Tether May be Backed by More than Just Dollars

Tether May be Backed by More than Just Dollars

Patrick Tan 21/06/2021
Tethers May be Backed by More than Just Dollars

Tether is no stranger to controversy, but as it turns out, the oft-maligned stablecoin may have more than a few aces up its sleeves.

For it will be like a man going on a journey, who called his servants[a] and entrusted to them his property.

To one he gave five talents, to another two, to another one, to each according to his ability. Then he went away.

He who had received the five talents went at once and traded with them, and he made five talents more.

So also he who had the two talents made two talents more. 18 But he who had received the one talent went and dug in the ground and hid his master’s money.

Now after a long time the master of those servants came and settled accounts with them.

And he who had received the five talents came forward, bringing five talents more, saying, ‘Master, you delivered to me five talents; here, I have made five talents more.’

His master said to him, ‘Well done, good and faithful servant.[c] You have been faithful over a little; I will set you over much. Enter into the joy of your master.’

And he also who had the two talents came forward, saying, ‘Master, you delivered to me two talents; here, I have made two talents more.’

His master said to him, ‘Well done, good and faithful servant. You have been faithful over a little; I will set you over much. Enter into the joy of your master.’

He also who had received the one talent came forward, saying, ‘Master, I knew you to be a hard man, reaping where you did not sow, and gathering where you scattered no seed, so I was afraid, and I went and hid your talent in the ground. Here, you have what is yours.’

But his master answered him, ‘You wicked and slothful servant! You knew that I reap where I have not sown and gather where I scattered no seed? Then you ought to have invested my money with the bankers, and at my coming I should have received what was my own with interest.’

‘So take the talent from him and give it to him who has the ten talents. For to everyone who has will more be given, and he will have an abundance.’

‘But from the one who has not, even what he has will be taken away. And cast the worthless servant into the outer darkness. In that place there will be weeping and gnashing of teeth.’

— Matthew 25:14–30, English Standard Version

From allegations that the dollar-based stablecoin has been used to manipulate the price of Bitcoin, to questions over whether every single Tether is backed by its equivalent in dollars, Tether, has had its fair share of controversies.

Yet Tether, which was the world’s first stablecoin, has also served the development and growth of the cryptocurrency markets.

As a digital halfway house between actual dollars and cryptocurrencies, Tether or USDT (as it is referred to) has long been a convenient place for traders to park their cryptocurrency gains while waiting for buying opportunities, or to purchase the myriad derivatives denominated in USDT.

But fresh disclosures from Tether now suggest that it has quietly become one of the largest investors in the U.S. commercial paper market.

According to estimates from JPMorgan Chase, Tether’s holdings in the market for U.S. corporate debt, rivals that of massive asset managers like Vanguard and BlackRock, while dwarfing those of tech giants like Google and Apple.

That Tether has never really been backed by its equivalent in dollars has long been a contentious issue.

At its inception, Tether maintained that every USDT minted was backed by a dollar in a bank account, but produced no audit report to back up those claims, instead relying on a report from accounting firm Friedman LLP that was done on a consulting basis.

Even Tether itself conceded at the time that,

“These consulting services consulting services do not constitute an audit or attestation engagement, which would include a significantly expanded scope of procedures and take substantially more time to complete.”

When the New York State Attorney General started investigating Tether and its parent companies in 2019, the stablecoin issuer quickly changed its assertions on its website that it was backed 1-for-1 to the dollar, stating instead that Tether was backed by “cash equivalents.”

And as any music fan will tell you, “equivalents” is not the same as the real deal.

Nobody flies to Las Vegas to pay US$500 to see a Celine Dion “equivalents” concert.

By early 2019, as the investigative noose tightened around Tether, its general counsel conceded that the stablecoin was only about 74% backed by fiat equivalents, as of April 30, 2019.

So not quite 100%, but ok, fractional reserve banking is still a thing no?

By last month, any pretense that USDT was backed by a Scrooge McDuck-type money pit was laid to rest when Tether revealed that USDT was just backed up by 2.9% in actual cash.

