Friday, September 2, 2022

Some thoughts about the resilience of decentralized stablecoins

If a decentralized blockchain protocol is worried about being shut down by the authorities, how can it defend itself? A recent discussion surrounding MakerDAO explores this question. MakerDAO (or just Maker) issues the Dai stablecoin, of which there are around $7 billion in circulation.

Rune Christensen, the founder of Maker, sees a precedent for a clampdown on Maker in the US Treasury's recent sanctions on Tornado Cash, a mixer. He worries that the authorities may try to shut down Maker by seizing its assets, specifically its real-world assets, or "RWA." To counter this threat, Christensen suggests that Maker turtle into what he calls phoenix stance:

Source: MakerDAO forum

While in phoenix stance, Maker would no longer rely on RWA. By RWA, he is referring to centralized stablecoins such as USD Coin and loans to banks and other financial institutions that have a physical address and a regulator. These are the sorts of assets that can be used by authorities as a lever to hurt the Maker protocol. With nothing for authorities to confiscate, presumably Maker would be resilient to attempts by authorities to shut it down.

I disagree. Christensen exaggerates the degree to which Maker's resilience relies on seizability. Seizing a protocol's assets is just one of many levers that authorities have to stop a protocol like Maker. In the case of Tornado Cash, for instance, sanctions were used, not seizure. Even though no ether in Tornado's smart contracts has been confiscated (indeed, it would be impossible to do so), the sanctions have effectively cut off much of Tornado Cash activity:

A ban or sanctioning of Maker would mean less licit usage of Dai, a removal of collateral from Maker, delistings of Dai at off-ramps like Coinbase, a drying-up of liquidity, and employees and investors abandoning it. Dai would shrink to irrelevance all this achieved without the government seizing an ounce of the collateral behind Dai.

To sum up, a focus on seizure-resistance, so-called Phoenix stance, won't render Maker meaningfully more resilient.

That being said, I agree with Christensen that removing real-world assets will make Maker less susceptible to being attacked. But the way I get to this conclusion is different.

Removing real-world assets from Maker would make the Maker system less usable. First, without centralized stablecoin reserves, Dai's peg to the dollar wouldn't be as tight. A looser Dai price would make it more inconvenient to own Dai. It would also make it riskier to borrow Dai, since borrowers couldn't know ahead of time precisely how much they'll have pay back. Secondly, the sorts of collateral acceptable for loans would be restricted to one asset, ether, which effectively cuts off huge parts of the market for Dai loans.

As Maker becomes more awkward, fewer people will use it, and it'll shrink... perhaps to the point that it begins to fly under everyone's radar. No regulator or authority is going to bother trying to shut down a rarely-used $50 million protocol. So it's the irrelevance that a no-RWA policy brings, and not the inability to seize assets, that leads to safety from attack.

Conversely, introducing real-world assets makes Maker more practical, attracts additional users, and brings Maker onto everyone's radar, which increases the odds of authorities shutting it down using any of the many levers they have at their disposal. (Conversely, the jump in relevance that RWAs entail also increases the odds of authorities finding regulatory space for Maker.)

To finish off, here's a way for Maker stakeholders to think about the system's susceptibility to being shut down, and how real-world assets enter into the equation:

Stakeholders should ask themselves how relevant Maker has become. Has Maker become so important (and its public perception so negative) that it is about to attract the baleful eyes of regulators? If so, one defensive option is to engage in a rational form self-sabotage: make the tool less useful. This will shrink the pool of Maker users, and thus the tool's visibility to regulators, and therefore the likelihood of it being shut down. Real-world assets enter into the picture because their removal is one way to impinge on the system's usefulness.

Of course, if a protocol is going to start engaging in self-sabotage, then the people making this decision better be pretty sure that their original assumption that regulators are furious is correct.

Monday, August 15, 2022

How to stop Forsage, Meta Force and other smart contract pyramid schemes

Serial smart contract pyramid schemer Lado Okhotnikov

[This is a republication of my latest opinion piece from CoinDesk.]

Last week the U.S. Securities and Exchange Commission (SEC) charged 11 individuals with creating and marketing Forsage, the world’s largest and longest-running smart contract-based pyramid scheme.

Alas, Lado Okhotnikov, the ring leader of Forsage and rumored to be based in the Republic of Georgia, remains at large. And while the original Forsage smart contracts are nowhere near as popular as they once were, they continue to welcome new money, SEC be damned.

Worse, Okhotnikov's new smart contract pyramid, Meta Force, continues to grow. Over $42 million in DAI stablecoins have been deposited into Meta Force by unwitting investors since the alleged scam debuted a month ago.

Smart contract pyramid schemers like Okhotnikov prey on the weak and vulnerable. What can we do to better fight them?

A quick history of smart contract-based pyramids

A pyramid scheme is an illegal business model where returns to existing investors are generated from newly recruited investors' money or fees. They are ultimately unsustainable because the supply of new investors is finite.

Pyramid schemes have existed for centuries. But pyramid schemers quickly realized the benefits of blockchain technology. MMM Global, a pyramid that tore through Nigeria, India, China and other developing nations through 2014 to 2016, used bitcoin (BTC) for payments. A group of researchers who studied the pyramid found that, at its peak, MMM Global was processing $150 million per day.

