Circle: Making or losing a little money is trivial; the ecosystem is the main artery!

Before the market opened on August 12th in the Eastern US, the first stablecoin stock, $Circle(CRCL.US), released its first financial report since going public. For this report, short-term performance is not the focus. The primary goal is to expand distribution channels and application scenarios to collectively grow the USDC ecosystem. This implies that necessary cost concessions and expense investments are indispensable, which means the profit figures will inevitably continue to look unattractive.

Therefore, the core of this financial report lies in the company's short- and long-term strategic changes and future outlook. Coincidentally, the management provided an annual guidance in the second-quarter report, with key indicators precisely addressing the current market's doubts about Circle—growth potential, business model, and short-term risks. According to Dolphin Research, this is the truly "eye-catching" aspect.

1. How does the management respond to the three major doubts?

Circle's listing, while surrounded by the halo of the first stablecoin stock, has not been without market skepticism. After all, Circle is still in the "startup" phase from 0 to 1, and skepticism is quite reasonable. Among them, the three core doubts almost grip the valuation lifeline of Circle. However, the highlight of this financial report is that the management has provided its response to market skepticism through short- and medium-term guidance.

(1) Unclear growth potential? — Future USDC scale CAGR growth rate of 40%

For growth stocks, the issue of growth potential is paramount. It is precisely because of the vast TAM that Circle experienced a tenfold stock treatment at the time of its initial public offering.

The market's question is, even if the stablecoin market size is confined to different expected ranges of 1 to 3.7 trillion, how much can Circle capture? With the passage of the Stablecoin Act, market competition is bound to intensify. Can Circle maintain its first-mover advantage? Because the future endgame is not clear at all, conservative funds have given Circle an absolutely high risk discount.

In this financial report, the management provided key guidance—maintaining an average annual compound growth rate of 40% for the scale of USDC in circulation over the coming years.

Regardless of whether this guidance exceeds current expectations, as we mentioned in the first take, the BBG consensus expectations have limited reference value, and there is actually no clear consensus expectation in the market. Whether the management provides a growth rate guidance that meets the target or not, it will be a boost to market sentiment. The core key is increasing the clarity of Circle or USDC's future growth, thereby reducing the intangible risk discount.

(2) Aggressive distribution worsening profitability? — Stable gross margin this year, controllable expense investment

Another short-term concern in the market is whether Circle will aggressively expand this year, rapidly increasing channels for distribution, thereby worsening overall profitability?

This concern may stem from some misunderstanding of the agreement between Circle and Coinbase. During the three-year bundling period, channels that can demand a share must become ecosystem partners, and the addition of ecosystem partners requires joint approval from Circle and Coinbase. For example, Binance, which was included as a partner at the end of last year, was able to enter the underlying ecosystem entirely based on its absolutely dominant market position.

However, even so, Binance only received a small "incentive" in absolute terms, rather than a true "revenue share." Therefore, Circle's channel expansion is more about cooperation in non-revenue-sharing dimensions. Even so, in the second quarter, Circle still established new partnerships with traditional financial institutions such as OKX crypto exchange, Fiserv, Visa, Whapay, and NexusPay, indirectly reflecting the competitive advantage of the USDC ecosystem.

Therefore, the management's guidance on this year's gross margin and expense investment (gross margin in line with expectations, expense investment below expectations) indicates that concerns about significant short-term profit deterioration can be put to rest. The company will control internal operational efficiency while expanding.

That said, Dolphin Research believes that in the 0-1 stage, there is no need to overly focus on short-term profitability. As we mentioned in the in-depth research on Circle, the immediate priority is to expand the scale through a united front. The expansion of the ecosystem is the key driver of value growth.From this perspective, Dolphin Research believes Circle is not "aggressive" enough.

(3) Business model with inherent bugs? — Focus on other income growth

Currently, 96% of Circle's revenue relies on interest from reserve assets, which is obviously not favorable in a rate-cutting cycle. Meanwhile, the hard-earned interest has to be shared with Coinbase, even for channel balance parts unrelated to Coinbase, so the market is also focusing on revenue generation beyond interest.

Other income mainly includes issuance income, trading, custody, Web3 API suite, and tokenized fund USYC. The CPN payment settlement service launched by Circle in May should not have contributed to revenue yet.

The management's expectation for other income this year is a growth of over four times, but on a quarter-on-quarter basis, there is a slowdown in the second half. Highlighting "other income" for guidance, at least from a strategic significance perspective, indicates that the development of new business models has gained management's attention.

Future new business models naturally derived from scenario expansion are a way to compensate for future risk exposure of interest income, but the current scale is still small, fundamentally relying heavily on the USDC ecosystem scale. Therefore, this again returns to the question of "maintaining expansion" or "maintaining profit." Undoubtedly, sacrificing short-term profit to expand the ecosystem is very necessary.

2. How is the current development of the USDC ecosystem? — Slight short-term share decline, still not fast enough

(1) The average USDC circulation value in the second quarter was 61 billion, reaching 61.4 billion at the end of the quarter, a quarter-on-quarter growth of 2%, slowing down compared to the beginning of the year. Despite being the most prominent, USDC's share in the stablecoin market declined by 1 point quarter-on-quarter. A slight consolation is that, according to Coingecko, the expansion of circulation scale has accelerated since July.

(2) USDC distribution, the proportion within Circle has rapidly increased to 9.8%, much faster than Dolphin Research expected. 23% is on Coinbase, and the remaining 68% is in other channels like Binance.

