Notes 12/2: Benham’s Testimony, Tether Loans

CFTC Chairman Rostin Benham reiterated the case to bring “comprehensive market regulation” to cryptocurrencies and said existing rules are sufficient to rein in hijinks in its ecosystem in his Senate testimony. “We (can) eliminate contagion by applying the same principles of financial regulation that we apply to traditional financial assets,” he said.

Benham’s views echo that of SEC Chair Gary Gensler. Media narratives have framed the latter’s quotes as an attempt to seize authority over crypto from its sister agency. Benham was more conciliatory in his approach. “There’s been a narrative about a power grab [between the two agencies],” he said. “Far from it. It is about filling a gap.”

A Gap in Digital Assets Regulation

And what is that gap?

Handing over authority to regulate cash commodity markets to CFTC, according to Benham. He pointed to LedgerX, an FTX derivatives trading subsidiary, that remains insulated from its parent company’s problems. LedgerX is registered with CFTC and has “near daily contact” with the agency, Benham said. “Digital assets remain secure on the platform, and it can continue operations.”

The CFTC’s remit is to ensure risk management and price discovery in commodity markets. A defining characteristic of the FTX fiasco was an absence of compliance controls and risk management that led to commingling of funds between various parties and their use in risky trades.


Paradoxically enough, Benham told lawmakers that a crypto regulation bill backed by Sam Bankman-Fried (SBF), FTX’s former CEO, could have prevented the exchange’s collapse by ensuring checks and misuse of customer funds.

The Digital Commodities Consumer Protection Act (DCCPA) prohibits commingling of customer assets with the assets of the digital commodity platform. [According to reports, Alameda Research, FTX Research’s sister entity, used the exchange’s customer funds for trading purposes].

But Kristin Smith, Director of Blockchain Association, tweeted that it would not have prevented funds misuse because FTX International was subject to laws in the Bahamas, where it is based, and not the United States.

Is Crypto Regulation Necessary?

That point brings us back to the central question of whether regulation is, in fact, necessary for digital assets. The argument to regulate them runs on thin ground. Price movement in crypto markets seems whimsical and volatile and their utility as a medium for daily transactions – the original use case for bitcoin – remains unproven.

Benham said he was “agnostic” about crypto’s success. But he made the case that failing to regulate crypto could be a risky move. “I don’t think we can regulate this [crypto] out of existence,” he said. “Even if we did, it would still exist outside, somewhere, and the risk would come back [to US markets].”

That risk touchpoint is good for CFTC’s budget. The agency is much smaller in size and has budget as compared to its behemoth SEC cousin. Congressional authority to regulate crypto would provide an estimated 20% boost to its 2023 budget and enable it to expand its team.

Dividing Responsibilities

Benham’s plan of action for crypto regulation involves splitting responsibilities with his counterparts at the SEC. In this scheme of things, commodity tokens, such as bitcoin, would become a CFTC responsibility while security tokens would fall under the SEC’s remit. Stablecoins were not discussed at the hearing but an earlier bill, proposed by Senator Pat Toomey, places them under the Office of the Comptroller of the Currency (OCC).

The divvying up of responsibilities between agencies may bring some clarity to regulation. But some questions relating to the same topic remain unanswered.

For example, what is the difference between security and utility tokens within the context of cryptocurrencies?

The definition of such tokens has become a source of much confusion among crypto entrepreneurs and enabled regulators to pick winners and losers in the ecosystem by applying selective action against some actors. So far, only Bitcoin, and to a certain extent Ethereum, have received an all-clear from both agencies as commodities.

Tether’s Loans   

By now, it has become difficult to keep track of the controversies at Tether. But here’s one more.

The Wall Street Journal published a report yesterday about secured loans in its reserves. The world’s biggest stablecoin lends out its US-dollar pegged stablecoin, USDT, to “eligible customers” who also post “extremely liquid” collateral for the loan. The amount of such loans as a percentage of Tether’s reserves to back its circulating supply jumped from 5% at the end of last year to 9.6% at the beginning of October this year.

As usual, the company deflected questions about the details of such loans. It did not divulge the identities of customers for its loans or the criteria it uses to screen them. It also did not reveal the nature of loan collateral it held in its reserves. “Tether’s disclosures are limited to the information contained in the mentioned reports,” a spokesperson for the company told the Journal.

A report in Bloomberg last year laid out some details of such transactions. The CEO of Celsius, a crypto lending firm that filed for bankruptcy earlier this year, told Bloomberg last October that it was paying interest rates of between 5% to 6% on a loan of $1 billion that used bitcoin as collateral.

A Risky Transaction

There are risks galore on both sides of the trade.

Tether’s value is pegged to the US dollar and has been unusually volatile this year amid a mounting list of scandals in crypto. That means the value of such loans has declined. On the other side of the trade, the value of collateral posted by borrowers has also suffered because of a downturn in crypto markets.

For example, bitcoin’s value has crashed by more than 70% in the last one year. This means that value of the Celsius collateral held by Tether would have experienced a similar decline. Tether claims it liquidated Celsius’s collateral without any losses.     

A Question of Affiliation

The Journal piece also mentions that Tether recently removed wording about affiliated entities taking out loans in its stablecoin. Up until now, the company has claimed no exposure to the bankruptcies and scandals in crypto this year.

However, recent reports have disclosed its relationship to FTX, which filed for bankruptcy this month, through shared management of a state bank in Washington. FTX’s former CEO Sam Bankman-Fried’s trading firm Alameda Research, was one of Tether’s biggest customers last year.

These reports hint of a connection between the two entities. Did Tether’s decision to remove wording from its reserve reports have something to do with its affiliation to FTX and Alameda?  

Test of Time

Appearing on CNBC, former Tether CEO Reeves Collins told Andrew Ross Sorkin that Tether has “withstood the test of time” and pointed to the stablecoin’s redemption numbers as evidence that it had liquid reserves.

But there is no documentary evidence or proof of those redemptions.

Tether’s overall supply in markets can also be controlled by burning the cryptocurrency, an action that may lead to bitcoin crashes. The stablecoin’s redemption process is also difficult and expensive, with the company taking a 0.1% cut of the total amount redeemed. This means that Tether, in actual fact, is not a 1:1 peg. It also contrasts with rival USDC’s promise to redeem on a 1:1 basis.

Why then would an investor willingly commit to the Tether roach motel?

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