The advantages of bitcoin are clear. While authorities can shut down a pyramid scheme by leaning on its payments processors or bank, the Bitcoin blockchain can't be turned off.

The rollout of Ethereum led to the next big innovation in pyramids: the smart contract pyramid scheme. In addition to relying on blockchains for payments, this type of alleged scam built its pyramid apparatus on the Ethereum blockchain using smart contracts.

There are advantages to using a smart contract to run a pyramid. The entire back office structure can be automated using code, which makes administration easier for the scammer. It also allows the pyramid to be marketed as an "honest" Ponzi; that is, because it is implemented by code rather than by hand, it can be said to always run correctly.

Furthermore, because that code is public, it can – in theory, at least – be audited by users.

Smart contract pyramids are safer for the scammer to run than traditional pyramids because they afford a degree of anonymity. And while the authorities can shut down a traditional pyramid by visiting the office out of which it operates, building it on Ethereum makes it much harder to stop.

Smart contract pyramids soon became endemic to Ethereum. A 2019 study by a group of Italian researchers cataloged 184 smart contract pyramids in play at the time.

Most of these were quite small. It was Lado Okhotnikov's Forsage that broke the mold. Forsage's first Ethereum smart contract, x3/x4, would process almost $240 million in payments in 2020. At one point it was Ethereum's second busiest contract, after tether.

Ethereum gas fees would soon rise, forcing alleged pyramid alleged scammers like Okhotnikov to migrate to cheaper blockchains. Over the next few years Okhotnikov launched five other smart contract Ponzis on the Tron and Binance Smart Chain blockchains. Recently, scammers have begun to move back to Ethereum thanks to level 2, or subsidiary blockchain, systems that have lowered costs. In Okhotnikov's case, he has set up his newest pyramid, Meta Force, on the Polygon Network.

A forensic analysis of Forsage

Thanks to the transparency of blockchains, Sarah Meiklejohn and other researchers carried out a precise analysis of Forsage’s payouts and losses, focusing on the $240 million Ethereum x3/x4 contract.

While the founders boasted that the system was transparent and open source, it took the researchers weeks of effort to understand the code, which meant that almost no Forsage participants could have actually audited the smart contract. So much for transparency.

Meiklejohn et al. found that the system had been coded at the outset to benefit only a few people. For instance, participants had to buy slots that offered the right to get payments from new recruits. After recruiting three participants, a slot would be blocked and the recruiter had to pay fees to reopen it and receive payment. The organizers’ slots, however, were coded to be exempt from this rule.

The SEC found that Okhotnikov had coded one of his subsequent pyramids, Ethereum xGold, to divert a portion of investor funds to a wallet that was not associated with a Forsage ID. This contradicted Okhotnikov’s representation that all funds were paid out to investors. By 2022, that address had diverted over 1,000 ETH.

In the end, Meiklejohn et al. report that 1 million Forsage accounts lost money, a remarkable 88% failure rate. The top 1,000 users made 50% of all profits. Okhotnikov and his fellow cofounders capitalized by positioning themselves at the top of the pyramid. The SEC accuses them of owning the best five spots in the x3/x4 Forsage pyramid, the topmost of which earned 5409 ether (ETH), well over $1 million, according to Meiklejohn et al.

Okhotnikov and his colleagues aggressively marketed their scams on social media. Forsage's official YouTube channel, which is now dedicated to the new Meta Force pyramid, currently has over 47,000 subscribers. The most popular Forsage video, which is in Hindi, has been viewed 384,000 times. This is despite YouTube's terms of service having a blanket ban on marketing pyramid schemes.

In their paper, Meiklejohn and her colleagues traced the location of most of the victims of Forsage to developing nations, in particular Nigeria, Philippines and Venezuela. This reveals these alleged scams for what they are: a way for a few rich people to steal from the poor and vulnerable. They need to be stopped. But how?

What can be done?

Because smart contract pyramids are built on censorship-resistant blockchains, they can't be attacked at the root, nor can they be undermined indirectly by removing them from the payments system.

Writing on CoinDesk, Lex Sokolin has proposed that white hat hackers organize to find vulnerabilities in smart contract pyramids and bring them down. It's a nice idea, but so far white hat hackers haven't shown much interest in chasing after pyramids.

Perhaps the most effective way to hurt smart contract Ponzis is by attacking their reputation. The SEC's charges will certainly help on this front. Now when a potential victim searches for Okhotnikov or one of his "investment" products, they'll have the opinion of the world's largest securities regulator to rely on.

The good news is that the SEC's actions seem to have had an effect. The rate of deposits to Okhotnikov's newest (alleged) scam, Meta Force, which has already attracted $42 million in deposits, began to decline the day after charges were announced. On YouTube, a nervous Lado Okhotnikov described the SEC’s charges as slander and defamation.

But we needed the SEC to begin its attack long ago. Publishing a cease and desist early on, like securities regulators in Montana and the Philippines did, would have helped tarnish Okhotnikov's reputation before his alleged scams could hurt more people.

Regulators like the SEC should try to harness the transparency of blockchains to their advantage. It's possible to see these things popping up and monitor how big they get, so regulators can very quickly mobilize resources to combat them.