So where did the rest of the money go? To better places it would seem.

Because holding cash is the equivalent of burying talents in the ground, Tether actually applied the monies that back USDT to other uses.

In May this year, Tether provided a breakdown of those reserves, as part of a settlement with the New York Attorney General, that revealed Tether’s holdings of just under US$30 billion in commercial paper, a short-dated investment similar to cash.

If true, Tether’s holdings of commercial paper would be the seventh-largest in the world.

According to JPMorgan Chase analysts, the large commercial paper holdings may suggest that Tether is still struggling to find a bank willing to take its cash as a deposit.

For Tether, this lack of access to banking facilities is not new, and lies at the heart of why it got into so much trouble to begin with.

In the beginning, Tether was processing its dollar transactions through Taiwanese banks, which in turn, sent the money through Wells Fargo, an American bank, to allow the funds to move outside Taiwan.

But by April 2017, these international transfer were blocked, leading to Tether filing suit against Wells Fargo in the U.S., a lawsuit which was dropped just a week later.

Because it had been unable to obtain a normal banking relationship, Tether was then alleged to have deposited over US$1 billion with a Panamanian payment processor known as Crypto Capital, where things got far more muddled.

According to the New York Attorney General, the funds were allegedly co-mingled corporate and client deposits and no contract was ever signed with Crypto Capital.

In the New York Attorney General’s investigation, it was alleged that by 2018, both cryptocurrency exchange Bitfinex (the cryptocurrency exchange tied to Tether) and Tether knew, or had suspected that Crypto Capital had absconded with the money but had never informed investors of the loss.

Tether roundly refutes these reports and allegations that USDT is used to manipulate the price of Bitcoin.

But correlation is not causation.

In fact, there is growing evidence that even if USDT was used in the past to manipulate the price of Bitcoin, the most recent rally may have had less to do with the controversial stablecoin.

During the first quarter of 2021, just as Bitcoin’s price rose, it wasn’t just USDT which saw an increase in its market cap, but USDC, a regulated stablecoin and BUSD, a dollar-based stablecoin issued by cryptocurrency exchange Binance, rose as well.

And although USDT’s rise was far faster than that of USDC and BUSD, the simple reason for that could have been because USDT has far more trading pairs than the latter two, and would be in greater demand as the cryptocurrency market as a whole was rallying.

As part of its settlement with the New York Attorney General, Tether is required to disclose its holdings every quarter, but has no obligation to make those disclosures public.

The New York Attorney General’s Office has not commented on whether Tether’s most recent report satisfied the requirements of its settlement agreement.

In February this year, as part of the settlement agreement with Tether, New York Attorney General Letitia James remained critical of the stablecoin issuer,

“Tether’s claims that its virtual currency was fully backed by US dollars at all times was a lie.”

According to the Attorney General’s investigation, there were instances when Tether was not fully backed in the past, but it is highly doubtful if any investors at this stage are still relying on USDT being backed 1-to-1 by dollars.

Cryptocurrency traders and USDT holders have demonstrated that they are more than willing to play the game of “Pass the Parcel,” betting that if Tether should fail, they wouldn’t be the one holding the can.

Tether for its part paid a US$18.5 million fine to the New York Attorney General’s Office, with no admission of wrongdoing.

And even now, Tether is making it patently clear that every USDT is not backed by a dollar, but equivalents.

However, a closer examination of those equivalents may make Tether seem intrinsically worth more than just dollars.

While commercial paper, of the kind that Tether holds in the billions, is not cash, it is often seen as the equivalent of cash, and more importantly, pays an interest rate, albeit fixed.

Yet anyone with USDT, looking to cash out to dollars directly with Tether, won’t be receiving any of that interest, and getting just the dollars they’re swapping for.

Nor will USDT attract any of the other interest payments that Tether receives through its complex holdings of commercial paper, debt and other securities, including gold.

In essence, Tether is acting like a bank, with USDT holders acting like its depositors, without Tether ever having to pay its deposit holders any interest.

