin, closely since 2017. Problems at Tether could bring down the entire crypto market house of cards.

Tether went into 2020 with an issuance of 4 billion USDT, and now there are 72 billion USDT sloshing around in the crypto markets. As of May 11, Tether claimed its reserve held $83 billion, but this has dropped by several billion alleged “dollars” in the past month. There’s no evidence that $10.5 billion in actual dollars was sent anywhere, or even “$10.5 billion” of cryptos.

Tether is deeply entwined with the entire crypto casino. Tether invests in many other crypto ventures — the company was a Celsius investor, for example. Tether also helped Sam Bankman-Fried’s FTX exchange launch, and FTX is a major tether customer.

Tether’s big problem is the acerbic glare of regulators and possible legal action from the Department of Justice. We keep expecting Tether will face the same fate as Liberty Reserve did. But we were saying that in 2017. Nate Anderson of Hindenburg Research said he fully expects Tether execs to end the year in handcuffs. 

Other stablecoins — Jeremy Allaire and Circle’s USDC (54 billion) claims to be backed by some actual dollars and US treasuries, and just a bit of mystery meat. Paxos’ USDP (1 billion) claims cash and treasuries. Paxos and Binance’s BUSD (18 billion) claims cash, treasuries, and money market funds.

None of these reserves have ever been audited — the companies publish snapshot attestations, but nobody looks into the provenance of the reserve. The holding companies try very hard to imply that the reserves have been audited in depth. Circle claims that Circle being audited counts as an audit of the USDC reserve. Of course, it doesn’t.

All of these stablecoins have a history of redemptions, which helps boost market confidence and gives the impression that these things are as good as dollars. They are not. 

Runs on the reserves could still cause issues — and regulators are leaning toward full bank-like regulation.

Sentiment

There’s no fundamental reason for any crypto to trade at any particular price. Investor sentiment is everything. When the market’s spooked, new problems enter the picture, such as: 

Loss of market confidence — Sentiment was visibly shaken by the Terra crash, and there’s no reason for it to return. It would take something remarkable to give the market fresh confidence that everything is going to work out just fine.

Regulation — The US Treasury and the Federal Reserve were keenly aware of the spectacular collapse of UST. Rumour has it that they’ve been calling around US banks, telling them to inspect anything touching crypto extra-closely. What keeps regulators awake at night is the fear of another 2008 financial crisis, and they’re absolutely not going to tolerate the crypto bozos causing such an event.

GBTC — Not enough has been said about Grayscale’s Bitcoin Trust, and how it has contributed to the rise and now the fall in the price of bitcoin. GBTC holds roughly 3.4 percent of the world’s bitcoin.  

All through 2020 and into 2021, shares in GBTC traded at a premium to bitcoin on secondary markets. This facilitated an arbitrage that drew billions of dollars worth of bitcoin into the trust. GBTC is now trading below NAV, and that arbitrage is gone. What pushed bitcoin up in price is now working in reverse.

Grayscale wants to convert GBTC into a bitcoin ETF. GBTC holders and all of crypto, really, are holding out hope for the SEC to approve a bitcoin ETF, which would bring desperately needed fresh cash into the crypto space. But the chances of this happening are slim to none.

The bitcoins are stuck in GBTC unless the fund is dissolved. Grayscale wouldn’t like to do this — but they might end up being pressured into it. [Amy Castor]

Whales breaking ranks — Monday’s price collapse looks very like one crypto whale decided to get out while there was any chance of getting some of the ever-dwindling actual dollars out from the cryptosystem. Expect the knives to be out. Who’s jumping next?

Crypto hedge funds and DeFi

Celsius operated as if it was a crypto hedge fund that was heavily into DeFi. The company had insinuated itself into everything — so its collapse caused major waves in crypto. What other companies are time bombs?

Three Arrows Capital — There’s some weird stuff happening at 3AC from blockchain evidence, and the company’s principals have stopped communicating on social media. 3AC is quite a large crypto holder, but it’s not clear how systemically intertwined they are with the rest of crypto. Perhaps they’ll be back tomorrow and it’ll all be fine. [Update: things aren’t looking good. 3AC fails to meet lender margin calls.] [Defiant; Coindesk; FT]

BlockFi — Another crypto lender promising hilariously high returns. 