The SEC should also consider fighting like with like. Smart contract Ponzi scams spread through garish videos on YouTube. Alas, the SEC didn't post its charges to its YouTube channel. A catchy video about Forsage would go much further than a terse tweet.

Finally, influential blockchain personalities like Ethereum co-founder Vitalik Buterin and Binance CEO Changpeng Zhao should step up and speak out against smart contract Ponzis when they crop up. They may not wish to do so, because admitting the problem may attract negative attention to the technology. But addressing these scams as early as possible will not only reduce damage to innocent people, it will also limit damage to the long-term reputation of blockchains.

Monday, August 1, 2022

The puzzle of electrum coins

From the Israel Museum in Jerusalem’s 2013 exhibition White Gold

 [Originally published at Bullionstar.]

For several years Brits have been hearing rumours that their 1p and 2p coins were on the cusp of being discontinued. Not so. Last month the UK Treasury announced its commitment to both coins. The 1 and 2p coins will continue to be produced for ‘years to come.’

Few bits of monetary technology have enjoyed as long an existence as the coin. The earliest coins were produced around 640 BC, some 2600 years ago, by the Lydians, who had built an empire in the western half of what is now Turkey.

To most of us, the usefulness of coins is self-evident. Sure, small coins like the 1p are a bit of a nuisance. They tend to accumulate in our pockets or piggy banks, never used. But compared to barter, or exchanging bits of unrefined metal, coins are a much better alternative.

One would assume that’s why the Lydians created coins in the first place: convenience. But the true story is much more puzzling than that. To this day we don’t entirely know why the Lydians began to turn precious metals into circular discs.

The traditional origin story for coins

The classic story for the adoption of coinage involves the efficiency gains that society enjoys when trade can be conducted by tale rather than by weight. Tale is a sum or a tally. All modern payments are done by tale. A payor counts up the right amount of coins (or notes), then passes the stack to the payee who – if they wish – can glance at the inscription on each coin’s face to ensure that it is legitimate. Circulation by tale is a convenient way of doing business.

But we take it for granted. Before coins appeared on the scene 2000 years ago, numismatists believe that people typically transacted with silver ingots and bars, otherwise known as hacksilber. These pieces could be cut up into smaller amounts in order to cover a range of different transaction sizes.

Because the bits of hacksilber were irregularly shaped, or non-fungible, they couldn’t by counted. Rather, they had to be weighed first, and only then could the transaction proceed. Weighing different bits of silver is a laborious process. A scale must be produced along with a set of weights that both the buyer and seller can trust.

Counting is much easier than weighing. If the stamp on the coin is reliable, buyers and sellers can trust to issuer to have already pre-weighed and standardized the metal for them. And so coinage would have dramatically reduced lineups and waiting time in busy markets all across the ancient world. What a fantastic invention.

Perfectly standardized

At first glance, Lydian coins have all the hallmarks of this classical origin story.

To begin with, they are quite beautiful. Each coin was typically stamped on the obverse side with a design in the form of an animal, human, or myth. On the reverse, or back-side of the coin, a square or rectangular design appears (see image at top). Did these designs constitute some sort of official guarantee of the coin’s weight and fineness? Or did they symbolize something else?

The coins generally lacked any sort of writing on them. Numismatists are thus unsure who actually issued the coins. Was it the city, the king, a merchant or some other rich individual?

One fact that all numismatists agree on is that the Lydians were assiduous to a fault about ensuring standardized weights for their coins. The biggest denomination, the stater, weighed 14.1 – 14.3 grams. Half staters contained half as much metal, followed by third staters (or trites), 1/6, 1/12, 1/24, 1/48, and 1/96th staters, the last of which contain just 0.15 grams of metal.

Smoothed distribution of Lydian coin weights around each denomination. Source: On the Origin of Specie, (2012)

Francois Velde, an economist at the Federal Reserve who dabbles in numismatics, has catalogued thousands of Lydian coins owned by private collectors and museums around the world. Using this data, one can see the remarkable precision of Lydian coinage (see chart above). The weight of the largest coins – staters and trites – tend to be tightly clumped near the standard weight.

Interestingly, the smallest denominations – the 1/96th staters – are much more loosely distributed around the standard weight (see the dark blue line). Velde (2012) attributes some of the lower accuracy of smaller denominations to the fact that they would have circulated more, and thus deteriorated faster.

The inconvenience of electrum

By carefully calibrating the weights of each denomination and stamping them with a seal, surely Lydia qualifies as the first society to make the technological leap to circulation by tale. But it’s here that the story begins to fall apart.

One of the curious facts of early Lydian coins is that they were made from a material called electrum. Electrum is a naturally occurring alloy of silver and gold, often found in streams and rivers. The problem with natural electrum is that the mix between gold and silver is variable. The silver content can be anywhere from 10% to 30%, according to numismatist Robert Wallace (1987).

Given this variability, Lydians must have had difficulties valuing electrum. A given electrum coin wasn’t fungible, or interchangeable, with its cousins. A coin with more gold in it would have a slightly different colour than one with less gold, as the chart below implies. And since gold was probably worth around 10 times more than silver in ancient times, electrum coins with more gold in them would have had a much higher intrinsic value than those with less. But how much more? According to Wallace, this lack of certainty would have caused “endless doubts and disputes over particular coins."

