Tether: a systemic risk for the crypto market?

Market Insights Jul 22, 2021

Tether Limited and Tether stablecoin are controversial due to their lack of transparency and the inability to show an audit with sufficient reserves. The company is also accused of artificially inflating the price of bitcoin.

Tether (USDT) is the first stablecoin and has existed since 2014. It has an impressive daily trading volume of over 90 billion dollars and is also the largest stablecoin by market capitalisation (over $62 billion as of June 2021).

Stablecoins by market capitalisation

Source: CoinGecko

Tether, as all stablecoins, uses a  principle of “collateralisation by reserve”: one USDT created is equal to one dollar (USD) in a bank account that belongs to the company.

Tether is therefore a tokenised representation of the dollar, meaning it has a 1:1 ratio to the US dollar. This mechanism works well if (and only if) users trust the existence of dollar reserves corresponding to the units of USDT in circulation.

There are many aspects of controversy that we will explore in this paper.

Tether and Bitfinex: a conflict of interest?

Bitfinex was the first platform to introduce USDT on its platform back in early 2015. Thanks to USDT, Bitfinex grew exponentially and became a market leader.

But, early 2017, we learned that Bitfinex interest in Tether was not disinterested. Indeed, Tether Limited and Bitfinex share a common management team and are just two entities of the same holding.

This problem of transparency combined with the arrival of new competitors caused Bitfinex to lose its leadership as a trading platform. However USDT is still the biggest stablecoin in the market today.

Tether: a fraud to inflate the price of Bitcoin?

Over the past few years, operators have completed several trillion dollars worth of cryptocurrency transactions through Tether without encountering any major issue.

However, gray areas remain which could undermine investor confidence. For some people, Tether is nothing more than a big fraud used to artificially inflate the price of Bitcoin. Indeed, repeated requests for independent audits that have gone unheeded, or the storage of funds carried out with a rather anonymous bank located in the Bahamas are elements against the solvency of Tether.

Other characteristics of Tether are troubling things:

Tether has a significant share of the stablecoins market, which gives it a big power to influence prices of cryptocurrencies:

  • The number of Tethers that can be printed is unlimited: Tethers are not mined like other crypto assets such as bitcoin.
  • The lack of decentralisation of Tether. Only Tether Ltd can issue USDT, which means it is impossible to check on the blockchain.
  • Lack of transparency: the relationship between Tether and the Bitfinex exchange looks like a huge conflict of interest if not manipulation.
  • With regards to the impact of Tether on BTC, a Griffin-Shams study found that Tether issues usually took place after sharp drops in Bitcoin, thereby offering support for BTC.

If it were proven that Tether is primarily used to manipulate the price of bitcoin, the impact on the entire cryptocurrency universe could be catastrophic.

The fraud could look like this:

  • Tether are issued without any collateral;
  • These Tethers are transferred to Bitfinex and are used for the purchase of Bitcoin;
  • Demand for Bitcoin is driving bullish momentum;
  • Tether issuers make their profits on Bitcoin and use their proceeds to reinvest in other crypto-assets;
  • Positive momentum in cryptos attracts new investors;
  • Issuers of Tether collect the gains and issue new Tether.
  • This sequence can of course be repeated endlessly.

Are there tangible elements to validate this thesis?

Is Tether really backed at a 1:1 ratio?
In April 2019, when the lawsuit was opened, the New York attorney general said that Bitfinex overestimated its reserves. Now, they announce that “as of April 30, 2021 Tether has cash and short-term securities for a total amount of approximately $2.1 billion, or approximately 74% of the amount of tokens currently in circulation. "

Based on this 74% collateralisation figure, it is possible to do some quick estimations. Considering a market cap of around $65 billion for Tether, $17 billion could indeed have been used to buy bitcoin (instead of dollars). This amount of 17 billion represents approximately 2% of the free float of the market capitalisation of Bitcoin.
A priori, an amount that corresponds to 2% of the free float appears insufficient to be able to significantly influence the price of bitcoin. In contrast, those billions could have an impact if used at the right time, such as times of the day and / or week when volumes are relatively low. To date, there is no hard evidence on this.

Arguments against the manipulation thesis

First of all, Tether's collateralisation seems very real. Tether Ltd says its reserves are completely backed by US dollars and cash equivalents. Moreover, the agreement reached with the New York Attorney General is rather reassuring: Tether has agreed to no longer operate in New York state but is not being prosecuted for any wrongdoing.

Finally, a Lysons-Natraj study showed that the various Tether issues did not have a direct impact on Bitcoin or Ether prices. According to this study, there is no manipulation of crypto prices even though there is some correlation between Tether's issuance and crypto prices.

Other stablecoins: USDC on the rise

To date, there are more than 60 stablecoins with a capitalisation close to $110 billion and a daily volume of over 100 billion.

USD Coin (USDC) stablecoin is Tether's (USDT) most important competitor. USDc was started in 2018 by Coinbase and Circle through a joint company called Center Consortium. While Tether is linked to the Bitfinex crypto exchange, USDc is linked to that of Coinbase, the online cryptocurrency brokerage firm now listed on Nasdaq. Both stablecoins offer equivalent functionality. The main difference is transparency. In the case of the USDc, 100% of the collateral is in US dollars and its reserves are publicly audited every month. As mentioned above, Tether has not been audited and doubts remain as to the strength of its reserves. This is why at Trakx, we decided to use USDc as the base currency to trade all the indices listed on the exchange.

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Gary Rebibo

CMO @Trakx