Stablecoin Attestation Deep Dive
Paxos and Circle publish similar attestation reports for stablecoin reserves. And in both cases a lot of folks seem confused by what the numbers mean. Terminology in finance is often needlessly jargon-laden or unclear. Here we are going to go through these reports in detail and explain what the words mean.
The reports we are working through are here for Circle and here for Paxos.
The key lesson here is that you should not make assumptions about what various technical elements in these reports mean. Sure maybe some of the complexity in finance exists to soften people up to take their money. But the language can also be remarkably concise and precise because it needs to be for markets to function.
Tokens Outstanding
Both documents use similar language to tell us how many stablecoins are out there in the world as of a specific date and time. Things are ok so long as the reserves exceed this value.
Paxos also includes a “weighted average maturity” for the portfolio. This is the average maturity of the instruments in the portfolio weighted by size. We will come back to this.
Treasuries
Both Paxos and Circle disclose US treasury securities held directly in their reserves. These look similar. CUSIPs are security identifiers. If you Google a CUSIP you can find the details. The most important part is the maturity date which both reports helpfully include.
So long as these securities have very near-term maturity dates they are essentially riskless both in terms of credit and price. Credit risk is minimal as the US government cannot run out of USD (some odd political issues notwithstanding). And price risk is minimal because they are so short dated that interest rates have only a tiny impact on price.
At the same time many of these bill issues are gigantic with tens of billions of a single CUSIP outstanding. Overlap in the securities held across stablecoin portfolios means nothing. If you have cash in a money-market fund you also overlap with these portfolios.
Circle’s Reserve Fund
Circle has set up, with Blackrock, a dedicated money-market fund for their USDC reserves. This fund is very normal except for two things. First it is only open to Circle. That is odd but not economically significant. And second the minimum investment size is $2 billion. That is gigantic even by institutional fund standards but again economically not a big deal.
Circle discloses the treasuries in the reserve fund in a separate section but with the same format.
There is no meaningful difference between the treasuries held outright and these except for the 0.17% fee Blackrock charges. This is a small drag on the reserve fund’s earnings but does not place USDC at risk as long as USD rates are well above the fee level.
Cash
Now the cash disclosures are not that similar. Circle and Paxos follow different strategies here and as a result the reports are significantly different. Both are reasonable near-zero-risk strategies but they are not the same.
Circle’s Cash
Circle discloses cash both held outright and within the reserve fund. And alongside the cash totals it includes amounts in transit due to timing and settlement processes.
Circle holds a lot of cash. This means Circle depends on their banks to pay a reasonable market rate of interest. That is fine. Large US banks generally pay commercial depositors fair rates. And Circle, with billions on deposit, is in a pretty good negotiating position.
This strategy also explains why Circle has treasuries outside the reserve fund. They can redeem shares in the fund for treasuries rather than cash per the prospectus and then manage liquidity on their own per:
This is all normal and fine. Circle is running a bit of credit risk on their banks. That is real risk and it should not be ignored. But, as they do not disclose the breakdown by bank we cannot dig too deeply.
Of course Bank of New York Mellon is pretty low risk — it is surely too big to fail on top of being a famously low-risk bank — while Signature and Silvergate might have some problems. Circle should do better by disclosing per-bank numbers or publishing a clear policy on reserve cash risk management.
Paxos’s Cash
Paxos uses two different instruments to hold cash: reverse repos and cash deposits.
Let’s take the cash first. Paxos does an excellent job breaking down their exposures and generally runs a small uninsured cash position. Risks are tiny overall. They are clearly better than Circle here.
Now reverse repos are very much a technical funding market instrument. On these trades Paxos takes a large cash balance and lends it, for interest, to a counterparty. To mitigate the risk on the transaction — to ensure Paxos does not care about the creditworthiness of the counterparty — they receive US treasury collateral with a market value in excess of the deposit.
That collateral is updated frequently, increasing or decreasing as required as the treasuries change in value. You may be asking “why do the prices change if treasuries are riskless?” And the answer lies in the maturity dates. These US treasury bonds are not necessarily super-short-dated and free of interest rate risk.
Go look at the report above. There are bonds with maturities decades in the future. These will drop in price if interest rates rise. But because the reverse repo collateral is maintained nearly-continuously there is little risk. Yes it is theoretically possible US interest rates spike by 10% within a day and one of these bonds drops dramatically in price at the same time the counterparty defaults. But this is quite literally a scenario in which the US government has lost control of the US bond market.
Just to be extra clear for those not used to interest rate trading: this has nothing to do with the well-publicized Federal Reserve policy rate. That rate impacts 1-day lending only. Yes it sometimes jumps by 1% or more within a day. But this directly impacts the prices only of very short dated securities with minimal interest rate risk.
If 30 year bonds were to fall in value by 20% or more within a day it likely means the US government is no longer around. If 30 year rates rise 1% or even 2% then at worst Paxos’s collateral drops from 105% to 95% for a few hours. This is not a major risk.
These Reports Are Not Perfect But They Are OK
Both Paxos and Circle could improve both their practices and reporting. But in general this stuff is fine.
It is not Paxos’ or Circle’s fault that financial market vocabulary is odd. And it is probably not possible for either company to run their product in a way that is 100% free of risk.
Overall Paxos is doing a meaningfully-better job on disclosure. Circle is getting nothing in terms of risk mitigation out of their Blackrock relationship. And likely that is also pushing up their costs a bit. Though that may be a bit unfair as Circle’s cost disclosures — via Blackrock, because Blackrock is required to make this information public — are more detailed than Paxos’.
Their approaches are not identical but both are reasonable. Both, however, could be better in terms of disclosure and risk management.