Approximate colours of Ag–Au–Cu alloys [Wikipidia]

What a contradiction Lydian coins are! The Lydians had evidently gone to extreme lengths to perfectly calibrate coin weights, and thus potentially exchange coins by tale, only to undo all the benefits of standardization by making coins with an arbitrary gold-silver mixture. Now buyers and sellers would have to settle on some laborious means of determining a given coin’s mixture, say like using a touchstone, before they could consummate a trade.

The Lydians could have avoided this problem at the outset by issuing coins using silver rather than electrum. Silver, after all, was already traded in ingot form. With silver coins, at least there would be no confusion about intrinsic value. But the Lydians chose not to go this route.

Which leads us to what may be the most popular theory for electrum coins, what I will call the “token" theory.

Electrum coins as tokens

It is Robert Wallace who can be credited with creating what is probably the most widely-accepted theory for electrum coins. Wallace (1987) began by imagining himself in the shoes of an owner of an electrum hoard around 640 BC. This individual had the following problem. His stash of metal was not uniform, and so fellow Lydians didn’t really trust its quality. How could our electrum owner get his suspicious counterparts to accept his metal for its full value?

The easiest solution available to our Lydian would be to refine his electrum into its silver and gold constituents, then sell each separately. But Wallace tells us that the technology for “parting" gold and silver – cementation – would not be available for almost a hundred years, circa 550 BC. So our electrum owner was stuck with his mongrel metal.

According to Wallace, our Lydian stumbled on the solution: turn his raw electrum into stamped coins. Why would a potential buyer trust electrum in coin form but not bar form? The answer is that the owner of electrum didn’t create just any regular coin. Rather than issuing discs that were valued for their (uncertain) metal content, our Lydian electrum owner designed them as tokens.

Electrum coin from Ephesus, 625-600 BC with a stag grazing [source]

A stamped piece of metal can be valuable either because of the material of which it is made or the symbol that is stamped on its face. A token is of the latter sort. By contrast, a piece of hacksilber is the former. It gets its value from the silver itself.

How did a mere stamp create value? Wallace hypothesizes that the issuer’s stamp indicated a promise to “accept back or redeem his coins" at a fixed rate. A skeptical buyer would therefore have no problem receiving an electrum token in trade. After all, the stamp guaranteed that the issuer would buy it back at that very same rate.

Fungibility regained

By setting his redemption price for tokens high enough, the issuer ensured that the market value of his coins would always exceed their intrinsic electrum value. This would have had the beneficial effect of making all his electrum coins fungible. After all, since both a silver-rich electrum token and a gold-rich one could both be redeemed at the issuer for the same fixed price, neither coin was any better than the other.

Electrum could now circulate freely rather than being handicapped by non-uniformity. The decision to turn electrum into coinage had converted “stocks of what was otherwise a doubtful and uncertain substance into negotiable currency large and fixed value," says Wallace. In the process, our electrum owner had become a much wealthier man than might otherwise have been the case.

So what about circulation by tale?

Despite the fact that the weight of electrum coins was so precisely calibrated, numismatists believe that Lydians exchanged the coins by weight rather than by tale, much as they had with hacksilber. The main bit of evidence for this is that electrum coins were never clipped.

Clipping is when someone scrapes or snips a bit of metal off of a coin before passing it on. The clipper keeps the shavings for themselves. Coins that circulate by tale are easily attacked by clippers. Since sellers will accept coins with little more than a glance to the stamp on the coin’s face, a buyer who scrapes off a bit of metal before handing the coin can easily get away with it.

A lack of clipping is consistent with the practice of weighing coins and only accepting those that are up to snuff. If a coin was even a bit too light, then the seller would not take it. And so no one would bother clipping them in the first place.

But if electrum coins circulated by weight and not tale, this hardly seem like a technological improvement over hacksilber. Lydian trade was still as slow and awkward as before.

However, the necessity of weighing electrum coins may have served a purpose. It may have been a security feature designed to protect the issuer’s wealth. Imagine that our issuer of electrum tokens has spent some staters into circulation. Prior to being returned to him for redemption, these staters had all been clipped. Since he has less electrum than what he started out with,  our issuer’s wealth has deteriorated.

To protect himself from this sort of theft, Wallace (1989) suggests that the issuer wouldn’t redeem just any of his tokens. As a security measure, he would only take back those that were still of their original weight. Since no merchant would want to be stuck holding a coin that could not be redeemed, they would always weigh each coin that was offered to them in order to avoid accepting light ones.

They only circulated domestically

Wallace’s theory explains another odd feature of electrum coins. Given the distribution of electrum coin hoards, numismatists believe that they didn’t circulate outside of their area of production. This is unusual for ancient coinage. Roman coins have been found as far afield as Sumatra, while Sassanian coins (minted in modern day Iran) have been unearthed in England.

But if circulation of electrum coins was premised on the guarantee that their issuer would redeem them, then that explains why they wouldn’t have circulated very far. People in a distant city would not recognize or trust the redemption promise of an unknown issuer, and so they wouldn’t accept them in trade.

