Morgan Stanley downgrades Circle: is USDC losing the stablecoin war?

Morgan Stanley slashed its Circle price target from $106 to $38, citing tokenized money market funds, shrinking $USDC supply, and a lower-margin revenue future that raises a harder question: whether any single stablecoin issuer can defend its economics.

Introduction

Circle went public in early 2026 to a thesis that sounded simple: $USDC was settlement infrastructure, and the company that issued the second largest stablecoin would collect rent on every dollar that passed through it. The stock surged over 120% from February through March as analysts at William Blair called $USDC a “core settlement rail” and projected growing market share against Tether. Six months later, Morgan Stanley has cut the price target by 64%, and the stock has lost roughly 30% year to date.

The downgrade is not just about Circle. It is about the stablecoin business model itself. When reserve income was the dominant revenue line, the economics were straightforward: hold dollars, earn yield, pay almost nothing to depositors. That model worked as long as stablecoins were the only way to park dollars on chain. It works less well when BlackRock offers a tokenized money market fund that pays yield directly, when exchanges demand 90% revenue shares for distribution, and when new stablecoin designs split economics among a broader set of participants.

This piece examines what Morgan Stanley’s downgrade says about $USDC’s competitive position, why the reserve income model is breaking down, and what the stablecoin market looks like when the product becomes a commodity.

What Morgan Stanley actually said

Analyst James Faucette moved Circle from equal-weight to underweight and set a $38 price target, down from $106. The core argument was a weaker long-term earnings outlook driven by three factors.

First, $USDC supply growth is slowing faster than expected. Morgan Stanley reduced its supply forecast by roughly 33% for 2027 and 44% for 2028. The bank expects $USDC contraction to continue as reserve income comes under pressure and Circle pivots toward lower-margin transaction revenue. GAAP earnings-per-share estimates came in about 3% below Wall Street consensus for 2027 and 20% below consensus for 2028. The magnitude of the 2028 revision is the more important number: it suggests Morgan Stanley believes the supply decline is not cyclical but structural.

Second, tokenized money market funds are cannibalizing stablecoin balances. BlackRock expanded its tokenized cash platform on August 3 with two new products: a tokenized share class of an existing money market fund (BSTBL) and a new stablecoin reserve vehicle (BRSRV) with daily dividend reinvestment. Both are designed to qualify as eligible reserve assets under the $GENIUS Act, directly targeting the capital that would otherwise sit in $USDC.

Third, Circle’s push into agentic payments has not gained traction. Morgan Stanley noted that transaction volume in the agentic payments product has fallen to about $41,900 per day, with an average transaction size of roughly 24 cents. Those numbers suggest experimental usage, not commercial adoption. For a company that has positioned itself as a payments infrastructure provider, the gap between the narrative and the metrics is wide.

The downgrade follows a similar move from JPMorgan in July, which cut forecasts for both Circle and Coinbase after analyzing the revised Hyperliquid agreement. Two of Wall Street’s largest banks are now bearish on Circle’s earnings trajectory, a consensus shift that makes the bull case harder to hold.

The Hyperliquid prisoner’s dilemma

Morgan Stanley’s downgrade arrived weeks after JPMorgan flagged a separate structural problem. Circle’s revised agreement with Hyperliquid, one of the largest crypto trading venues, changed how revenue flows between Circle and Coinbase.

Hyperliquid is now the leading decentralized perpetual futures exchange, processing more than $150 billion in trading volume in July alone. Its volume relative to Binance climbed to 11.5%, making it an increasingly important distribution channel for $USDC. The platform holds about $6 billion of $USDC, roughly 8% of circulating supply.

Under the new arrangement, Coinbase classifies $USDC on Hyperliquid as “on-platform” and collects the reserve income generated by those balances. Coinbase then pays 90% of that income to Hyperliquid. JPMorgan estimated that Coinbase previously split nearly all of the revenue evenly with Circle under older distribution agreements.

The bank called this a “prisoner’s dilemma.” Both Circle and Coinbase need Hyperliquid’s volume. Hyperliquid knows this. The result is that distribution economics get worse for both companies as large venues extract more favorable terms. For a payments company that once described $USDC as dominant in stablecoin trades, the shift is significant: volume alone does not guarantee margin.

The precedent is the more dangerous element. If Hyperliquid can extract a 90% revenue share, other large venues will demand similar or better terms. Every basis point of reserve income redirected to distribution partners is a basis point Circle and Coinbase do not earn. The prisoner’s dilemma is that neither company can refuse without ceding the venue to a competitor.