Nexo — And another. Nexo offered to buy out Celsius’ loan book. But Nexo offers Ponzi-like interest rates with FOMO marketing as well, and no transparency as to how their interest rates are supposed to work out.

Swissborg — This crypto “wealth management company” has assets under management in the hundreds of millions of dollars (or “dollars”), according to Dirty Bubble Media. [Twitter thread]

Large holdings ready for release

Crypto holders have no chill whatsoever. When they need to dump their holding, they dump.

MicroStrategy — Michael Saylor’s software company has bet the farm on Bitcoin — and that bet is coming due. “Bitcoin needs to cut in half for around $21,000 before we’d have a margin call,” Phong Le, MicroStrategy’s president, said in early May. MicroStrategy’s Bitcoin stash is now worth $2.9 billion, translating to an unrealized loss of more than $1 billion. [Bloomberg]

Silvergate Bank — MicroStrategy has a $205 million loan with Silvergate Bank, collateralized with Bitcoin. Silvergate is the banker to the US crypto industry — nobody else will touch crypto. Silvergate is heavily invested in propping up the game of musical chairs. If Silvergate ever has to pull the plug, almost all of US crypto is screwed. [David Gerard]

Bitcoin miners — Electricity costs more, and Bitcoin is worth less. As the price of Bitcoin drops, miners find it harder to pay business expenses. Miners have been holding on to their coins because the market is too thin to sell the coins, and borrowing from their fellow crypto bros to pay the bills since July 2021. But some miners started selling in February 2022, and more are following. [Wired]

Mt. Gox — at some point, likely in 2022, the 140,000 bitcoins that remained in the Mt. Gox crypto exchange when it failed in 2014 are going to be distributed to creditors. Those bitcoins are going to hit the market immediately, bringing down the price of bitcoin even further.

Feature image by James Meickle, with apologies to XKCD and Karl Marx.

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Why is bitcoin dropping in price?

As I write this at 9 pm ET, on May 5, the price of bitcoin is $36,300. It slid from $39,000 Thursday to below $36,000 at one point, causing a disturbance in the force.  

There were two sharp drops — at 15:00 UTC precisely and 19:00 UTC precisely, with attempts to walk the price back up both times. The last thing you want is to kick off a panic, so there will always be whales in the background trying to lift bitcoin back up when it falters. 

After starting the year at $46,700, bitcoin saw a January sell-off, which pushed the price down to $35,000. Apart from that, the world’s most popular crypto has been trading in a range of around $40,000 — a far cry from its record of $68,990 in November 2021. 

Why did it slip Thursday? Because bitcoin mirrors the stock market, mainly tech stocks. 

On Wednesday, Fed Chairman Jerome Powell said there may be .5% rate increases over the summer, but that officials weren’t considering a .75% increase.  

The momentary glee pushed stocks up on Wednesday, but those gains were erased on Thursday when the Federal Reserve raised its target federal funds rate by half a point — the second increase by the central bank this year.

Stocks tumbled. The Dow Jones fell 3.1%. The S&P 500 fell 3.6%, and the tech-heavy Nasdaq slid 5% — its biggest drop since June 2020.

Bitcoin is down 27% since the beginning of the year — and 47% since it’s November all-time high. Tech stocks have also done poorly this year. Google’s parent company Alphabet lost 20% of its share price, Microsoft is down 17%, and Meta has fallen 34% since the start of the year. 

Are the good times coming to an end? 

Over the last two years, the stock and crypto markets have been able to turn a blind eye to the reality of the pandemic because there was plenty of money flowing into the game to keep things going. 

Stimulus bills approved by Congress beginning in 2020 unleashed the biggest flood of federal money into the US economy ever. Roughly $5 trillion went to households, shops, restaurants, airlines, hospitals, local governments, schools, and other institutions. 

Stimulus checks ($1,200 in April 2020, $600 in December 2020, and $1,400 in March 2021) helped fuel a stock-buying spree — and a crypto buying spree. 

Starting in 2022, government programs meant to invigorate the economy during the pandemic ended. Now, reality is settling in. Americans are starting to think hard about the future. They are taking a good long look at their bank accounts and their budgets. 