Electrum diluted with silver

Another oddity of electrum coins is that they often contain far more silver than the natural electrum out of which they were manufactured. Electrum found in naturally-occurring deposits usually contains no less than 70% gold, but the coins themselves often contain just 45-55% gold. For some reason, Lydians coin issuers chose to introduce a bit of pure silver into the electrum mix before coining it.

In the chart below, for instance, the vertical column that represents the 1/6 stater denomination contains around 14 different coins. The majority of these coins contain less than 65% gold.  Only two contain more than 80% gold.

Most electrum coins contained less than 70% gold. Source: Velde

Why would the Lydians have chosen to dilute electrum with silver? The intrinsic value of natural electrum was quite high. Given that gold was worth around ten times the value of silver, numismatists estimate that the most commonly available coin, the trite, was worth several sheep, or ten day’s wages (de Callatay, 2013). Converting into modern terms, the trite would be worth the equivalent of a $500 bill. This hardly seems a very convenient denomination. The smallest coin, the 1/96th stater, was worth about a day’s wages, and thus not useful as small change (Velde, 2012).

Wallace (1987) suggest that by mixing some silver into the natural electrum, the intrinsic value of the coin would have been reduced. The price at which the issuer promised to redeem the coin could now be lowered. This reduction would have permitted electrum coins to participate in a wider range of transactions, thus increasing their usefulness.

Still more questions

New data and theories about electrum coins have improved our knowledge. Unfortunately, it seems that we remain “confused but on a higher level!" remarks historian Francois de Callatay (2013). While Wallace’s theory is elegant, it leads to only to more questions.

Velde asks some of the more glaring ones. If electrum coins were redeemable, what did the issuer promise to redeem their coins with? Gold? Silver? Perhaps they be used to discharge taxes? If gold and silver were to be used to redeem electrum coins, why not use these materials as the basis of coinage instead?

And what did the issuer keep in reserve to “back" his guarantee, wonders Velde. If each coin had to be 100% backed by gold, then our issuer would have had to incur the costs of storing and vaulting the yellow metal. This would have meant that issuing coins wasn’t very profitable. One wonders why our electrum owner would have bothered producing them in the first place.

Electrum coins, what happened to them?

Whereas the Brits still seem to be quite fond of their 1p and 2p coins, the Lydians quickly discontinued their electrum coinage. About a hundred years after electrum coins were first issued, they disappear from the numismatic record.

Around 550 BC, King Croesus decided to issue individual silver and gold coins. This switch from electrum to pure gold and silver coincides with the discovery of the process of cementation, the ability to separate gold from silver. Presumably decomposing electrum into its constituent parts in order to create a uniform currency was deemed superior to issuing electrum discs.

Except for a few smaller city-states that continued to issue electrum coins for another century or two, never again would a mixed silver-gold coin be issued. All that remains is a mystery for modern numismatists to puzzle over.


de Callatay, Francois. White Gold: An Enigmatic Start to Greek Coinage. 2013. [link]
Velde, Francois. On the Origin of Specie. 2012. [link]
Velde, Francois. A Quantitative Approach to the Beginnings of Coinage. [link]
Wallace, Robert. The Origin of Electrum Coinage. 1987. [link]
Wallace, Robert. On the Production and Exchange of Early Anatolian Electrum Coinage. 1989. [link]

Saturday, July 30, 2022

How profitable is the world's largest stablecoin?

In a recent blog post, the world's largest stablecoin issuer Tether mocked its smaller competitor, Circle (which issues USD Coin), for being unprofitable. Tether isn't wrong. Circle is losing a lot of money. In Circle's first quarter of 2022, lost $113 million).

But what about Tether? How profitable is it? Unlike Circle, which has taken steps towards an IPO and therefore publishes its finances, Tether is privately-owned, and so information about it is hard to come by.

Luckily, we can get a feel for Tether's profitability by scanning Tether's six attestation reports, the first of which dates back to February 28, 2021. In each report Tether discloses the difference between its assets and its liabilities. For those who have slogged through Accounting 101, you'll know that the difference between a firm's assets and liabilities constitutes its equity. I've plotted out Tether's equity below:

From equity, we can get an approximation of profit. Whenever a firm earns a profit, that profit gets added to its equity. So roughly speaking, an increase in a firm's equity is a measure of the flow of profits it has made over that period.

From March 31, 2021 to March 31, 2022, Tether's equity -- the gap between its assets and liabilities -- increased from $149 million to $162 million, which means that it earned $13 million over that 12-month period. For most of us, $13 million is a fair chunk of change, but it's surprisingly low given that Tether is one of the crypto-economy's largest and most important pieces of infrastructure. I know dozens of small-cap stocks that earn more than $13 million a year.

There are a few caveats to this. The increase in equity might not be due to profits. When a firm raises new capital, this capital gets added to its equity. So any increase in Tether's equity over time could be due to the profit it earns, newly raised capital, or a combination of both.

As far as I know, Tether didn't announce any capital raises in 2021 or early 2022, so based on the reasonable assumption that no capital was raised that during the 12-months ended March 31, 2022, all of Tether's $13 million rise in equity stemmed from profits.

Another caveat is dividends. A firm's equity can also change if it pays out dividends to shareholders. Say that Tether paid out $10 million in dividends in the 12-months ended March 31, 2022. That would have removed $10 million in equity from the firm. In which case its profit was much higher than $13 million. If Tether did pay a series of undisclosed dividends, then we can't use its equity over time to get a feel for its profit.

