According to reports, traditional hedge funds have begun shorting Tether, the world’s biggest stablecoin by market capitalization and transaction volume. Leon Marshall, head of institutional sales at Genesis – a market maker, told the Wall Street Journal that interest from traditional hedge funds in shorting Tether has spiked in recent weeks.

There are two reasons for this. First, they believe that the broader macroeconomic slump will affect Tether’s peg with the US dollar as investors continue deleveraging from risky assets. This means that liquidity available to crypto markets will continue to dry up, making it difficult for cryptoassets to hold their value.

Second, they are suspicious of the quality of Tether’s reserves. The stablecoin has refused to divulge details about its holdings, especially those relating to commercial paper and non-US Treasuries. In the recent downturn, when asset prices across the board have tumbled, the quality of those holdings has become especially important because it could inflate reserve requirements for the stablecoin.

For example, previous reports have indicated that Tether had commercial paper issued by Chinese real estate companies in its portfolio. A slowdown in China’s real estate sector has declined the value of such paper, possibly shrinking Tether’s reserves to back its stablecoin.

The Difficulty of Shorting Tether

A March Bloomberg piece offered more details on the mechanism for shorting Tether. Geography determines the trade’s two sides. U.S. funds are more inclined to short the stablecoin because it refuses to detail its reserves. Those in Asia are more apt to go long on the stablecoin because they are “crypto-native” and believe in its utility in the ecosystem.

But Tether is an expensive cryptocurrency to short. According to the Bloomberg piece, traders pay a premium of as much as 12% to buy Tether from a market-maker to fashion a put position against the stablecoin. They would also have to execute the position outside the U.S. because no exchange based here offers the facility to short Tether.

Difficulties apart, increased interest in crypto markets from mainstream financial players has meant that the monetary stakes have become higher and put positions against Tether have multiplied in recent years.

Will Shorting Tether Bring It Down?

Shorting is essentially a money-making opportunity for funds and traders. They might uncover a fundamental flaw or hidden truth about a company’s operations and seek to profit from this knowledge. In Tether’s case, its flaw – suspicions about the quality of reserves backing its stablecoin – has been public knowledge for many years. It has managed to withstand pressure from investors and regulators alike and claims to have honored redemption requests running into billions of dollars.

When Tether falls below its peg, it is an opportunity for investors to redeem the de-pegged stablecoin for $1. Thus, shorts create temporary profit-making opportunities for traders but they are not likely to bring down the coin.  

Yesterday, CNBC host Jim Cramer asked SEC chief Gary Gensler about Tether’s situation. Gensler shirked from criticizing the stablecoin directly. “Transparency is the basic bargain [in the investing formula],” he said and compared the stablecoin to a money market fund and a bank. Both entities take invest client deposits and promise liquidity and redemption at par.

Tether’s case is complicated by the fact that it is a critical component of volatile crypto markets and bridges the worlds of fiat and inaccessible cryptocurrencies. But the absence of stablecoin regulation has meant that it has remained largely unaccountable to investors and authorities.

For example, Bloomberg columnist Matt Levine estimated that the stablecoin has a 0.2% capital ratio based on the March disclosure of its reserve assets. That is not even a fraction of the 8% capital ratio required of banks after the financial crisis. This means that it would not be able to survive for long, if there is a run on its assets.   

A Measured Descent

Based on its current trajectory, Tether’s fall from premiere position in stablecoins seems to a measured descent rather than a crash. In 2022, Tether has mostly traded at a premium to its peg. But the stablecoin is losing market share to USDC – a stablecoin launched in 2018 and backed by Coinbase.

The latter coin also overtook Tether in transaction volumes for the first time on Ethereum’s network about a week ago. At $55.8 billion, its market cap is also catching up with Tether’s $66 billion valuation in crypto markets.