USDC

How USDC Works: A Deeper Look at Stablecoins

How USDC Works: A Deeper Look at Stablecoins

Team Circle Team Circle July 9, 2021

USD Coin - the world's leading fiat-backed stablecoin. Learn how it works!
This article was originally published on November 7th, 2018, and most recently updated on July 9th, 2021.
 
Stablecoin usage has exploded since DeFi Summer 2020. In fact, USD Coin (USDC) grew 2,400% to a market cap of $24 billion dollars, and processed over $700 billion in on-chain transactions in the past year.

With traders using USDC to enter and exit crypto markets, countries using USDC to securely disburse financial aid during COVID-19, and businesses using blockchain Payment APIs to send USDC around the world 24/7, it’s important to know how USDC works and the role stablecoins play in today’s global economy.
 

Table of Contents

What is a stablecoin?

Stablecoins are cryptocurrencies designed to maintain a stable value. 

Where cryptocurrencies like Bitcoin are known for their price volatility and traded as a speculative investment, the aim of stablecoins is to maintain a consistent, predictable level of buying power.

Today, stablecoins play a critical role within crypto asset markets by serving as fiat on-ramps, as collateral within Decentralized Finance (DeFi) borrowing and lending protocols, within eCommerce for online goods, and on digital asset marketplaces for Non-Fungible Tokens (NFTs).

As blockchain technology evolves, stablecoins will continue to play a major role in the reimagining of the financial system and will serve as global, borderless money.

Types of Stablecoins

There are dozens of stablecoins in existence, and they account for over $108 billion of the total $1.3 trillion dollar cryptocurrency market (as of July 2021).

Stablecoins generally fall into one of three categories: fiat-backed, crypto-backed, and algorithmic.

1. Fiat-backed stablecoins

Fiat-backed stablecoins are created with a 1:1 backing of a fiat currency. While some stablecoins use complex algorithms to maintain stability (algorithmic stablecoins) and others are backed by cryptocurrencies, fiat-backed stablecoins take the most straightforward approach. 

This is the method employed by CENTRE’s USDC

By tying the value of USDC to a stable fiat currency, the potential for speculation is dramatically reduced, resulting in a price stable asset.

2. Crypto-collateralized stablecoins

Crypto-collateralized stablecoins use crypto assets like Ethereum to back stablecoins and provide price stability pegged to the value of those reserve assets.

The most successful crypto-backed stablecoin is MakerDAO's DAI with a circulating supply of ~$5.5 billion as of July 2021.

3. Algorithmic stablecoins

Algorithmic stablecoins use software economic models to provide price stability without relying on underlying collateralized assets. Algos as they are sometimes called, are still in experimental stages.

What is USDC?

From less than $950 million a year ago to more than $25 billion in circulation today, USDC is the fastest-growing dollar digital currency in the world.

USDC is issued by regulated financial institutions, backed by fully-reserved assets, redeemable on a 1:1 basis for US dollars, audited every month by Grant Thornton, LLP, and governed by Centre, a membership-based consortium that sets technical, policy and financial standards for stablecoins.

USDC’s security and regulatory compliance gives global finance companies like Visa, vanguard crypto enterprises like FTX, and multiple layer 1 smart contract platforms, the confidence needed to use USDC as a safe medium of value transfer.

Compliance, Transparency, and Stability

It is crucial to build strong relationships with governments who are seeking to understand stablecoin technology and ensure that markets can adopt it safely.

At the 113th annual Utah Bankers Association Convention the Federal Reserve Board of Governors Vice Chair for Supervision, Randal K. Quarles, made it clear that regulation and financial stability of stablecoins is a principal concern.

"We do have a legitimate and strong regulatory interest in how stablecoins are constructed and managed, particularly with respect to financial stability concerns: the pool of assets that acts as the anchor for a stablecoin's value could—if use of the stablecoin became widespread enough—create stability risk if it is invested in multiple currency denominations; if it is a fractional rather than full reserve; if the stablecoin holder does not have a clear claim on the underlying asset; or if the pool is invested in instruments other than the most liquid possible, principally central bank reserves and short-term sovereign bonds."

 

 

Circle, the original creators of USDC, have focused on deep and high-quality engagement with regulators since its inception, and hold the broadest licensing of any crypto company in the world.

Circle is a registered Money Services Business (MSB) with the Financial Crimes Enforcement Network (FinCEN) of the US Treasury Department, holds money transmission (or equivalent) licenses in 48 US states and territories, and was the first company to receive a BitLicense from New York. 

Circle also holds an E-Money Issuer license from the Financial Conduct Authority in the UK. These licenses enable the company to offer fiat and crypto asset storage, currency exchange, and payment services in the US, UK, and European Union.

