Circle under pressure of interest rate cuts

Author: Jack Inabinet, Bankless

Compiled by: Saoirse, Foresight News

Original Title: Circle's Dilemma of Interest Rate Cuts

Modeling analysis of the impact of interest rate changes on reserve income as well as distribution and transaction costs over the next 12 months.

Source: Circle

Despite Circle's reported net loss of $482 million for the second quarter, which is far below analysts' expectations, this unexpected difference is primarily due to a $424 million accounting write-off related to employee stock compensation at the time of the initial public offering.

Even so, Circle's financial situation still highlights the vulnerability of this company that is on the brink of breaking even. At the current level of USDC supply, it cannot withstand the impact of a significant drop in interest rates.

Solution

At first glance, a decrease in interest rates may reduce Circle's interest income per dollar in reserves, harming profitability. However, for holders of CRCL, the good news is that changing a simple variable can completely turn the situation around...

Powell and many financial commentators believe that current interest rates are at a "restrictive" level, and fine-tuning the Federal Reserve's policy rate can address the weak labor market while also controlling inflation.

If the judgments of these experts are correct, interest rate cuts may trigger an economic rebound, leading to sustained high employment rates, lower credit costs, and a surge in the cryptocurrency market. If this optimistic scenario materializes, the demand for crypto-native stablecoins may rise, especially when they can offer decentralized finance native yield opportunities that exceed market levels.

To offset the negative impact of a 100 basis point rate cut (which is the minimum level considered in Circle's aforementioned sensitivity analysis), the circulation of USDC needs to increase by about 25%, which requires injecting $15.3 billion into the crypto economy.

Based on the net profit for 2024, Circle's current price-to-earnings ratio is 192 times, making it a high-growth opportunity. However, despite the stock market's optimistic outlook on CRCL's expansion prospects, this stablecoin issuer needs to achieve growth to survive if the Federal Reserve implements interest rate cuts in the coming weeks.

If the Federal Reserve cuts interest rates by at least 25 basis points, Circle will need to increase the supply of USDC by approximately 3.8 billion dollars to maintain its current profit level.

As Circle puts it, "Any relationship between interest rates and the circulation of USDC is complex, highly uncertain, and unproven." Currently, there is no model that can predict how USDC users will react to low interest rates, but history shows that once a rate-cutting cycle is initiated, it often happens quickly.

Despite the scenario of economic prosperity, Circle may be able to offset losses caused by declining interest rates through growth, but data shows that the company has an inherent conflict with the low interest rate environment.