The longer the Russia-Ukraine war goes on, the bigger its economic costs will be — and the war is looking like it will drag out for possibly years. 

Inflation is at its highest level since the 1980s, reaching 8.5% in March from a year ago. When I go to the grocery store, I can see the prices going up weekly. Avocados at Trader Joe’s are $2.29! 

Rising food prices are terrifying to a lot of people. Gas prices in parts of the country (California, Nevada) are over $5. It takes a lot of money to fill up the tanks in the SUVs Americans love. 

People are moving away from risky investments — like crypto — and fleeing to safety. They want to make sure they can weather inflation and any future slowdown in the economy. 

So they are putting their money into things like I Bonds right now. Just go to Treasury Direct. You can put $10,000 per year in I Bonds and they are paying 9.62%. That’s a lot safer than bitcoin. 

Of course, it’s not just rising interest rates that are rattling the crypto markets. Bitcoin needs fresh cash to keep prices buoyed, and it’s not clear where that next batch of fresh cash is going to come from. 

I wrote earlier about Grayscale’s Hotel California. The Grayscale Bitcoin Trust (GBTC) arb opportunity that pushed bitcoin to new heights in 2020 and early 2021 has dried up.  

Between January 2020 and mid-February 2021, bitcoin climbed from $7,000 to $56,000. GBTC is now trading at 25% below net asset value, and Grayscale stopped issuing new shares in March 2021. 

Grayscale is pushing for the SEC to convert GBTC into a spot bitcoin ETF to open the gates for more cash to flow into the cryptoverse. But it is doubtful that will happen. 

The SEC has rejected every spot bitcoin ETF to date, and — as I’m sure the commission will recognize — Grayscale can redeem those shares on its own at NAV if it wants.  

And then there’s Tether. On March 11, 2020, when the WHO declared COVID-19 a pandemic, causing a massive sell-off in stocks and crypto, Tether’s market cap was $5 billion. Today, 83 billion tethers are underpinning the price of bitcoin. What’s underpinning tethers?

It’s widely accepted amongst crypto critics that Tether is a fraud. Hindenburg’s Nate Anderson predicted that Tether’s two public faces would end 2022 in handcuffs. 

If you include the 48 billion USDC sloshing around in the crypto markets, I suspect insiders can pump the price of BTC past $50,000 anytime they want with stablecoins — but they don’t because there would not be enough cash in the system to keep up with withdrawals.

The same network effects that pushed bitcoin to its highs can unravel. At some point, people will want to sell their bitcoin for cash — not tethers or USDC. That means someone has to be on the other side of the deal ready to hand over real dollars. 

I don’t think the Big Crash is happening now, but the bitcoin sell-off on Thursday was an indication of just how wobbly things have become. All the conditions are ripe for a collapse in the crypto markets. It’s just a matter of time. 

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What’s backing Circle’s 25B USDC? We may never know

Jeremy Allaire is taking his Boston-based company Circle public via a SPAC. Circle is best known for its stablecoin USDC, which now has a market cap of $25.5 billion. 

In all his press interviews talking up the future potential of stablecoins — “Circle sits at the center of the next major transformation that the internet is bringing to the world,” he said in an investor website video  — there is one question Allaire consistently avoids giving a straight answer to: 

What is backing USDC? 

Based on his current scheme to take his company public, he may not have to come up with an answer anytime soon. 

What’s a SPAC?

SPAC stands for special acquisition company. 

Otherwise known as a “blank check” company, a SPAC is basically a shell set up by investors with the sole purpose of raising money through an initial public offering to eventually acquire another company  — “a company for carrying on an undertaking of great advantage, but nobody to know what it is.”*

Going public through an IPO is a rigorous process. It requires you to file a Form S-1 with the US Securities and Exchange Commission. An S-1 is a full-body exam, a cavity search, where you lay out all of the material weaknesses of your company. There is really nowhere to hide in an S-1. 

When you take your company public through a SPAC, however, the SPAC goes through the IPO process — not the company it ends up buying. And since a SPAC is just a room full of investment banks and private equity dudes, its S-1 is simple and straightforward. A SPAC has no skeletons in the closet. 

Once the SPAC submits its S-1 and raises money via an IPO, it goes out and finds a private company to buy and then merges with the company. In the merger, the private company gets the money and the SPAC holders get shares in the new combined entity.