USD Coin's financial stability, regulatory compliance, and transparency is exactly what federal regulators like Quarles are looking for in dollar digital stablecoins.

"All of these factors create "run risk"—the possibility that some triggering event could cause a large number of stablecoin holders to exchange their coins all at once...and that the stablecoin system would not be able to meet such demands while maintaining a reasonably stable value. But these concerns are eminently addressable—indeed, some stablecoins have already been structured to address them. When our concerns have been addressed, we should be saying yes to these products, rather than straining to find ways to say no."

 

Blockchains that natively support USDC

USDC launched in 2018 as an ERC20 token on the Ethereum blockchain which is an open-source smart contract platform for developing decentralized applications. 

Combining the stability of the US dollar with the power of Ethereum presented a variety of use cases including blockchain gaming and launching crypto startups.

Since then, native asset support for USDC has been launched on various other layer one blockchains including USDC-SPL on Solana, USDC-ASA on Algorand, as a native asset on Stellar, and as USDC-TRC20 on TRON.

Total USDC on each blockchain

To see the total USDC on each chain, visit their block explorers:

  • Etherscan - 24,461,222,811 USDC-ERC20 as of Friday, July 2nd, 2021
  • Solana Explorer - 785,000,019 USDC-SPL as of Friday, July 2nd, 2021
  • Algo Explorer - 165,635,238 USDC-ASA as of Friday, July 2nd, 2021
  • Stellar Expert - 9,576,64 Stellar USDC as of Friday, July 2nd, 2021
  • TRONSCAN - 108,548,391 USDC-TRC20 as of Friday, July 2nd, 2021


Wallet partners that adopt the CENTRE protocol standard have access to reach network participants on multiple blockchains, further expanding the functionality of USDC for businesses and traders alike.

How does USDC work?

In this section we’ll cover a few of the most important elements of USDC’s functionality including:

How the CENTRE protocol works

CENTRE is a protocol for digital wallet interoperability across currencies and borders, across diverse software implementations, and across multiple blockchains, ledgers, and settlement rails.

At a high level, CENTRE provides:

  • A mechanism for issuing members to mint and redeem asset-backed fiat tokens
  • Protocols to enable stablecoin transaction interoperability on public blockchains
  • Network membership rules and smart contracts to govern, audit, and manage the licensed network participants that mint, transact, and redeem stablecoins

For more information, read Centre's whitepaper.

Global, interoperable money

Money should work like email — unencumbered by distance, borders and service providers. USDC is a step towards making that notion a reality.

An email sent to someone on the other side of the planet arrives just as efficiently as an email sent to someone around the corner. Traditional transactions typically take longer and become more expensive as the distance between two parties increases. 

USDC works more like email — a transaction sent from New York to Australia is processed no differently than a transaction sent from New York to New Jersey.

Geographic boundaries become irrelevant.

Someone using Yahoo can email a Gmail user, but an AliPay user can not pay someone who uses PayPal. This is because today’s payment applications lack interoperability or the ability to settle transactions directly over the open internet. 

USDC was built on open standards, which means that it is interoperable with any application that also adopts those standards.

USDC can be sent from Circle’s apps and services or Coinbase Wallet to a Ledger Nano or any digital wallet compatible with the ERC-20 token standard.

Users are no longer confined by their choice of digital wallet.

How USDC is regulated

Circle was the principle architect of USDC, and the intellectual property has since been delegated to an independent consortium, Centre, that was founded by Circle and Coinbase to manage the support, governance, and ongoing R&D for the open-source software project.

Fiat-backed stablecoins face a unique challenge: dollar digital stablecoins are reliant on a 3rd party to maintain reserves of fiat currency. As such, trust in the 3rd party holding the asset is an integral part of creating a properly functioning fiat stablecoin.

Centre is an independent entity that oversees the rules for the issuance and redemption of USDC, ensures that issuers remain compliant with the law.

To further instill trust, USDC fiat reserves are attested to on a monthly basis by independent CPA Grant Thornton.

How USDC is minted

Cash from a bank account is used to mint USDC which can then be used for B2B payments and to earn high interest yield in DeFi protocols.

The interaction between a token-issuing member and the CENTRE network is codified in a series of smart contracts created and maintained by Centre, along with a protocol and network policies to facilitate such interactions. 

Customers who on-board through a stablecoin on-ramp, such as an exchange that is a CENTRE token-issuing member, can transfer fiat funds into that CENTRE issuer’s account. 

The issuer then executes a series of commands with the CENTRE network to verify, mint, and validate fiat tokens pegged to the value of those deposited funds. The customer can then transfer those tokens elsewhere in order to use them.

