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Tether’s ruffled feathers

Exclusive Research

  • Tether is back in the spotlight as the media continues to investigate its reserves.
  • Tether Holdings has successfully evaded regulatory pressure and media questions in the past, but will this time be different?
  • Should they face a bank run and be found insolvent, there will be ripple effects on the crypto industry.

Background

Tether (USDT) is a stablecoin issued by Tether Holdings Limited. Its value is pegged to the US dollar and it is currently the fifth largest cryptocurrency by market capitalisation.

Tether has always remained controversy’s favourite child and many critics have depicted it as a systemic risk to the cryptocurrency ecosystem. On 9 August 2021, Tether published an independent accountant’s report which stated that the group’s consolidated assets exceeded its consolidated liabilities. Tether wanted to reassure its users about the stability of the most popular stablecoin, as it started a fresh printing of billions of USDT after a two-month hiatus.

Tether contributes a big chunk of cryptocurrency trading volume. People prefer it, as its value remains tightly coupled to the US dollar and its transferability, through different blockchains, provides great ease. The vocal critics of Tether say that it is used to pump Bitcoin’s price.

Tether Holdings limited is not a banking entity. It is neither regulated nor properly audited. It thrives from the disinterest that traditional banks have towards the cryptocurrency business, obtains real dollars and returns an equal number of tokens. The company has a history of financial misappropriation. Earlier this year, it settled a case with the New York attorney, but was consequently prohibited from doing business in New York state.

The holders of Tether have no legal guarantee or contractual right that the tokens can be redeemed for dollars.

As Bitcoin is trading above $57,000 and the total cryptocurrency market capitalisation has surpassed $2.3tn, controversies around Tether have resurfaced. Unlike some other stablecoins, Tether does not maintain the required level of transparency. Are the tokens really backed by dollars? Tether’s website says every token is fully backed by reserves which can be cash, cash-equivalent, cryptocurrency, commercial papers or treasury bills. This is a departure from its early days, when the company used to claim that 1 USDT was always equivalent to 1 USD. At the same time,Tether is the de-facto industry standard, as it is the most widely used stablecoin.

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The controversial past

Realcoin, a 2014 project, was the precursor of Tether. In 2015, Cryptocurrency exchange Bitfinex launched trading of Tether tokens. There was no official relation between Tether and Bitfinex and both entities denied any link between them. In 2017, the Paradise Papers published leaked documents indicating that Bitfinex officials were responsible for setting up Tether Holdings Limited. Tether’s early history was complicated.

Tether grew exponentially in 2017. From January 2017 to September 2018, the number of outstanding tokens of Tether grew from about $10m to about $2.8bn. At the end of 2017, a huge number of tokens were hacked from Tether’s reserves and the company responded with a hard fork of the Omni Protocol to make the tokens invalid. After that incident, Omni added a feature to make the transactions frozen by the issuing authority; a position still maintained by the company.. In early 2018, almost 10% of Bitcoin’s trading volume was coming from Tether and by the middle of that year, Tether was contributing almost 80%. Critics became vocal about the Bitcoin price manipulation scheme involving Tether and it was called a ‘Ponzi’ or ‘Scam’.

Researchers at the University of Texas published a paper to demonstrate how Tether tokens were used to "provide price support and manipulate cryptocurrency prices". US federal prosecutors started to investigate the matter in 2018. Tether promised transparent audits to prove that their tokens were backed by authentic reserves many times but their promises were never kept.

Where is the money?

A Bloomberg post recently raised questions about Tether’s asset backing again. Tether is like a bank that takes dollars from people and gives them digital tokens. Out of the 69bn circulating Tether tokens, 48bn were issued this year. So the company should have $69bn or equivalent in its reserves. Where is the money? The amount seems astronomic. With this amount of cash reserves, Tether would bea top 50 bank in the US.

Tether responded by saying “Crypto—and Tether in particular—are fostering a revolution in financial inclusion, transforming a model that doesn’t work in a modern world. This article does nothing more than attempt to perpetuate a false and ageing story arc about Tether based on innuendo and misinformation, shared by disgruntled individuals with no involvement with or direct knowledge of the business’s operations.”