The merging process requires considerably less due diligence than a traditional IPO, which is why the space is full of frauds and get-rich-quick schemes. Not all SPACs are frauds, of course, but it’s a clever way to lever up and then sell the debt to the public via shares. 

Because many of the companies taken public this way have little to show in terms of a business plan, SPACs have resulted in a slew of shareholder lawsuits. The most glaring example is electric truck startup Nikola. Three months after the company went public with a $3.3 billion valuation via a SPAC, short-seller Hindenburg Research revealed it was an intricate fraud. (The truck was rolling downhill!) Nikola’s stock collapsed, its CEO ended up stepping down, and a series of class actions followed.

“SPACs are oven-ready deals you should leave on the shelf,” an FT headline read in December. Then-SEC Chairman Jay Clayton voiced similar concerns last year. 

“I’m still keeping my mind open to the fact that there could be a good SPAC out there,” Hindenburg founder Nate Anderson told the FT. “I just haven’t seen it yet.”

Details of Circle’s SPAC

Circle is merging with Concord Acquisition Group (NYSE: CND), a SPAC sponsored by investment firm Atlas Merchant Capital. The transaction is expected to close in the fourth quarter, according to the press release.

When the transaction closes, a new company will acquire both Concord and Circle and become publicly traded on the NYSE under the ticker symbol “CRCL” — and CND will disappear. 

Concord raised $276 million in its December IPO. Here’s Concord’s S-1. It’s short, only a few pages. Compare that to the 200-page S-1 of Coinbase, the US crypto exchange that went public via direct listing in April — quite a difference.

Investors have committed another $415 million in PIPE financing to sweeten the Circle deal. PIPE, or private investment in a public equity deal, is a way to raise capital from a select group of investors who receive shares at a discount to the public market price.

Circle also raised $440 million in a May funding round. That leaves Allaire’s company — valued at $4.5 billion in this deal — with $1.1 billion in gross proceeds upon the close of the transaction. 

Circle’s finances

What do we know about Circle’s finances? Specifically, the assets behind its stablecoin? Not a lot, really.

Concord Acquisition filed an 8-K with the SEC announcing the upcoming merger. The form links to several documents. Of those, the only financial information on Circle is an investor presentation and Circle’s financial statements from December 31, 2020 and 2019. 

Here’s the thing — six months ago, Circle was in an entirely different situation than it is now. In December 2020, USDC had a $4 billion market cap. Its market cap grew to six times that in the first half of this year. Six times! Yet somehow, Circle appears to be going public without submitting its financials for Q1.

This is curious given that Q1 was a prosperous period for most crypto companies. Between January and March, $6 billion USDC were created. In that same timeframe, the price of bitcoin climbed from $29,000 to 59,000. So why would Circle leave out its March 31, 2021, financials?

This doesn’t mean that we’ll never see them. Circle could post its Q1 financials before the merger goes through.

Also, Concord still needs to file a Form S-4. An S-4 is required in a de-SPAC transaction (closing of the SPAC merger) where the SPAC’s shares are exchanged for the target’s shares.  

I wrote to Concord and Circle asking them these three questions:

  • When do you plan to file your S-4 in regard to your Circle transaction?
  • Do you plan to file the breakdown of the collateral backing the Circle stablecoin?
  • Do you have a target for your SPAC combination? If so, what is the date?

Circle and Concord answered none of the questions. Instead, they sent me back a list of 2020 and 2021 press quotes from Allaire and a link to their press release. You can see their response here.

What we know

Circle, founded in October 2013, first announced USDC in September 2018. The stablecoin is managed by a consortium called Centre — here’s their original white paper. Circle was the first member of the consortium. Coinbase joined in October 2018, and so far, there are no other members. 

Circle bought crypto exchange Poloniex in February 2018 for about $400 million with big plans to turn it into a regulated exchange. The experiment failed, and Circle ended up selling Polo less than 18 months later at a $156 million loss. 

Sean Neville, Circle’s co-founder, stepped down shortly after, without giving any clear reason for his departure. 

In December 2019, right about the time Neville left, Circle spun off its Circle Trade over-the-counter desk to focus exclusively on stablecoins. USDC issuance was slow and steady at first and then took off like a rocket in late 2020. 