Note: CENTRE does not maintain fiat asset reserves itself, and CENTRE is not an issuing member or financial institution. CENTRE is a network scheme manager and technology provider that enforces compliance to ensure stability, accountability, and consumer protection. Similarly, issuing network members do not control the fiat token contracts, but use them to interact with the CENTRE network.

How USDC is redeemed

Redemption follows the reverse sequence of the minting process: 

  • Fiat tokens are removed from circulation when a customer visits an off-ramp
  • The CENTRE Node operator processes multiple verification checks
  • Funds from fiat reserves are transferred to the customer’s external bank

How state channels work

State channels increase the speed and lower the cost of transferring USDC on public blockchains by only posting the first and last transaction (e.g. account balances) to the underlying blockchain (e.g. Ethereum).

Intermediary transactions are recorded locally between the state channel participants which allows stablecoin payments at internet speeds with the security and transparency of blockchains.

Here’s how it works:

  • Participants agree to an initial state and write the transaction on the blockchain
  • Intermediate updates are cryptographically signed by each participant to validate the new agreed upon state 
  • Participants agree on a final state and write the transaction to the blockchain.

When one party wishes to close a channel, a “challenge period” begins which allows the other participants to have a period of time to either:

  • Agree, and the channel is closed and the changes are committed immediately
  • Dispute the final state by submitting a state signed by all parties with a higher sequence number
  • Do nothing, which will constitute agreement once the challenge period expires

How chained state channels work

Chained state channels allow two state channels that are not connected directly to securely transact with one another indirectly using intermediary connections between other state channels.

A chain of states is established in which the funds will be released if and when the recipient can produce a secret. The final recipient is then given the secret, which they pass up the chain, and everybody in the chain can use to claim the funds.

Chained state channels use a hashed time-locked contract (HTLC) that makes the chained payment as secure as executing it through a normal state channel. 


How businesses use USDC

Stablecoins are critical market infrastructure. 

Since the introduction of Bitcoin in 2008 and the subsequent creation of thousands of other crypto assets, digital asset markets have sprouted up all over the world.

From providing fiat on-ramps into these vibrant markets where investors can swap fiat currencies for stablecoins, to allowing traders to fluidly exit their crypto trade positions in times of downward price swings and arbitraging price discrepancies, stablecoins are the backbone of crypto markets.

In addition to markets, businesses can leverage Payment APIs to send money anywhere in the world, 24/7, without centralized intermediaries like banks.

Payment APIs and Treasury Management Software

Cryptocurrencies and smart contracts enable truly programmable money which has the potential to completely reimagine traditional financial products.

However, a price stable currency like USD Coin is needed if blockchain-based financial products are to challenge the legacy incumbents.

Circle’s Payment APIs empower businesses to accept credit card, wire, and ACH payments, and programmatically make fast, global payouts to customers, vendors, and suppliers with Circle’s Payouts API.

With support for over 80 countries, and the ability to accept payments from any originating currency, Circle’s Payment APIs offer businesses a truly global payments and corporate treasury infrastructure.

Circle Payment API Example: NFT Marketplace

Here is an example of how USDC works when a customer purchases a Non-Fungible Token on an NFT marketplace.

Diagram showing how NFT stores can use Circle's Payment APIs to enable customers to buy a non-fungible token (NFT) with USD Coin through a credit card payment.

  • The buyer wants to use a credit card to add USDC to their digital wallet
  • The buyer enters their credit card information on the NFT marketplace
  • The card payment is processed using Circle’s Payments API
  • Circle, a trusted issuer, mints an equal amount of USDC on the blockchain
  • Once verified on the chain, the USDC is deposited into the buyer’s digital wallet
  • The buyer can now use USDC to purchase their NFT


To withdraw funds from a marketplace, the opposite transaction occurs:

Diagram showing how an NFT marketplace can use Circle's Payout APIs and treasury software to pay NFT creators.

  • The user initiates a withdrawal transaction
  • The user’s USDC that is verified on the blockchain is burned (i.e. redeemed)
  • USDC is moved out of Circle’s reserve wallet
  • The user’s payout information is routed to Circle with the Payouts API
  • Circle burns USDC and debits from the marketplace account
  • Circle processes an ACH transfer or wire payout
  • The user receives USD in their bank account


In addition to payments and disbursements, corporate treasury departments can leverage internet-native digital currencies like USDC to earn interest on cash reserves through high interest yield accounts, and interact directly with DeFi protocols like Compound on Ethereum through Circle’s new DeFi API product.

The future of USDC

As the adoption of stablecoins grows, opportunities will be created that enable 100s of millions, and eventually billions, of people to join the open financial system

Stablecoins like USDC will provide a bridge from the traditional financial system that is heavily reliant on the corresponding banking system and limited by legacy technology to a decentralized, public network of blockchains that power the internet of value where money moves as easy as email.

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