Tether reserve risks are serious & more stablecoin regulation is coming

Dispatch #24 – 2021

July 23rd, 2021

This week The Dispatch looks at the stablecoin market and the risks posed by a lack of reserve audit at Tether, the largest stablecoin. Additionally, there’s clear evidence of US authorities desire to impose additional oversight of stablecoins, which could well be a positive. It is ironic that decentralized digital assets like bitcoin might be negatively impacted by a lack of trust (loss of confidence) in a centralized stablecoin. It is disappointing that crypto trading firms that utilize Tether don’t speak out more forcefully. The full discussion lineup follows:

Tether, opaque reserves = elevated risk
Stablecoin regulatory oversight will rise
Bipartisan crypto legislation proposed
Blockfi troubles with States – would national regulations help?
Musk, Dorsey & Woods provides insightful discussion
Crypto adoption: JP Morgan private clients, Amazon & Saquan Barkley
Venture flows into crypto/blockchain accelerated in 2Q

** Note The Dispatch will not publish the next two weeks **

Tether – What’s the reserve backing and risks to wider ecosystem

Tether is the largest stablecoin with a circulating value of $62bn. A stablecoin is a blockchain-based digital currency that’s designed to hold a 1:1 value to the pegged fiat currency. Most stablecoins are US$-backed. Tether is neither regulated by a national authority nor has reserves undergone an audit by a reputable third party. In addition, Tether was sued and settled with the NY Attorney General (see Dispatch #16), as well the company founders have colorful backgrounds.

Rapid rise in Tether in circulation

Tether has seen a meteoric rise over the past 12 to 18 months. There was $4.2billion Tether in circulation at the start of 2020. We are now at $62bn. The 2^nd largest stablecoin, USD Coin (USDC) has also grown rapidly from just over $500m at the start of 2020 to now over $26bn.

Tether in Circulation

Source: CoinGecko

As concern over Tether’s reserves have increased lately, we’ve seen USDC’s growth rate accelerate relative to Tether. Over the past 90 days, USDC in circulation has more than doubled to $26.7bn whereas Tether has risen just 26% to $62.1bn.

Tether dominates crypto trading

As the chart below from The Block illustrates. Note USDT = Tether.

The bear thesis is documented in the sources listed below, if you’d like to investigate further.

This Grant Williams podcast with Bennett Tomlin. https://ttmygh.podbean.com/e/gwp_0013/ . To be clear, Tomlin, Williams & Noble (other guest) are Tether skeptics.
Bennett Tomlin tweet thread. This has a copious amount of information on the many allegations, and founders’ backgrounds. https://twitter.com/BennettTomlin/status/1188096974840647680?s=20

Dispatch readers based in the US do not have direct Tether risk because it is not listed at most large exchanges here. Instead, alternatives like USDC, Gemini USD (GUSD) and Paxos are available. However, if uncertainty over reserve backing leads to a run on the Tether, that could have notable short-term impact on the wider crypto ecosystem. If, on the other hand, you have invested a small percentage of your wealth in bitcoin with a 3-5 year view, then the short-term issues are less of a concern.

Tether’s attestation statement

This is the extent of Tether’s reserve information. This is an unacceptably low transparency of the one of the most critical components of today’s digital asset market.

Source: Tether release

Furthermore, this attestation statement was only published as required by the settlement with the NY Attorney General.

Ideally you would want the USD backing to be with cash at a bank or at least in short term treasuries. However, given Tether’s unregulated status, if they had $60bn sitting in a global bank, it could (probably would) be seized by US authorities. All US dollars flow through the NY Fed. We can see why Tether have opted for short term securities, mostly commercial paper. This is very similar to how a money market fund operates, except that money market funds in the US are registered with the SEC.

Lack of reserve leads to social media speculation

Now there’s social media speculation that Tether’s reserves have been invested in commercial paper issued by beleaguered China property company Evergrande. Evergrande default fears have rise, and the tweet below captures the speculation connecting the two entities. Reddit discussions have also picked up the speculation.

Source: Twitter

This tweet provides more evidence that Tether needs to release a proper audit. Until then, speculation of this nature will persist, as they can’t be dismissed. It’s unfortunate that the largest crypto trading firms that utilize Tether haven’t pushed the company for more transparency.

