Tether (USDT), the world’s largest stablecoin by market capitalization, showed signs of losing its dollar peg in the wake of the collapse of Terra’s UST stable coin. But the price has stabilized, with its chief technology officer telling holders that the currency continued to support redemptions. 

Tether, which aims to match USDT to USD at a rate of 1:1, dropped to a low of $0.9485 on 12 May as UST crashed. It has been trading around $0.9988, rather than the exact parity at $1.

People use stablecoins to facilitate cryptocurrency trading, transfer money, and earn interest. However, the lack of regulation and transparency surrounding these coins, particularly Tether, have authorities on edge. Here are some of the reasons why:

Tether is only backed by 5.81% in cash reserves (the rest comes in other forms)

Holding Tether is not the same as holding U.S. dollars. The price may be pegged to the dollar, but if there was a run on Tether — lots of people tried to swap their Tether for dollars — there’s no guarantee the company would have enough cash to pay out.

Tether originally claimed that a U.S. dollar backed every USDT in its reserves. But the reality is more complicated: Tether is backed by a mix of:

• Cash
• Cash equivalents
• Secured loans
• Corporate bonds
• Other investments

In June,2022, it published details of its reserves in a pie chart. The breakdown showed it had 85.64% in “cash and cash equivalents.” However, looking at that in more detail, only a small proportion of the 85.64% is held in cash:

Common Doubts About Tether

Of course, ‘Tether is resilient and safe’ is not the only interpretation of the redemptions doing the rounds on the Web. One other major interpretation is that the withdrawals were basically an act intended to manipulate the market into having confidence in Tether at a time when confidence in stablecoins was very low.

This is the view, for instance, of economics author Frances Coppola, who noted that Tether’s own breakdown shows it has very little cash (5.81% according to the breakdown above).

Likewise, prominent Tether-Bitfinex critic Bitfinex’ed has tweeted that the redemptions were possible because no real cash changes hands when Tether issues USDT and sends it to an exchange. Instead, Tether’s ‘customers’ simply got their ‘IOUs’ back from the issuer.

Unsurprisingly, there’s no real proof that Tether has done this (if only because such proof would require a whistleblower or some kind of confession). Still, such claims are lent some degree of credibility by the simple fact that Tether has not always been upfront and transparent in the past.

For instance, returning to the Paolo Ardoino interview we published in February 2021, Tether’s CTO claimed the following:

“Once verified, the user will first have to deposit fiat currency into Tether’s bank account … Tether will then credit the corresponding amount of USDT into the Tether wallet address provided by the user … Through this process, Tether ensures that all tether tokens are backed 100% by Tether’s reserves.”

This statement gives the impression that Tether’s reserves were composed entirely of cash. However, in May of that year, Tether actually released an unverified breakdown of its own reserves, showing that its cash holdings comprised only 5.81% of the nominal value of the USDT in circulation.

In other words, Tether may not have been entirely honest in early 2021, unless it shifted its reserves from predominantly cash to predominantly ‘cash equivalents’ in the intervening months.

While we cannot prove deliberate lies, the New York Attorney General was assured enough to declare in late February 2021 that Tether has repeatedly misrepresented the status of its reserves between 2017 and 2019. Of course, this doesn’t prove what Tether may or may not have been doing since 2019, but it at least casts serious doubt over any claims it now makes.

As such, skepticism as to the recent redemptions is plausible and hard to dispel with any real confidence.

If Tether fails, it could shake the whole crypto industry

The Federal Reserve is concerned about stablecoins as a whole, but it has singled out Tether in particular. At the end of June, President of the Federal Reserve Bank of Boston, Eric Rosengren, listed Tether as a potential challenge to financial stability.

He told Yahoo! Finance: “The reason I talked about Tether and stablecoins is if you look at their portfolio, it basically looks like a portfolio of a prime money market fund but may be riskier.”

Prime money market funds are basically funds that invest in the type of commercial paper debt mentioned above — the type that makes up almost 50% of Tether’s total reserves.

The worry is that Tether is operating in a similar way to a bank or other financial institution but without any of the regulations that banks follow to protect consumers and prevent economic crises. That’s why there’s such a push for stricter stable coin regulation — to protect both the economy and the crypto industry.

As Rohan Grey, an assistant law professor at the Willamette University College of Law told the Financial Times, “The growing world of stable coins arguably underpins the entire crypto community right now. If that collapses, the whole space could collapse.”

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DISCLAIMER: The Information on this website is provided as general market commentary, and does not constitute investment advice. We encourage you to do your own research before investing.

Issac

Coincu Ventures