The Hyperliquid situation also exposed a structural vulnerability in $USDC’s DeFi positioning. When a major protocol can credibly threaten to migrate away from $USDC, it reveals that Circle’s moat in DeFi is thinner than its market share suggests. Unlike traditional payment networks, where switching costs are measured in years of integration work and regulatory approvals, DeFi protocols can swap their underlying stablecoin with a governance vote and a few smart contract deployments. The portability that makes DeFi innovative also makes every stablecoin position in it inherently fragile.

Why tokenized money market funds matter

The deeper threat to Circle is not a competing stablecoin. It is a competing product category.

Stablecoins are bearer instruments that represent a claim on reserves. They do not pay yield to holders because doing so would likely classify them as securities under the Howey test. This is why Circle earns money: the company keeps the yield generated by reserves, and holders accept a zero-interest dollar in exchange for on-chain utility.

Tokenized money market funds invert this arrangement. BlackRock’s BUIDL, launched in 2024 with Securitize, has grown to roughly $2.5 billion in assets. It pays yield to holders, trades on chain, and is increasingly used as collateral for borrowing and leveraged trading. The new BSTBL and BRSRV products expand the same model across multiple blockchains. Securitize serves as BRSRV’s transfer agent and tokenization provider, and both funds intend to qualify as eligible reserve assets for permitted stablecoin issuers under the $GENIUS Act.

For institutional users, the choice between holding $USDC (zero yield, issuer takes all reserve income) and holding BUIDL (yield-bearing, SEC-registered fund) is increasingly obvious. The $GENIUS Act’s framework for stablecoin reserves further legitimizes tokenized MMFs by allowing them to serve as eligible reserve assets for permitted stablecoin issuers. BlackRock’s CFO Martin Small stated during the Q2 2026 earnings call that the company manages $60 billion of reserves for Circle, “representing about a quarter of the $300 billion stablecoin market,” and wants to be “the reserve manager of choice.” The implication is clear: BlackRock is positioned on both sides of the table. It manages the reserves that back $USDC and simultaneously offers a product that competes with $USDC for the same capital.

The tokenized real-world asset market has grown more than 200% over the past year to over $30 billion, according to rwa.xyz. Citi projects tokenized securities could reach $5.5 trillion by 2030. U.S. money market funds alone hold more than $8.4 trillion in assets. If even a fraction of that capital moves on chain through tokenized MMFs, the addressable market for zero-yield stablecoins shrinks proportionally.

The $USDC supply problem

$USDC’s circulating supply has fallen from nearly $80 billion in March to roughly $73 billion by August 2026. This $7 billion contraction happened during a period when the broader crypto market was under stress, but it also reflects structural shifts that predate the downturn.

Tether’s $USDT remains dominant in absolute supply, holding more than $140 billion in circulation. But $USDC’s advantage was supposed to be regulatory legitimacy: a U.S.-regulated, fully reserved stablecoin that banks and institutions could trust. That advantage still exists, but the gap between regulatory legitimacy and revenue is widening.

The supply decline is not uniform. $USDC has been gaining distribution through new chain integrations. Circle brought $USDC to the XRP Ledger in June 2025 as part of a broader multi-chain expansion. Coinbase launched a $USDC-powered payments product on Shopify in June 2025. But these distribution wins have not translated into net supply growth, suggesting that outflows from existing chains are exceeding inflows on new ones.

Circle’s stock price initially reflected optimism that the company could grow beyond stablecoin issuance into payments, cross-chain infrastructure, and enterprise services. The stock’s 120% rally through early 2026 priced in this expansion narrative. Morgan Stanley’s downgrade reprices that narrative, arguing the base business (reserve income) is weaker than expected and the new businesses (payments, agentic transactions) are not yet contributing meaningful revenue.

Mizuho noted in July that Circle’s final approval from the U.S. Office of the Comptroller of the Currency to create First National Digital Currency Bank was a positive milestone, but warned that investors may be overestimating its significance. The bank charter gives Circle new capabilities, but it does not solve the underlying economics of a product whose moat is eroding.

The geographic dimension of $USDC’s supply contraction adds another layer of concern. Circle’s European market share has declined steadily since MiCA implementation, with compliant alternatives capturing share that $USDC previously held by default. In emerging markets, where the largest marginal demand for dollar stablecoins exists, $USDT’s dominance exceeds 90% in most corridors. Circle’s regulatory-first approach resonates with institutional users in the United States, but the fastest-growing stablecoin markets are precisely the ones where regulatory compliance is least valued by end users.

