One of the reasons to invest in stablecoins is their de-pegging event.
When stablecoins trade below their intended peg of 1:1 with a fiat currency, short traders can turn around and exchange them for the promised parity. In that respect, stablecoins are like money market funds.
Over the years, Tether, the world’s biggest stablecoin by market capitalization, has lost its peg numerous times and traded at a discount or premium to its intended parity with the US dollar. According to reports, it has also been the subject of many shorts by speculators.
That story makes for a great narrative if shorting Tether was not an exercise littered with booby traps – regulatory and financial – that would cause sane investors to think twice about the venture.
The Tether Short Traps
The considerable collateral involved in shorting Tether is one of the problems associated with it. But the trade’s risks are far more fundamental.
The most important one is the absence of a trusted venue to execute the trade. Before it went bankrupt, FTX was one of the few places where traders could short the stablecoin.
According to a Tether blogpost, the exchange accounted for $200 million of its overall shorts. In the current ecosystem, no prominent crypto exchange offers users the option to short Tether. Even those who offered the facility earlier have stopped it.
They have shifted to Tether-margined products (USDT-M) in which trade margins and final settlement for derivatives trades are in Tether. While it increases demand and circulation for the stablecoin, this practice also multiplies risk because Tether is prone to scandals.
The Crypto Counterparty Risk
The other problem related to shorting Tether is counterparty risk. Cryptocurrency exchanges regularly manipulate and fake volumes. This means they can inflate or decrease demand for the stablecoin to make it trade at a discount or premium.
There have been many such instances in the past. Two such examples are Tether’s $1,000 premiums at Bitfinex and Kraken. The events liquidate shorts and turn into money generating events for crypto lending firms and exchange market makers. Considering the problems with redeeming Tether, it is doubtful if retail investors benefit from the trade.
The Decentralized Alternative
The alternatives to centralized exchanges are decentralized finance (DeFi) platforms. DeFi platforms are supposed to have eliminated counterparty risk by using smart contracts. Such contracts store collateral and programmatically release it when the trade is executed.
But these platforms simply convert counterparty risk into protocol risk. Their technology base makes them vulnerable to hacks. Besides, many such platforms are held up by derivative stacks and unreliable coins that are vulnerable to bank runs and might drain the protocol of its liquidity within minutes.
Where’s My Money?
These problems are not the end of the story, however. The more fundamental problem with shorting Tether relates to money.
Shorts are opportunities to make money. Given the uncertainty around Tether’s reserves and the number of times that it has lost its peg, shorting the stablecoin should be a lucrative and popular exercise. But it is difficult to find beneficiaries of this trade. There doesn’t seem to be much information about people or companies that have booked profits from shorting Tether.
We already know the incest and interrelationships between crypto companies enables worthless tokens to acquire inflated market capitalizations running into millions and billions of dollars. Likely then, it is possible that shorts liquidation will result in distribution of largesse amongst related parties.
For example, Bitfinex and Tether share common management and have been fined earlier for commingling funds. A Tether premium at the exchange breaks a short bet and funnels money to iFinex – the common parent to both entities.
The Tether Connection
A report by online publication Protos last year listed exchanges where shorting Tether is possible. Many of these exchanges are unknown and operate in a crypto netherworld with zero guarantees for liquidity or markets.
Some, like Bittrex and Poloniex, were also charged with collusion in cases that accused Tether of manipulating the price of Bitcoin. They enabled trading of unbacked Tether and facilitated its conversion into other cryptocurrencies like Bitcoin that traded directly against fiat.
FTX’s sister entity Alameda Research was a broker and a market maker at the exchange. It was also one of the biggest buyers of Tether in 2020. Anyone shorting the stablecoin at the exchange would have to borrow it from Alameda to place the trade.
According to Protos’ list, Tether traded at a premium to its peg in March, clearing $12 million in trades on FTX. That trade must have been a disaster for those who were short Tether. It must have also made Alameda rich.
But the trading firm cannot have been the only beneficiary. The figures relating to Alameda’s purchase of Tether coins are suspect and the company reportedly shares ownership of a small Washington bank in the United States with Tether’s banking partner. The bank’s deposits skyrocketed after Alameda’s investment. The identity of entities or individuals making the deposits is still unknown.