UST. Celsius. Three Arrows Capital. The list of crypto’s casualties in the current downturn is growing by the day.
There’s more bad news ahead. Experts say that the crypto ecosystem is due another capitulation event. “Some giant player will go to zero [soon],” Shark tank personality and crypto investor Kevin O’Leary told Coindesk recently.
The chances it might be Tether, the world’s biggest stablecoin, are high.
Tether is a pioneer among stablecoins. It has functioned as a connecting rail between the disparate worlds of nascent crypto and established fiat currencies since its launch in 2014. The stablecoin accounted for as many as 90 percent of all transactions occurring in crypto as recently as three years ago. But its reputation has come under a cloud in recent times.
Critics have accused the stablecoin of being “Bitcoin’s biggest secret,” a “big Ponzi scheme,” and “a time bomb.” They say that the company does not have adequate reserves to back the numbers of its tokens circulating in the market.
This means that if there is a bank run, as happened in the case of UST recently, its investors will be left holding the bag. Churn in the cryptocurrency ecosystem has also made Tether’s peg increasingly wobbly. The company’s steadfast refusal to submit itself to regulatory scrutiny and third-party audits of its reserves has worsened the situation.
Further investor concerns are centered around the structure of its operations. It has shifted banking relationships several times over the years. A mysterious CEO with a sketchy past had added to the ingredients of a scandal brewing at the company.
The Case Against Tether
Tether’s premise, when it was launched, was a simple one. Each circulating token was to be backed by a US dollar to guarantee liquidity and immediate redemption for investors in crypto’s high risk ecosystem. It’s function as a bridge with fiat helped bring new investors into crypto. Tether’s premise worked well in the first few years of crypto because token valuations and transaction numbers were measured in thousands or, in rare instances, millions of dollars.
The situation changed five years ago, when crypto markets exploded on the back of relentless media coverage. More traders of cryptocurrencies translated to more demand for Tether tokens because most of the crypto universe remains inaccessible to fiat currency even today and there were few to no alternatives to Tether.
According to data from analytics firm Messari, Tether had 15 million circulating tokens at the beginning of 2017. By May 2022, that figure had ballooned to 83.2 billion. That figure does not include the token’s liquid supply locked up in smart contracts or its use in projects as a backstop for their own reserves. At the very least, then, the company backing Tether – iFinex – has had to print more than 82 billion tokens to manage demand.
Printing new Tether coins is the easy part. Finding an equivalent dollar of reserve for those coins proved trickier. Like Tether’s CEO, its parent iFinex is a mysterious entity and there is not much detail about its finances available on the web.
In its search for reserves, Tether has diversified its portfolio. According to the its latest balance sheet, less than 3% of its reserves now consist of cash.
The majority, amounting to slightly less than half, consists of US Treasury bills. The remaining portion is an array of assets, including commercial paper or paper issued by companies to fund their operations and non-US Treasury bills. The problem is that not much is known about the quality of commercial paper held by Tether.
The company’s responses to questions about that part of its reserves are an exercise in obfuscation and evasion. For example, in a CNBC interview last year, Tether CTO Paolo Ardoino insisted that Tether’s commercial paper was grade A2 and above but refused to provide details of the investments. “We don’t disclose our commercial partners…we believe it is important to respect the privacy of banking partners we work with,” he said.
Privacy is important. So is accountability, especially when you are as big as Tether. A Bloomberg report last year stated that the company was among the biggest holders of commercial paper in the world. A portion of it consisted of paper issued by Chinese companies. A global downturn has tanked the value of such holdings.
In the past, the company has stated that it maintains a buffer over and above its market cap to ensure liquidity. But overcollateralized stablecoins run the risk of becoming undercollateralized as the value of underlying assets falls. Tether paid a $41 million fine to the CFTC last year because it was fully backed – to the amount of its reserves based on the number of Tether tokens circulating in the market – only about a quarter of the time between June 2016 to February 2019.
iFinex also paid a $18.5 million fine to the Securities and Exchange Commission (SEC) for commingling client and corporate funds. In the latter case, Bitfinex loaned $850 million to Tether to bolster its reserves. “Bitfinex [Tether’s parent company] and Tether recklessly and unlawfully covered-up massive financial losses to keep their scheme going and protect their bottom lines,” New York Attorney General Letitia James stated.
While there have been several questions raised about Tether, its executives have repeatedly stonewalled efforts to find out more about its reserve makeup. In some instances, those takes have been decidedly surreal. Tether co-founder and digital marketing veteran Reeves Collins told a CNBC interviewer, hand on his heart, that he “truly believed” Tether tokens were backed 1:1 on dollar but could not guarantee it.
Is Tether Too Big to Fail?
Less than five years ago, a Tether crash would have caused a catastrophe in the crypto ecosystem because of the stablecoin’s dominant role in facilitating transactions within crypto. The situation has changed considerably since.
In 2018, Binance and Huobi – two of the world’s biggest cryptocurrency exchanges by trading volume – were among the biggest holders of Tether. Now they have designed their own stablecoins to facilitate transactions in their ecosystem.
USDC, another stablecoin, is also eating away at Tether’s market share. Backed by big names such as Coinbase, USDC accounts for almost 30 percent of all transactions in crypto right now. The stablecoin’s ascent has been swift: it had a market capitalization of $55 billion to Tether’s valuation of $69 billion, as of this writing.
More importantly, while Tether has shied away from regulation, USDC’s parent Circle has embraced it. The stablecoin is advertised as the “world’s largest regulated stablecoin.” [But that assertion is not entirely true since there is no regulation specific to stablecoins].
Circle, USDC’s parent company, also releases monthly reserve reports attested by accounting firm Grant Thornton for USDC. Its CEO has appeared in Congress to testify on stablecoin regulation. To that extent then, Tether’s collapse might not have the same impact that it would have had some years ago.
The red herring here is the crypto economy’s opaque web of relationships and nested narratives that emerge after a scandal. The extent to which Tether is used at various exchanges is still unknown. Its investments into and relationships with other crypto platforms is also not fully known. Tether has invested in two other companies – gift card company Bitrefill and gaming outfit Exordium – besides Celsius.
Tether’s demise might take down minor tokens, those whose circulation and valuations are illiquid and volatile, but its effect on the top tokens is unknown. A report released last year concluded that about half of all Bitcoin transactions were conducted using Tether. But its data was not tested for reliability.
In that respect, Tether is the remnant of a different, unregulated time in crypto, when there was not much public accountability for firms operating in the sector. As cryptocurrencies clamor for mainstream acceptance and regulation, Tether will have to change and provide more transparency into its workings or fall by the wayside.