However, courtesy of an interview with Paulo Ardoino, Tether's chief technical officer, we know that Tether doesn't pay any dividends:

So assuming that Ardoino is telling the truth, $13 million in profits over the 12-month period ending March 31, 2022 seems like an accurate estimate to me, given no dividends and the assumption that no capital has been raised.

For the accounting sticklers out there, I don't think that any of Tether's $13 million in profits comes from changes in the prices of the assets it owns. The category of assets most likely to have risen in value over the last twelve months is Tether's $5 billion or so in opaque other investments. However, in Tether's attestation reports it says that it has adopted the practice of valuing its other investments at their cost price (less impairments), not their market price. So even if those assets had appreciated, it would not be recognized on Tether's profit line.

How exactly did Tether earn $13 million in profits?

During the period lasting from March 31, 2021 to March 31, 2022, Tether had an average of around 60 billion stablecoins in circulation. That is, Tether's customers had deposited $60 billion with Tether, and Tether had issued its customers 60 billion Tether tokens. The company doesn't pay interest to coin holders, which means it gets to keep all of the income generated by this $60 billion in cash for itself. Assuming an average interest rate of around 0.25% over that period, Tether would have enjoyed interest revenues of around $150 million over those twelve months.

It also would have earned a few million from fees on redemptions and deposits. Each time a customer wants to convert Tether tokens into actual U.S. dollars, they must pay a 0.1% fee.

Out of this $150 million or so in revenue from interest, and another few million from fees, Tether paid  expenses such as salaries, court settlements, rent, lawyer fees etc. after which it ended up with $13 million.

What can we expect going forward? 

Thanks to research by Intel Jakal, we know that Tether has invested $62.8 million in the equity of collapsed lender Celsius (see spreadsheet). Presumably the Celsius investment is part of Tether's $5 billion in other investments. Shares in Celsius are likely be worthless now, which means that Tether will have to write off its Celsius investment as a complete loss. There's a good chance that this $62.8 million write-off will overwhelm whatever income Tether earned over the three months ending June 30, 2022, resulting in a negative quarter. So Tether's capital, which came in at $162 million at the end of March, could very well fall when it publishes its next attestation report.

Tether may have other risky assets in its other investments that are impaired, too, in which case its losses may be hefty enough to push its equity into negative territory. (Unless it raised equity, a possibility that Patrick Mackenzie considers).

Counterbalancing Tether's losses on its other investments is the improvement in interest rates. Treasury bill rates are at 2% or so these days, much higher right than the mushy 0.25% reward they offered in 2021. This jump in rates comes courtesy of a big pick up in inflation. This means that going forward, Tether will earn much more interest income on its base of customer deposits. 

For instance, recall that my best guess was that over the 12-months ended March 31, 2022, Tether brought in $150 million in revenue at 0.25% on a base of 60 billion Tether tokens in circulation. Crank this rate up to 2% and revenues rise to $1.2 billion per year. Assuming costs don't rise much, Tether's profits will jump by quite a bit over the 3-months ended June 30, 2022, and subsequent quarters as well.

However, if inflation is beneficial to stablecoins like Tether, it will also be problematic, for the following reason:

Because Tether only pays 0% to those who own Tether stablecoins, but market interest rates are currently at 2%, people will do there best to cut their holdings of Tether in order to invest elsewhere, say in Treasury bills. This is already happening. MakerDAO, one of the largest single owners of USD Coin, is taking steps to sell its hoard of $3.5 billion USD Coin (which like Tether yields 0%), to buy higher yielding conventional fixed income securities such as bond ETFs.

At the same time, competing stablecoins will enter the market that do pay interest, stealing even more market share from the 0%-yielding stablecoins. This will result in a contraction in the size of 0%-yielding stablecoins Tether and USD Coin, and a smaller base over which their issuers can earn interest. (Unless they themselves pay interest, which will of course cut into their profits.)

As you can see, being a stablecoin issuer is a very tough business.

Friday, July 22, 2022

Improvements to stablecoin transparency

[This article originally appeared in CoinDesk. It explores some improvements to stablecoin transparency recently initiated by New York regulators. In my opinion, there are two key changes. Up till now, stablecoin issuers have typically been examined by their auditor at the end of the month. With the new guidance, management's assertions must now be tested not only at the end of the month but also on one randomly selected business day during the month. Secondly, stablecoin issuers will be required to submit their internal controls to audit. Both measures will improve the trustworthiness of attestation reports.]

New York Regulators Have Planted a Seed for Stablecoin Transparency

Good news for stablecoin users: Stablecoin transparency standards are set to improve.

This comes courtesy of the New York Department of Financial Services (NYDFS), which last month issued formal guidance for NYDFS-approved stablecoin issuers, including upgrades to the amount and quality of information that issuers must provide to the public.

Increased transparency is a welcome development. It means users will have a better ability to vet stablecoins, and with more eyeballs on them, stablecoins issuers will be pressured to provide a safer product.

The new regulations will directly apply to gemini dollar (GUSD), issued by Gemini Trust, and binance USD (BUSD) and paxos dollar (USDP), issued by Paxos Trust. Those stablecoins were introduced in 2018 when the NYDFS initiated its regulatory framework for stablecoins.