(3) As of the end of the second quarter, the number of digital wallets MeWs (crypto wallets holding more than $10 on-chain) reached 5.7 million, a net increase of 800,000 quarter-on-quarter, accelerating compared to previous quarters. This is a relatively forward-looking indicator, truly representing USDC's user penetration. The larger the number of USDC digital wallets, the more market share it can capture in the future.

3. Overview of important financial indicators

Dolphin Research's View

Circle's valuation is entirely built on the long-term outlook beyond five years, with high uncertainty, so short-term volatility is inevitable, heavily relying on marginal changes from a qualitative perspective. This "not solid enough" investment experience requires building a sufficiently high psychological defense and growth belief.

Although it is a financial report window, for Circle, which has fallen nearly 30% from its peak, short-term performance is clearly not the key to affecting the stock price. But as mentioned earlier, Dolphin Research believes that the highlight of this financial report is the "guidance," the level of guidance itself will certainly affect expectations, but more importantly, the management has provided growth guidance over multiple years—CAGR 40%, which can help the market better perceive Circle's growth certainty and provide a clearer development path.

However, from the short-term USDC ecosystem indicators, compared to the fear of performance deterioration (in a catalyst-free dull window period, repeatedly eroding valuation), Dolphin Research still expects Circle to have more aggressive and rapid expansion, and the current growth guidance from the management (assuming a 5-year time dimension for the 40% CAGR) is lower than Dolphin Research's previous neutral expectation for USDC (328 billion vs. 433 billion).

In addition, Circle's "compliance" advantage, after the passage of the Stablecoin Act, essentially becomes a "first-mover advantage." Therefore, the progress during this window period is very critical, otherwise, the trend that the market conservatives worry about will occur—intensified competition, and a continuous decline in USDC's market share.

And once it fails to consolidate its first-mover advantage on the user side, before the steady-state situation arrives, establishing a stable ecosystem with a monopoly or strong position first, it will eventually fade into obscurity. As the CEO said, the final competitive landscape will only leave a few platforms. The issue of the business model, compared to the growth space of capturing scenarios and market share, is a minor issue. Once a strong ecosystem is established, the bug in the business model is just a switch to another monetization method.

Detailed Analysis Below

I. Steady Expansion of the USDC Ecosystem, but Not Fast Enough

The average USDC circulation scale in the second quarter was 61 billion, reaching 61.4 billion at the end of the quarter, a quarter-on-quarter growth of 2%. The current minting was 42.2 billion, redemption was 40.8 billion, and the net issuance slowed down compared to the beginning of the year. However, according to Coingecko, the growth of USDC circulation balance has accelerated since July.

Compared to the most direct competitor USDT, USDC's share only had a significant relative increase at the beginning of the year, and in the second quarter, the two leaders expanded almost in sync, meaning the combined share of the TOP2 in the overall market is increasing.

The changes in USDC distribution across different channels in the second quarter align with the assumptions made by Dolphin Research in the in-depth article—Circle is striving to increase its internal share to reduce the erosion of Coinbase's revenue share. As shown in the figure below, the proportion of USDC within Circle has rapidly increased to 9.8% by the end of the quarter, much faster than Dolphin Research expected. Under a neutral expectation, Dolphin Research's expectation for the proportion of USDC within Circle is 20%.

Circle's way of increasing its share is through "direct connection," building its own on-chain wallet, and developing more scenarios that can directly interact with institutions. This scenario expansion and penetration will also help develop new business models in the future.

Another core indicator reflecting ecosystem development—the number of effective digital wallets, as of the end of the second quarter, the number of digital wallets MeWs (crypto wallets holding more than $10 on-chain) reached 5.7 million, a net increase of 800,000 quarter-on-quarter, accelerating compared to previous quarters. This is a relatively forward-looking indicator, truly representing USDC's user penetration. The larger the number of USDC digital wallets, the more market share it can capture in the future.

II. Q2 Performance: Basically inline, non-interest income significantly exceeded expectations

Since 96% of Circle's revenue comes from reserve asset interest income, which can be considered public data, the main source of expectation difference is other income, and the second-quarter performance significantly exceeded expectations.

In addition to issuance income, platform integration solutions are one of the future growth drivers of other income, as well as custody, tokenized fund channel fees, etc. The main dynamics related to the second quarter include:

In May, Circle launched the CPN payment network, which can provide an innovative platform for financial institutions to use stablecoins for payments, with over 100 institutions currently in cooperation discussions. Additionally, in the second quarter, Arc was launched, an open Layer-1 blockchain tailored for stablecoin finance, with the intention of establishing a full-stack technology fintech platform.

However, the above business developments are expected to have contributed little to revenue in the second quarter, with significant contributions expected in the second half.

The main source of revenue, influenced by the pace of USDC expansion and the current treasury rate environment. The USDC scale expanded by 86% year-on-year in the second quarter, but with declining rates, the final revenue growth rate also slowed down quarter-on-quarter.

From a purely financial indicator perspective, a rate-cutting environment will suppress "paper" growth rates, thereby repeatedly eroding valuation in a catalyst-free dull window period.

III. Controlling Operational Efficiency While Expanding

The profitability situation, especially the guidance on full-year expense spending, also slightly exceeded expectations in the second quarter. While the USDC scale doubled and revenue grew by 50%, the expense growth rate excluding SBC actually slowed from 32% yoy in Q1 to 28% yoy in Q2, reflecting the company's attention to maintaining high internal operational efficiency while expanding externally.

Ultimately, the second-quarter gross margin was 38%, slightly down quarter-on-quarter, with adjusted EBITDA of 126 million, both basically in line with expectations.