What if the deletion of a digital currency could damage, or even destroy, the entire cryptocurrency ecosystem? Lately, there has been a focus on stablecoins, the silent and powerful players of the cryptocurrency space.
Questions about stablecoins, particularly one called tether, have been kicking around financial circles for months: are they as stable as they should be? A vocal group of people, including the likes of Jim Cramer, Nouriel Roubini, podcasters Bennett Tomlin and Cas Piancey, and pseudonymous blogger Bitfinex’ed, have raised questions about tethering as a possible systemic risk to the cryptocurrency ecosystem. On August 9, Tether issued a certificate on its reserves, a way of reassuring users that the most popular stablecoin is, well, stable.
Reading: Tether bitcoin manipulation
The certification seems unlikely to reassure tether’s most vocal critics, some of whom fear its real use is to keep the price of bitcoin high. The company has also been investigated by the New York Attorney General for claims surrounding its endorsement and reached a settlement with the Nyag earlier this year. As part of the agreement, Tether is prohibited from doing business in the state of New York, the financial capital of the US world.
The fears surrounding stablecoins are not just limited to connection. After months of hesitation and hesitation from regulators, United States Securities and Exchange Commission Chairman Gary Gensler has now clearly called for more authority to regulate cryptocurrencies. “We have a role as a nation to protect those investors from fraud.” Treasury Secretary Janet Yellen met with the President’s Task Force on Financial Markets to talk specifically about stablecoins.
At this time, there is no standardized way for stablecoins to disclose the assets that back them. It seems like an obvious target for regulators, but there is also a way to do away with stablecoin needs. in fact, the way to get rid of stablecoins could be… the dollar but digital.
what is a stablecoin?
These digital currencies, which are pegged to other assets such as the US dollar or the euro, are primarily used as payment mechanisms. Stablecoins’ name reflects the idea that pegging makes them less volatile than cryptocurrencies like ethereum or bitcoin, whose value can vary widely. Usually when someone sets up a stablecoin, there is a reserve for the assets, which is held as collateral.
some stablecoins are also centralized. with cryptocurrencies like bitcoin or ethereum, if you get hacked and lose money, well, sorry, you’re screwed. this is not the case for some stablecoins; when $600 million was stolen from polynetwork, tether simply froze the $33 million of its tokens that were included in the heist. which made those funds useless to the attacker.
What do people use stablecoins for?
payments, says bruce mizrach, economics professor at rutgers. The real competitors to stablecoins like Tether (USDT) are things like Venmo and PayPal. Most of the time, the fees they charge for transactions are relatively low, Mizrach found. Tether fees are typically less than a dollar, while off-net ATM fees are around $3.08. (However, about 1 percent of transactions have fees greater than $25.) the same goes for usdc, another stablecoin.
They are also used as a place to store value when investors exit cryptocurrency trades, says richard li, chief executive of 4k, an nft marketplace. imagine an investor, we will call him mars vulrich, he wants to secure some profit that he made in bitcoin. Now our friend Mars can get back out of the US dollar trade and send it to his bank account, but it will take a couple of days. Part of that delay is that Mars has to comply with anti-money laundering laws to get out of cryptocurrency and back into the US dollar. During that time, if Mars sees a good opportunity to invest in another cryptocurrency, he won’t be able to reach that money.
Now, you could exit your bitcoin trade to a dollar-pegged cryptocurrency. the relatively quick transaction would mean that your funds would be available for another investment immediately. if mars is trying to transact fast, it might choose to do so instead of switching between traditional banking and cryptocurrencies.
Stablecoins can also be used for margin trading. Our friend Mars can borrow money from an exchange like Kraken, which will use its own funds to help execute the trade. but mars has to provide some collateral for the loan, and stablecoins can be useful for that. margin trading is risky: it can lead to very large losses.
This sounds like something that government regulators, like the Securities and Exchange Commission, would be interested in.
it is! SEC Chairman Gary Gensler suggested that the stablecoins might actually fall under the authority of the SEC, in comments on the Aspen Security Forum. specifically, he said that stablecoins “can also be securities and investment companies. To the extent they are, we will apply all investor protections of the Mutual Fund Act and other federal securities laws to these products.”
Okay, but hasn’t that happened yet?
not. However, cryptocurrency regulation is a hot topic right now, and Gensler used to teach cryptocurrency courses during his last job at mit.
Why might the secretary want to get involved?
well stablecoins are huge. the most popular, tether, launched in 2014 and is pegged to the dollar. It has a market capitalization of more than $60 billion. USDT tokens are involved in half of bitcoin trading worldwide. and there have been questions about whether moves in tether have created price manipulation in bitcoin. an academic study found that a particular player on the bitfinex exchange uses a newly printed tether to buy bitcoin when bitcoin prices fall, to support the price of bitcoin. apparently this works.
Tether had no problems recently?
Why don’t we go over a quick history? If you’d like a less abbreviated version, journalist Amy Castor has put together a comprehensive timeline; this men’s magazine article also gives you some of the history.