The NYDFS is one of the most influential financial regulators in the world. By dint of peer pressure and customer demand, one hopes these improvements spread to other large, non-NYDFS-regulated stablecoins like USD coin, tether, trueUSD – and also to stablecoins yet to emerge.

It’s all about the assets

When people debate the intricacies of stablecoins, the most pressing thing they want to know is what backs the stablecoin. There are good reasons for that.

With good old-fashioned bank deposits, a bank's deep layer of capital offers depositors a degree of protection should the bank's investments sour. Stablecoin issuers, however, lack the large amounts of capital that banks possess. Furthermore, unlike with bank deposits – which are insured by the government up to a certain amount – you're on your own if the stablecoin in your wallet fails.

So the safety of a stablecoin is highly dependent on the assets that are backing it. That's why the topic of stablecoin backing attracts so much attention in the press and on social media, and why transparency is so important.

The durability of a stablecoin’s underlying assets is important to more than just the people who own the stablecoin. It's also crucial to the broader crypto economy, because stablecoins act as the plumbing of crypto. If a major issuer like Tether were to fail, it would drive the entire ecosystem into a crisis.

One way for people to gain sufficient confidence in a stablecoin is by getting a peek at its internal workings. A stablecoin issuer accommodates that by providing public information about the assets backing the stablecoin. By doing so, the issuer gives a stablecoin credibility, which may help it grow and earn more profits – but only if the public approves of what it has seen in the sausage-making process.

To ensure the information about its assets can be trusted by the public, stablecoin issuers first pass it through the hands of an independent auditor. The auditor examines the information and offers its opinion on whether the numbers are accurately stated.

The practice of providing the public with independently verified insights into stablecoin assets emerged in 2018 when the issuers of newly created stablecoins USD coin, gemini dollar and paxos dollar began to work with auditors to publish monthly "attestation" reports. Three years later, in 2021, Tether – issuer of the largest stablecoin – began to publish its own attestation reports, albeit quarterly.

This glance behind the curtains through the mediation of an independent auditor ultimately provides users like you and me with useful information.

But the glance that the public is afforded is good only if it is 1) timely, 2) provides a broad amount of useful information and 3) can be trusted.

The NYDFS's new standards address those three issues.


The utility of information degrades as it gets older, especially in the fast-moving crypto economy. The NYDFS new guidance requires attestation reports to be published monthly and no later than 30 days after the end of the month.

Stale attestation reports have been a problem among stablecoins issuers. In 2021, attestations for USDC were arriving 50 days after the attestation date. Tether's latest attestation was published 49 days after its March 31 attestation date. Users of this tardy information were left to speculate how the crypto declines of April, May and June may have affected Tether's finances.

Tether and USD coin aren't NYDFS-regulated coins and thus their issuers aren’t required to conform to the NYDFS’ standards on timeliness. However, given that competitor Paxos is implementing the standards for binance USD, Tether and Circle, the issuer of USD coin, may have no choice but to conform.


A long look behind the curtains is better than a quick glimpse.

The NYDFS will broaden the amount of information available in attestation reports by requiring that stablecoin's assets be reported not only in aggregate, but also by asset class. So a stablecoin issuer would have to list how much commercial paper it owns, its allocation to money-market mutual funds, its deposits, its bonds and its quantity of Treasurys. That is, separately, instead of lumping it all together.

Some stablecoin issuers like Tether already do that. But others don't. The attestations for binance USD, for instance, inform us that Paxos may own deposits at banks, Treasury bills or Treasury bonds, but doesn't reveal what the proportions are.


An auditor's approval isn't worth much if the stablecoin can game the system. Of the updates to NYDFS' guidance, the most important ones will improve the trustworthiness of stablecoin reports. There are two ways it will do that.

First, the NYDFS will require auditors to not only examine a stablecoin’s end-of-the-month asset count, but also run a check on "at least one randomly selected business day during the period." Requiring a random in-between day examination prevents a stablecoin issuer from holding one set of risky assets for most of the month only to switch into safer assets the day before the auditor examines it.

Tether in particular should consider adopting the NYDFS’ random in-between day test as a best practice. Tether's three-month interlude between examinations is much longer than its competitors. By having its auditor test one random day during that period in addition to the end-of-period day, Tether would provide users with much needed assurance.

Second, the NYDFS will require that a stablecoin auditor provide an opinion on the effectiveness of a stablecoin issuer's internal controls. That must occur once a year.

Internal controls are the rules and procedures that companies adopt to prevent mistakes and fraud. They include separation of duties, verification of invoices, reconciliation and controlled access to financial reporting systems. After the Enron and WorldCom scandals of the early 2000s, the Sarbanes-Oxley Act made it necessary for U.S. public companies to undergo regular audits of internal controls.

At the present time, auditors that attest to the investments underlying stablecoins issued don't examine the effectiveness of an issuer's internal controls. An auditor need only acquire whatever "degree of understanding" of an issuer's internal controls that is necessary in order to carry out their assessment of its assets.

That's why all attestation reports contain something to the effect that "we did not test the operating effectiveness of such controls and express no such opinion on such controls." (That's from the attestation for paxos dollar.)