Open USD and the shared economics model

Open USD represents a different competitive vector. Instead of a single issuer controlling reserves and economics, Open USD distributes governance and revenue among a broader set of participants. Morgan Stanley noted that this model could make it more expensive for Circle to maintain $USDC distribution incentives, because exchanges and platforms may prefer a stablecoin where they share in the economics from the start.

This is not theoretical competition. The stablecoin market is fragmenting along multiple axes. Deutsche Borse listed $USDC and EURC under MiCA in late 2025. Fidelity, State Street, and BlackRock have all launched stablecoin reserve funds under the $GENIUS Act framework. The EU is preparing MiCA revisions in response to the $GENIUS Act. Each new entrant adds to a landscape where stablecoins compete not just on trust and distribution but on economics.

The shared economics model addresses the incentive problem directly. When an exchange holds $6 billion of a stablecoin and earns nothing from the reserves backing it (as with $USDC before Hyperliquid renegotiated), the exchange has every reason to demand better terms or switch to a competitor that offers revenue sharing by default. Open USD builds that sharing into the protocol layer, removing the need for bilateral negotiations.

For Circle, this means the competitive landscape is not just Tether on one side and tokenized MMFs on the other. It is also a new class of stablecoins designed from the ground up to share economics with distribution partners, a model that Circle’s centralized issuance structure was not built to match.

The shared economics model also creates a governance challenge that centralized stablecoins avoid. When reserve income flows to multiple stakeholders, disputes over revenue allocation, protocol upgrades, and risk management become multi-party negotiations rather than unilateral decisions. The DAI experience at MakerDAO demonstrated how complex governance can slow critical risk management actions during market stress. If Open USD faces a similar governance friction during a crisis, the consortium structure that attracts liquidity in good times could become a liability during market turbulence.

The interest rate sensitivity problem

Circle’s revenue model has an often overlooked dependency: interest rates. When the Federal Reserve held rates above 5%, $USDC reserves generated substantial yield. Every billion dollars of $USDC in circulation produced roughly $50 million in annual reserve income at those rates. But as rates decline, reserve income falls proportionally, even if $USDC supply stays flat.

This creates a double bind. $USDC supply is already contracting. If the Fed cuts rates in 2027 or 2028, as most economists project, Circle’s revenue per dollar of $USDC declines at the same time that the number of dollars is shrinking. Morgan Stanley’s 2028 EPS estimates, which are 20% below consensus, likely incorporate some degree of rate sensitivity, though the bank emphasized supply contraction as the primary driver.

The interest rate dynamic also affects the competitive landscape. Tokenized money market funds pass yield through to holders, which means their attractiveness is directly tied to prevailing rates. In a high-rate environment, the gap between a zero-yield stablecoin and a yield-bearing MMF is large. In a low-rate environment, the gap narrows, which could slow the migration from stablecoins to tokenized funds. The question is whether Circle can survive the transition period.

Tether faces the same rate sensitivity on its reserve income, but Tether’s cost structure is dramatically different. Tether operates with a fraction of Circle’s headcount and has no public market disclosure requirements, no preferred stock dividends, and no bank charter to maintain. If reserve yields fall to 3%, Tether’s margins remain healthy. Circle’s margins, burdened by public company costs, may not.

The timing of this rate dependency is particularly concerning for Circle. The company completed its IPO in April 2025 at a moment when short-term rates were near their cycle peak. Public market investors who bought Circle stock at $106 were implicitly pricing in sustained high interest rates. As the Federal Reserve signals a potential 150 to 200 basis point cut over the next 18 months, the revenue base that supported Circle’s IPO valuation is compressing in real time. Unlike Tether, which has no public shareholders to satisfy, Circle must report quarterly earnings that reflect this deterioration.

What the OCC bank charter actually enables

Circle’s approval from the Office of the Comptroller of the Currency to create First National Digital Currency Bank received considerable attention but limited analysis of what the charter actually enables. A federally chartered bank can do things a non-bank stablecoin issuer cannot: it can hold deposits, extend credit, operate a payments network directly through the Federal Reserve, and offer fiduciary services. For Circle, this is potentially transformative, but only if the company uses the charter to build banking services that generate revenue independent of reserve income.