The biggest question at the moment, which has been in play for a while, is what is backup tethering. in 2014, it was originally called realcoin, and the idea was that it would be backed by the US dollar on a one-for-one basis. for some time, the website said: “each tether is always backed 1-to-1, by traditional currency held in our reserves.”
in February 2019, this text changed to: “each tether is always 100% backed by our reserves, which include traditional currency and cash equivalents, and from time to time may include other assets and loan receivables made by tether to third parties, which may include affiliated entities (collectively, ‘reserves’).”
If “affiliated entities” caught your eye, well, you’re not alone. You see, in 2014 Tether also announced a partnership with cryptocurrency exchange Bitfinex. In 2017, the Paradise Papers leak established that the same people control both Bitfinex and Tether.
See also: Dan Kaminsky Highlights Flaws Bitcoin
“tether and bitfinex are two different businesses and groups with two different goals,” a tether spokesperson told me when I asked about the relationship between the two.
in 2019, new york state attorney general letitia james said: “our investigation has determined that the operators of the trading platform ‘bitfinex’, who also control the virtual currency ‘tether’, have engaged in a cover-up to hide the apparent $850 million loss of commingled corporate and client funds [sic].” tether’s attorney admitted that tether was only 74 percent backed.
regardless, tether settled the case with the state of new york. in the settlement agreement, the attorney general’s office found that tether had no reserves to back stablecoins in circulation for periods of time. On November 1, 2018, he posted a “verification” of his cash reserve at Deltec Bank & trust ltd from the bahamas, saying that tether was fully backed by cash. however, the next day, that money started moving from tether accounts to bitfinex accounts.
tether declined to comment on why money moves between bitfinex accounts and tether accounts.
the settlement agreement, by the way, prevents tether from doing business with anyone in new york. bitfinex and tether did not admit wrongdoing, but paid an $18 million fine; tether must also provide quarterly reports on its reserves for the next two years.
oh wow. so tether said he was endorsed and the new york attorney general found out that wasn’t true?
yes. Here’s how Attorney General James put it: “Tether’s claims that its virtual currency was fully US-backed. uu. dollars at all times was a lie.”
meanwhile, on August 9th, tether tweeted “tether has always been fully supported”.
ouch. did tether provide the quarterly report it promised?
mmmmmmm, well, the first step was pie charts! As of March 31, about 76 percent of Tether was backed by cash and cash equivalents, including unspecified commercial paper, which is a type of short-term debt issued by companies. “cash and cash equivalents” is made up of 4 percent cash; most of the rest is commercial paper, accounting for about half of tether’s collateral, or about $30 billion.
the recent attestation is more detailed. According to him, about half of the $62.8 billion in assets are held in commercial paper and certificates of deposit. a quarter of assets are in treasury bills, a significant increase from the last report, which may reassure some people as treasury bills have a reputation for being very safe assets. According to accounting firm Moore Cayman, Tether has more money in its reserves than is required for redemption.
Is this a normal report?
We don’t know whose commercial paper is holding tether, and that’s a bit strange. I asked the company directly and the spokesperson’s written response was: “we are a technology company and we take close care of our relationships with counterparties. At this time, we do not disclose the composition of our commercial paper holdings.” that’s… unusual.
bloomberg’s mat levine made a useful comparison: this is what jp morgan reveals in one of his money market funds, and it’s much more detailed than what we got from tether. you can see the issuer, the specific identification code, how much money is invested and the market value, among other things, for each share.
there is another comparison stablecoin, and that is usdc, which is also pegged to the dollar. it is the second largest stablecoin, actually! Anyway, USDC’s parent company, Circle, is attempting a SPAC. so we obtained a certification of its assets: 61 percent cash and cash equivalents and 9 percent commercial paper. but usdc has its own problems; coinbase had been promising that there was $1 in a bank account backing each token. the attestation showed that this was not true.
of the top 10 stablecoins, the most transparent is gemini, says mizrach. It is fully backed by dollars in fdic-insured accounts. “That’s the transparency model,” he says. tie, naturally, would not agree. “We are the most transparent stablecoin issuer,” the spokesperson told me.
but tether is still worth a dollar?
more or less, yes. most people who own tether bought it from someone else, and probably won’t try to redeem it, but just sell it. however, in theory, there could be a run, like if the economy suddenly crashed or there was another, more damaging government investigation or something.
Is there another investigation?
yes, according to bloomberg. This is bank fraud, with possible criminal charges.
This investigation doesn’t particularly concern Alan Konevsky, Chief Legal Officer of tzero, a security token trading platform. “This was a company that was trying to figure out how to get off the ground in a pretty hostile financial services climate where they couldn’t even open a bank account,” he says. “many crypto companies have had a hard time trying to open bank accounts.” some of the problems tether has experienced may be due to regulatory uncertainty, he says.
has anyone tried just asking tether what’s up?
Actually, yes. deirdre bosa of cnbc had act paolo ardoino (who is also the ct of bitfinex) and general counsel stuart hoegner (who is also the general counsel of bitfinex) for a bizarre half hour interview during which almost nothing was said. /p>
worth watching in full if you’re curious, but the highlights are: tether won’t say more about their trading paper (due to non-existent “privacy” concerns), won’t deny that the trading paper is Chinese, and they say never They have denied a customer who wanted a trade. the market trusts tether, says ardoino, because it is popular. “We think the market has spoken,” he said. “We believe that the market has voted with its feet.”
also, “we are working to get financial audits,” hoegner said.