Additional stablecoin regulation in the US is likely

With the rapid growth of stablecoins, global regulators are increasingly focused on the financial stability risks posed by these lightly regulated money alternatives. Just this week the Presidential Working Group announced they are working on new regulations. More details in this Reuters article.

This WSJ article provides deeper background on stablecoin usage in crypto trading and how some of the regulators’ fears are based on private money in the 1800s. The Dispatch finds it ironic that decentralized digital assets like bitcoin could be impacted by a centralized stablecoin.

Stablecoin financial stability risk is similar to issues with money market funds of 2008 and 2020. The Fed had to backstop money funds. There is no lender of last resort for stablecoins.

The tweets highlighted below offer texture to the multi-faceted stablecoins issues.

Caitlin Long is the Founder of Avanti Bank and the single best the authority on the connectivity between crypto and traditional financial plumbing, in the Dispatches view. Kevin Werbach is a Wharton professor. This tweet thread is the source for Werbach’s tweets. This is the reserch paper he referenced in the thread, if you’d like to nerd out!

The following podcasts with Caitlin Long as a guest offers an in-depth view on stablecoins, financial stability and traditional financial plumbing.

Bipartisan Securities Clarity Act introduce in Congress

House Reps Tom Emmer (R-MN), Darren Soto (FD-L) and Ro Khanna (D-CA) collectively introduced the Securities Clarity Act. As this Financial Advisor Magazine article says, the Act will aim to provide clarity to crypto assets being commodities and not securities. This Block Crypto article provides a summary.

Blockfi runs into trouble with States: Would Federal legislation have prevented this?

Blockfi’s core business is a crypto lending account, which allow you to lend out your crypto and receive interest. Blockfi is the most conservative of the operators that offer crypto interest, in the Dispatch’s opinion. Three states have issued cease and desist letters, as this Coindesk article notes. The Dispatch is no legal expert, but wonders if Federal legislation would prevent a messy state-by-state fight. The crypto yield accounts offer high yields by taking advantage of the unique supply/demand and arbitrage opportunities available in crypto. Yes, the risks are far different than FDIC guaranteed bank deposits, but a suitably regulated product is good for consumer choice in our yield-starved world.

Jack Dorsey, Cathie Woods and Elon Musk discussion at the B Word conference

Here is an insightful 45 minute discussion (https://www.youtube.com/watch?v=Zwx_7XAJ3p0) between Dorsey (Founder of Twitter & Square), Musk (Tesla) and Woods (Ark Invest).

There’s good material about Bitcoin energy usage, positive social impact of cheap international money transfer and how Bitcoin could accelerate the move to renewables. International money transfer, for example, is estimated at US$700bn annually with merchants charging 8%-30% of the value transferred. With regard to Musk and bitcoin, it’s now clear to the Dispatch that he is on a journey of crypto discovery, and is doing so publicly along with his 50m twitter followers!

Crypto adoption news

JP Morgan allows private clients to buy listed crypto funds like GBTC. This is not as notable as Morgan Stanley offering wealth management clients Bitcoin mutual funds. Business Insider story.
Saquon Barkely of the NY Giants to take endorsement revenue in bitcoin: Barkely will convert his endorsement money into bitcoin. More details on this Bitcoin.com article.
Amazon hiring for blockchain. The company has posted a Digital Currency Blockchain Product Lead to work in the payments acceptance team. Fortune article.

Venture flows into crypto accelerated in 2Q

Source: The Block

This is another manifestation of the liquidity created by global Central Banks. Perhaps some of these ventures become home runs, but many are likely to falter by the wayside, at a higher percentage than in traditional commerce. There’s a winner-takes-all network effect in blockchains, and blockchains’ inherent efficiency could eliminate anti-trust concerns of a single winner.

BITCOIN SCHOOL – Continued summer break!

Enjoy the summer, watch out for Delta and do reach out if you have any questions or comments about the material in this Dispatch.

Asi

Important Disclosures

This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of RockDen Advisors LLC and are subject to change at any time based on market and other conditions. Past performance may not be indicative of future results.