The most direct application is lending. A bank can take in deposits and lend against them, collecting net interest margin on the spread between the lending rate and the deposit rate. This is the business model that traditional banks have used for a century. If Circle can position $USDC balances as de facto bank deposits and lend against them at scale, it creates a revenue line that grows with lending activity rather than shrinking as interest rates fall or $USDC supply contracts. The key is whether Circle can attract borrowers who want dollar-denominated loans settled in $USDC, a use case that does not yet have a large established market but aligns with the agentic payments narrative the company has been pushing.

The second application is direct Federal Reserve access. Banks can hold reserves at the Federal Reserve and participate in the Fed’s real-time gross settlement system. This would allow Circle to settle $USDC transactions at the Fed level rather than through correspondent banking relationships, reducing friction and cost in the settlement process. For a company that has positioned $USDC as settlement infrastructure, direct access to the world’s largest settlement system is not a trivial capability.

The OCC charter also changes Circle’s regulatory standing under the $GENIUS Act framework. Permitted stablecoin issuers under the $GENIUS Act include federally chartered banks, which means Circle’s bank subsidiary could issue $USDC under a different regulatory category than its current non-bank structure. This distinction matters for reserve requirements, capital treatment, and the scope of permissible activities.

Mizuho’s caution that investors may be overestimating the charter’s near-term significance is well-founded. Building a functioning bank from a regulatory shell takes time, capital, and operational infrastructure. Regulators require proof of adequate systems, controls, and staffing before a newly chartered bank can operate at scale. But the charter represents optionality that Circle’s competitors do not have. If reserve income continues contracting and Circle can pivot the bank toward lending, custodial services, and direct settlement, the long-term revenue model becomes more durable than current analyst consensus suggests.

What would invalidate the bearish thesis

Morgan Stanley’s downgrade rests on three assumptions: that $USDC supply continues contracting, that tokenized MMFs take share from stablecoins, and that Circle cannot build a high-margin payments business fast enough to offset the decline.

If any of these assumptions prove wrong, the bear case weakens substantially. A recovery in crypto trading volumes could reverse the $USDC supply decline, as happened in late 2024 when DeFi activity surged and $USDC supply grew rapidly. If the Clarity Act passes and prohibits yield-bearing stablecoins, Circle’s zero-yield model becomes a regulatory advantage. If agentic payments adoption accelerates from $41,900 per day to meaningful commercial volume, the revenue mix shifts.

The bank charter from the OCC could also become a differentiator over time. A federally chartered bank can offer services that a non-bank stablecoin issuer cannot, including lending, custody, and direct access to the Federal Reserve payments system. If Circle uses the charter to build banking services on top of $USDC, the revenue model diversifies beyond reserve income.

The $38 price target is not a floor. It is a forecast that depends on current trends persisting. The stock traded at $42 after the downgrade, meaning the market has not fully priced in Morgan Stanley’s bear case. If any of the assumptions break, the stock could move significantly in either direction.

What to watch

$USDC circulating supply trajectory. The most direct indicator of Circle’s revenue base. If supply stabilizes above $70 billion, the downgrade may have been too aggressive. If it falls below $65 billion, the earnings revisions get worse.

BlackRock BUIDL and BRSRV adoption. Track total assets in tokenized money market products. If BUIDL grows past $5 billion by year end, the institutional shift away from stablecoins as a yield-free parking vehicle is real. BlackRock’s Cash Management Group oversees nearly $1.073 trillion in cash strategies, giving it vast distribution power.

Hyperliquid $USDC balances and competing venue terms. Currently about $6 billion and rising. The revenue share terms set a precedent for other large venues. If Hyperliquid grows to 15% of $USDC supply, the distribution economics deteriorate further. Watch for other exchanges renegotiating similar terms.

Clarity Act passage and stablecoin yield provisions. The legislation could reshape stablecoin regulation. A version that allows stablecoin yield would undermine Circle’s argument that its zero-yield structure is a feature. A version that prohibits yield would protect it.

Circle Q3 earnings and guidance. The first earnings report after the downgrade will reveal whether management acknowledges the structural pressures or disputes them. Watch for updated $USDC supply guidance, agentic payments metrics, and any changes to the Coinbase revenue-sharing arrangement.

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Disclaimer: This article is for informational purposes only and does not constitute financial advice. The information presented is based on publicly available reports and data as of August 3, 2026. Always conduct your own research before making investment decisions.