Why didn’t the CEO show up for this interview?
This is what Ardoino had to say about it: “So our CEO [Jan Ludovicus van der Velde] and our CFO Giancarlo [Devasini] are two great businessmen. they are working as hard as they can, they are super hard workers. they are deeply involved with our businesses and run the day-to-day operations, and are also extremely available to our clients.”
van der velde and devasini are also the CEO and CFO of bitfinex, respectively.
Did you ask tether about any of this?
I did, and I didn’t get past bosa. “At this time, we do not disclose the composition of our commercial paper holdings,” the tether spokesperson said. I also asked if the commercial paper was Chinese. tether declined to comment on that.
what happens if you make other people nervous and the connection goes to zero?
To be honest, I don’t know. but many other stablecoins have failed! for example, of all stablecoins created in 2015, 80 percent failed, according to mizrach’s research. and 25 percent of those created in 2018 also failed. that makes the failure rate of stablecoins comparable to that of other digital assets.
we may have gotten a preview of what could happen with tether in a run on a different stablecoin in June. the iron titanium token, an algorithmic stablecoin that was partially collateralized, fell from $60 to nearly zero in the space of a day. mark cuban lost his investment, telling bloomberg, “the investment was not so great that i felt the need to dot every i and cross every t. I took a flyer and lost.”
according to tether, there is no need to worry. “tether has never refused a customer a trade, and tether stress tests are not hypothetical,” a tether spokesperson said. “In March 2020, bitcoin halved in just a couple of days. Just two months ago, we had one of the worst days in bitcoin history, with prices dropping 30 percent in just a few days in May. During those events, the tether peg remained strong, all trades were honored, and the price on exchanges remained stable. tether has been stress-tested multiple times and has handily passed each and every time.”
tether declined to comment on in-kind swaps.
okay. so how risky is tether to other cryptocurrencies?
“tether, being the largest, would endanger all but the most transparent stablecoins,” says mizrach. however, gemini would likely benefit from a connection failure, and usdc could as well.
tether is often used as a parking spot for high-frequency traders, mizrach says. it is also used for leveraged cryptocurrency trading, notes li. that means if tether loses its connection, you can also accumulate bitcoin and ethereum. (tether is involved in more bitcoin transactions than the US dollar). “It can be interpreted as part of a systemic risk,” Li says. “But I think the risk is exaggerated relative to what most people think.” in his opinion, the real risks are that people will be out of work and then unable to pay their mortgages, as well as the risks of climate change.
a report by jp morgan in february pointed out that usdt does many of the same things in the crypto world that banks do in traditional finance, but without the same oversight and without deposit insurance. therefore, if people were unwilling or unable to use connection tokens, “the most likely result would be a severe liquidity shock to the broader cryptocurrency market,” which could lead to everyone trying to sell at once.
on the other hand, konevsky tells me he doesn’t think it will be as catastrophic as others fear. “It would be painful,” he says. “But I don’t think it will crash cryptocurrencies or stablecoins.” other alternatives to tethering are available, he notes. li agrees. “If tether went to zero, I’m sure there would be a panic in the markets,” he says. “but it probably won’t be a total collapse.”
Are there broader implications for finance outside of cryptocurrency?
Yes, according to Fitch, one of the Big Three credit rating agencies. let’s say there’s a run on tether tokens, and tether suddenly has to sell its commercial paper. that “could affect the stability of credit markets in the short term if it occurs during a period of increased selling pressure in the cp market”, especially if other liquidations occur at the same time.
The other thing Fitch points out is that during a period of financial stress, Tether may not be stable.
fitch is not only concerned about the broader consequences for the financial system. Treasury Secretary Janet Yellen and Boston Fed President Eric Rosengren have also expressed concern about him.
so… what happens now?
Well, there is a possibility that the regulation of cryptocurrencies will change; Rumors from the treasury secretary and the SEC chief certainly suggest that regulatory changes are coming.
But one way to make the connection unnecessary is to create a digital dollar, and some US lawmakers seem enthusiastic about the idea, including Sen. Elizabeth Warren (D-MA). (china is already doing something like this). a digital dollar would drive out all dollar-pegged stablecoins, because that would mean zero counterparty risk, mizrach says. “That’s the biggest risk of tying,” she says.
tether, naturally, disagrees: “we think it’s a good thing that governments take inspiration from private stablecoins, and especially tether, as the most innovative, liquid, trusted and popular stablecoin. we think there is room in the space for both cbdcs [central bank digital currencies, like the digital dollar] and private stablecoins like tether.”
li sees central bank digital currencies as inevitable. “I just hope they bring a level of transparency,” she says. he also wants lower fees on transactions. “It’s ridiculous that it’s 2021 and we’re still paying 2.9 percent fees to process transactions in the traditional world. it’s a robbery.”