News that a number of investment firms are shorting the top stablecoin, Tether’s USDT, is a development that could have a serious impact on the entire cryptocurrency market, and especially crypto payments.
The Wall Street Journal reported on April 3 that Fir Tree Partners and Viceroy Research LLC, among others, have taken “substantial” short positions against tether, a dollar-pegged stablecoin whose price isn’t supposed to move.
With $82 billion USDT in circulation, tether is far and away the most popular stablecoin used to facilitate the buying and selling of cryptocurrencies.
But it is also far and away the most controversial; the lack of transparency about the nature of the reserve assets backing its tokens dollar-for-dollar plays a central role in the concerns raised recently by regulators, Congress and the Biden Administration’s move to regulate the cryptocurrency market.
The problem is that short sellers don’t just bet against an asset such as a stock or cryptocurrency — they often actively move to drive its price down by drawing attention to their concerns. This is not always subtle. In October, short seller Hindenburg Research offered a $1 million “bounty” for “information leading to previously undisclosed details about cryptocurrency ‘stablecoin’ tether’s backing.”
This could be disastrous for crypto traders if Tether, with $82 billion in tethers circulating, “breaks the buck” — which is what has to happen for the short sellers to profit. This was behind the January 2021 GameStop fiasco, when a Reddit community rebelled against shorters and deliberately drove the price of the video game retailer up to hurt them.
“Failure of a stablecoin to perform according to expectations would harm users of that stablecoin and could pose systemic risk,” the President’s Working Group (PWG) on Financial Markets said in its November report on stablecoins. “The mere prospect of a stablecoin not performing as expected could result in a ‘run’ on that stablecoin — i.e., a self-reinforcing cycle of redemptions and fire sales of reserve assets.”
This also poses a payment system risk, the PWG warned, particularly as stablecoins are moving out of crypto trading and into a broader payments role as digital assets are pushing into the mainstream. While Meta’s globally controversial Libra/Diem stablecoin project for Facebook collapsed last year, in December the social media giant announced that its two billion WhatsApp messaging service’s users would soon have access to Paxos’s Pax Dollar (USDP) stablecoin.
Saying that “payment stablecoins face many of the same basic risks as traditional payment systems,” the PWG report warned that these risks are not “managed centrally by the payment system operator.”
A precarious position
The importance of tether to the crypto market is best shown by 24-hour trading volume. On April 4, USDT’s volume was more than $74 billion. The No. 2 stablecoin, Circle’s USDC, had a market capitalization of $51.5 billion, but 24-hour volume of just $3.6 billion. The No. 3, Binance USD, had a $17.6 market cap and 24-hour volume of $5.3 billion.
The tether stablecoin is also heavily used by crypto traders to park funds while awaiting market opportunities, so the damage to bitcoin and crypto trading and traders would be immense.
The problem is that Tether, as a company, has a long history of being less-than-forthcoming about the make-up of its reserves.
In May 20, it settled a lawsuit by the New York Attorney General (NYAG) that accused it of lying about having one-to-one reserves for $18.5 million, followed in October with a $41 million settlement with the Commodity Futures Trading Commission, or CFTC.
Tether could not be reached for comment by press time, a spokesperson told PYMNTS.
While Tether admitted no wrongdoing, the NYAG settlement forced the company to release its first-ever accounting of its reserves.
The results were unnerving.
Nellie Liang, Under Secretary for Domestic Finance of the Treasury Department, told the House Financial Services Committee in February that based on its disclosures, her “understanding” was that Tether’s reserve includes assets that “are not credit risk free” — including commercial paper — and that USDT “may not be… fully collateralized under all conditions.”
In May, the first such quarterly report by Tether’s Caribbean auditing firm, Moore Cayman, showed that just 2.7% of the reserves backing USDT were held in fiat cash.
Almost half of Tether’s reserves were in commercial paper and short-term unsecured loans to companies; while no details about them were made public, the WSJ noted that some short sellers believe it included Chinese property developers whose companies were in free fall.
Tether reported that its commercial paper holdings have dropped 21% in Q4 2021 alone.
The reserve also held secured loans, corporate bonds, precious metals, fiduciary deposits and cryptocurrency, among other investments.
Tether, for its part, noted that it has never failed to back its stablecoin, even during the steep price collapse in May 2021.
Worth the risk
All that said, the Federal reserve concluded in a February report said that stablecoins’ risks are manageable, and given the potential rewards as they come into mainstream finance, worth it.
The report also concluded that the best way to manage those risks is to require that they are backed one-to-one by cash deposits in banks.
Circle, which was also found to have a substantial portion of its well-audited reserves in non-fiat investments, quickly moved to bring them all into either cash or short-term Treasury notes. Paxos’ stablecoin is backed 100% by cash, the firm said.
Read here: USDC Now Backed By Cash, US Treasuries
If there’s one takeaway from the news that short sellers are coming after Tether, it’s that the need to regulate stablecoins is stronger than ever.
That’s the focus of a new bill by Rep. Trey Hollingsworth (R-N.C.) and Sen. Bill Hagerty (R-Tenn.), which would set standards for stabelcoins’ backing reserves.
The Stablecoin Transparency Act seeks to “lay down a foundation providing stablecoin issuers clarity to ensure consumers are well-protected and to ensure that the future of the technology is well-protected,” said Rep. Hollingsworth. “As these digital assets proliferate across financial services and permeate Americans’ lives, we should make sure it happens safely to enable more development and investment in the industry.”