Stablecoins issuers have the reputation of being like wildcat banks — a reference to banks in the 19th century that flaunted regulation and issued bank notes with abandon and often without any intention of redeeming them. 

Under the gold standard in operation at the time, these state banks could issue notes backed by gold and silver coins — though the quality of these reserves was often a question. State regulations did exist but wildcat banks, generally located in remote, hard to reach areas, were known for their creative workarounds.

Stablecoin companies issue virtual dollars that act a bit like real dollars, only they’re on a blockchain. USDC, which began life as an ERC-20 token on Ethereum, is currently on four blockchains with plans to expand to several more. 

USDC reached its first $1 billion market cap in July 2020. In the following 12 months, it literally created $24.5 billion worth of stablecoins — and we have no idea what is backing those.  

According to Centre’s website, USDC “is issued by regulated and licensed financial institutions that maintain full reserves of the equivalent fiat currency.” Every USDC is supposedly redeemable on a 1:1 basis for US dollars. 

USDC receives monthly attestations provided by accounting firm Grant Thornton LLC. These are not full audits — they are more like snapshots in time. 

The most recent snapshot is for April 30, 2021, when there were 14.7 billion USDC in circulation. The report doesn’t say much other than “US Dollars held in custody accounts are at least equal or greater than the USDC tokens outstanding at the Report Date and Time.”

However, another note on the report states that “US Dollars held in custody accounts are the total balances in accounts held by the Company at federally insured US depository institutions and in approved investments on behalf of the USDC holders at the Report Date.” (Emphasis mine.) 

Apparently, Circle’s boilerplate USDC reserves investment disclosure changed between Feb 28 and March 31, 2020, to add the phrase “and in approved investments.”

So, what are those approved investments? Who approves them? What percentage of assets are in that category? We don’t know, because Allaire won’t say. In an interview with Coindesk on June 30, he completely avoided the question, instead, rambling on about fiduciary responsibility, electronic stored money transmission, etc. (Doomberg transcribed the interview.)

High-interest ‘yield product’

On December 31, 2020, USDC was backed 100% by cash per its financial statements. Now Circle is promoting a high-interest “yield product.” The idea seems to be that you can lend Circle your USDC, and they will in turn lend them to degenerate gamblers who want leverage for crypto margin trading.

“Our Yield services provide a compelling and powerful way for institutions and corporations to access the yields that are coming from stablecoin and USDC-based borrowing and lending markets,” Allaire said in a conference call to investors.

These yield products offer 3% to 7% interest paid monthly, Circle claims — well above a risk-free rate of return. Yet, even Circle doesn’t appear to know how its yield services make money.  

“Our yield product service is an innovative product which is difficult to analyze vis-a-vis existing financial service laws and regulations around the world,” the firm says in its investor presentation. (Emphasis mine.)

Even more concerning, Circle’s business model appears to rest on bitcoin never collapsing in price: “Our yield product is collateralized predominantly by bitcoin and the value of that collateral is directly exposed to the high volatility of Bitcoin.” 

Allaire promotes USDC as the complete antithesis of Tether — the dubiously backed stablecoin that claims to have 50% of its $62 billion market cap in “commercial paper,” but doesn’t say anything about what that commercial paper consists of or where it is held. 

Despite efforts to distance itself from Tether, Circle is starting to look more and more like a similar scheme, only with a different critter on the wildcat banknotes. 

Will we ever get a straight answer from Allaire in regards to what’s behind USDC? Looks like we’ll have to wait till the S-4 comes out — that will be the real measure of transparency. 

In the meantime, I’m reminded of Dan Davies’ Golden Rule from his book “Lying for Money,” which includes a series of case studies on frauds.

“Anything which is growing unusually quickly needs to be checked out, and it needs to be checked out in a way that it hasn’t been checked before,” Davies writes. “Nearly all of the frauds in this book could have been stopped a lot earlier if people had been a bit more cynical about growth.”

* Charles Mackay, Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, Chapter 2. “The South-Sea Bubble.”

Feature image: Bank of Brest five dollar bill. The Bank of Brest in Michigan was one of the most infamous wildcat banks that sprang up in the freewheeling economic environment in the US during the 19th Century.

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