The only reason that USDT is not worth more than the dollar is because Tether isn’t paying out any interest on its deposits.

But therein lies another problem, what can Tether do with all the income that it generates from its reserves?

The most obvious thing to do of course would be to buy more Bitcoin or any other cryptocurrency for that matter.

By pushing up the price of Bitcoin, demand for USDT goes up, as it has been consistently shown to do over the past seven years.

With more USDT, Tether can then buy more securities, and use the income generated from those securities to buy more Bitcoin, ad infinitum.

And even if Tether itself is not pushing up the price of Bitcoin, the mere presence of so much USDT swishing around in the system, provides plenty of dry powder to pump up the price of Bitcoin by traders.

Glassnode, a blockchain data analytics firm (full disclosure, Novum Alpha uses their service), presents this relationship between Bitcoin and stablecoins in the form of the Stablecoin Supply Ratio or SSR.

According to Glassnode, if the price of Bitcoin is low, stablecoin supply is able to buy a larger proportion of the circulating Bitcoin supply and therefore push its price up.

But as the price of Bitcoin goes up, that supply of stablecoins is able to purchase fewer and fewer Bitcoin on the market, which reduces its ability to move the price upwards.

And data from Glassnode reveals that the growth of stablecoins throughout 2020–2021 held the SSR metric at historical lows, resulting in an explosive rally in Bitcoin.

But as Bitcoin hit a new all-time-high, stablecoin growth started to plateau and the sharp drop in price has seen the market cap of stablecoins like USDT and USDC essentially stay unchanged over the past month since Bitcoin has come off its all-time-high.

The important thing to note is that stablecoin market cap has flattened, but not shrunk, meaning that if traders are looking to exit the cryptocurrency ecosystem altogether, they’ve not been voting with their feet.

If USDT’s backing was a matter of concern for investors, it’s not apparent, but that Tether is having a free lunch at the expense of its depositors should be.

For so long as Tether adopts any reserve structure that isn’t the equivalent of dollars in the bank, it’s basically behaving as a bank and each USDT should be seen more as a promissory note than digital tender (not quite legal as yet).

To be sure, Tether may not have much choice in the matter.

Had banks been willing to bank Tether from the get-go, Tether may not have had to adopt this convoluted reserve structure to begin with, but that it has been forced to, may actually make USDT more valuable than its fiat currency cousin.

Since Tether is looking to best avoid controversy, it can’t actually be paying out interest on USDT deposits — which is essentially what every holding of USDT is — a deposit with the “Bank of Tether.”

Unlike holding the greenback which generates no yield, Tether’s reserves actually do, regardless of how small.

Whether or not Tether’s capital structure will raise the ire of regulators or not remains to be seen, but it would be unfortunate if Tether was punished for applying itself.

It seems USDT users are more than happy to accept asset-backed Tethers.

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Patrick Tan

Crypto Expert

Patrick is an innovative entrepreneur and a lawyer passionate about cryptocurrencies and the business world. He is the CEO of Novum Global Technologies, a cryptocurrency quantitative trading firm. He understands the business concerns of founders and business people helping them to utilise the legal framework to structure their companies to take advantage of emerging technologies such as the blockchain in order to reach greater heights. His passion for travel, marketing and brand building has led him across careers and continents. He read law at the National University of Singapore and graduated with Honors in the Upper Division and joined one of Singapore’s top law firms, Allen & Gledhill where he was called to the Singapore Bar as an Advocate & Solicitor in 2005. He created Purer Skin, a skincare and inner beauty company which melds the traditional wisdom of ancient Asian ingredients such as Bird's Nest with modern technology. In 2010, his partner and himself successfully raised $589,000 from the National Research Foundation of Singapore under the Prime Minister’s Office. He has played a key role in the growth of Purer Skin from 11 retail points in Singapore to over 755 retail points in Singapore and 2 overseas in less than a year. He taught himself graphic design, coding, website design and video editing to create the Purer Skin brand and finished his training at a leading Digital Media Company. 



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