There is no doubt that Tether has been a market leader with a proven track of innovation and a source of liquidity in the market. What if Tether collapses and can’t repay investors? Will the whole crypto ecosystem burst like a bubble, if it is proven to have inadequate reserves?

What if Tether goes to zero?

Tether’s CEO recently deleted his Twitter account. The company has loaned billions of dollars to crypto companies. One billion dollars was loaned to Celsius Network, a lending-borrowing business. Tether was the lead investor in Celsius Network’s funding round in June 2020. Everything does not always go as planned and Tether is definitely a big problem this time.

A bank run can happen when financial institutions issue fixed-value liabilities backed by assets with uncertain or dubious value. As more people start withdrawing their money, the probability of default increases. The crypto world has already seen a bank run event. Iron Finance collapsed on 16 June of this year. Iron Finance, a DeFi or decentralised finance platform, had a partially collateralised stablecoin protocol with the objective of providing a dollar-pegged stablecoin. The bank run caused losses worth nearly $2bn to investors due to partial collateralisation.

Such a situation is also possible for Tether. If people rush to sell Tether tokens for Bitcoin, Ethereum or other stablecoins, the price will plummet. If it is found that Tether prints the tokens without any real reserves, the value of the tokens can go to zero. Nobody will be happy to hold a stablecoin that has inappropriate asset backing. Tether has undertaken many unexplained actions since its inception and the inadequate disclosures of Tether are really suspicious.

Possible impact on traditional finance

If Tether faces a sell-off pressure, it will have to liquidate its reserves. Tether holds huge commercial papers and it can bring instability to the short-term credit market. A ‘Fitch Ratings’ article describes stablecoins as contagion risks and Tether’s CP holdings can be more than very big prime money market funds (MMF) in the US. Again, the exact nature of Tether’s CP holding is unknown. A Bloomberg report alleged that Tether was holding huge Chinese debt as CP. Some days back, the company stated that it did not hold any commercial paper issued by China’s Evergrande Group, the world’s most indebted real estate company.

Tether has already managed similar situations

On 15 October 2018, the Tether token price fell to $0.88 as traders perceived high credit risk and started to sell their tokens for Bitcoin. For a substantial time, the tokens were trading at the level of $0.915 before reaching their pegged value of $1. People were paying a 6-7% premium to shift to other stablecoins like TUSD. The crumbling of a stablecoin is definitely a bad sign from the investment perspective, but Tether recovered fast and maintained its market leading position in the stablecoin sector consistently. It is possible that Tether tokens are not backed by equivalent assets, but the project team has really managed the uncertainties and regulatory pressure well. Bitcoin fell below $30,000 some months back when China banned mining of the cryptocurrency. A huge number of Tether tokens were printed after that and Bitcoin’s price has also appreciated considerably. Most probably, the Tether team accumulated Bitcoin at the $30,000 level and can sell some of its holdings to maintain the dollar pegging of the tokens in the real term and get rid of the problem. The regulatory watchdogs have increased surveillance and the crypto ecosystem is being forced to abide by the laws of the land. Tether may be forced to become transparent regarding its asset backing this time and they may be able to do it successfully.

Conclusion
Tether was once used only in centralised exchanges but now it is the most popular stablecoin in DeFi. Huge DeFi value is locked in Tether tokens across all popular decentralised platforms. The crypto market has seen many fraudulent companies in the past, but Tether is valued at $69bn and if any scam unfolds, the shock wave will turn into a tsunami. Despite being a stablecoin, Tether has seen spikes in its prices. If it is found to be insolvent, there will be a liquidity crisis in the market and it will lead to extreme fear and panic among investors. Considering the business volume of Tether and its global acceptance, the company has a lot of things to lose if it does not maintain transparency now. The market has a lot of other stablecoin players and they will quickly capture the opportunity if Tether fails.

Nothing in this article constitutes professional and/or financial advice. The content is provided exclusively for informational and/or educational purposes. Nothing is to be construed as an offer or a recommendation to buy or sell any type of asset. Seek independent professional advice in regards to financial, tax, legal and other matters.

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