This is a black hole in current attestation practices. If internal controls aren't adequate, the numbers can’t be trusted. By requiring an auditor to examine a stablecoin issuer's internal controls every year to assure those controls are effective at promoting compliance with regulations, the NYDFS addresses this shortcoming.

Circle and Tether should consider voluntarily submitting their internal controls to annual examination and so reach the standards being met by their New York competitors. Because an organization's internal controls offer vital protection against fraud, anyone who owns stablecoins that conforms to NYDFS standards will be able to sleep soundly at night.

Thursday, June 30, 2022

Watching Tether

This is a quick post to share some of the things I've learnt from watching Tether over the last two months. I'm hoping other Tether watchers find this information useful and share some of their own Tether watching tricks in the comments section. (No conspiracy theories, please. Just analysis).

There's two sides to watching Tether. You can observe its real-world activity like its attestation reports, press releases, brushes with the law, and its social media accounts. Or you can follow its life on the blockchain, where it issues digital stablecoins. This post focuses on the latter. In particular, I'm going to analyze the blockchain for redemptions: those on-chain transactions in which Tether units move from Tether customers back to Tether itself.

I'm going to assume some basic knowledge of Tether and blockchain analysis.

To understand how Tether works on-chain, the most important wallets to track are Tether's two treasury wallets. Tether's Tron-based treasury wallet is located here, and the Ethereum-based wallet is here. (Tether also issues tokens onto other blockchains, but the amounts are relatively small, so for simplicity's sake I'm going to focus on Ethereum and Tron-based Tether activity.)

All Tether units begin and end their life in Tether's treasury wallets.

They begin life when Tether creates, or mints, new units. As long as they remain in Tether's two treasury wallets, these new units are not yet officially in circulation. Tether tokens only enter circulation when Tether issues themor transfers themfrom its treasury wallet to a customer.

Tether mints new units only rarely, and when it does, in large sizes.

In the 350 days from July 1, 2021 to June 15, 2022, Tether minted 24 times on Tron and 9 times on Ethereum. That's around one minting every ten days.

Tether almost always mints in $1 billion increments. This $1 billion balance gets slowly drawn down as customers submit requests to Tether for small batches of Tether units, often in the $10 million to $100 million range. Effectively, this means that Tether's two treasury wallet usually hold a large multi-million working inventory of non-circulating Tether units.

These balances of freshly-minted non-circulating Tether are regularly augmented by inflows of redeemed Tether units. Redemptions occur when customers transfer their unwanted Tether tokens to Tether's treasury wallet to be redeemed for a wire transfer of regular dollars. Each redemption reduces the quantity of Tether in circulation while increasing the quantity of non-circulating Tether units sitting in Tether's treasury wallets.

In the 350 days from July 1, 2021 to June 15, 2022, I count 432 redemptions (177 Tron, 255 Ethereum). That's an average of over one redemption per day.

Tether doesn't destroy, or burn, each incoming Tether redemption. It waits for a number of redemptions to accumulate in its treasury wallet and then burns them all in one big batch.

In the 350 days from July 2021 to June 15, 2022, I count just 12 burns (11 Tron, 1 Ethereum). The amounts burnt are large, often over 1 billion.

So to summarize, the inventory of Tether tokens held in Tether's treasury wallets is determined by the number of incoming Tether tokens (from occasional mintings and frequent redemptions), and outgoing Tether (from occasional burns and frequent issuance).

I've charted out what this treasury working balance looks like going back to late 2021. Note that the chart combines both Tether's Tron and Ethereum treasury balances.

You can see that in 2021 and early 2022 Tether typically let its treasury wallet balances rise to $2-4 billion before burning them. In May and June 2022 it altered this practice by allowing them to balloon to over $10 billion. (Tether recently burnt 11.1 billion Tether units, bringing its working balance back to more normal levels.)


Having worked out how treasury wallets function, I want to focus a bit more on the redemptions themselves. Of the 432 redemptions that I counted from July 2021 to June 15, 2022, a total of 133, or 31%, come from wallets tagged as being owned by Bitfinex, a cryptocurrency exchange owned by Tether's parent. (26 Tron, 107 Ethereum).

Bitfinex maintains two Ethereum addresses that hold Tether tokens (Bitfinex 2 and Bitfinex 3) and one Tron address.

Why do such a large proportion of transfers sent to Tether's treasury wallet originate from Bitfinex? 

What I believe is happening is that rather than sending redemptions directly to Tether's two treasury wallets, large traders often send them to Bitfinex instead. Once the Tether tokens arrive in Bitfinex's wallet, Bitfinex makes the trader whole by wiring them actual U.S. dollars. So from the trader's perspective, the redemption process is complete. They have cashed out their Tether units.

From Bitfinex's perspective, however, the redemption process is not done. 

Rather than sending traders' redeemed Tether tokens immediately to Tether for cancellation, Bitfinex generally holds them for a period of time. I suspect that Bitfinex delays these transfers so that it can meet incoming requests from traders for new Tether issuance out of its own inventory. A delay also allows Bitfinex to accumulate additional redeemed Tether tokens so that it can send the balance in one convenient end-of-period batch to Tether's treasury rather than multiple small transfers.
We have evidence that redemptions are happening via the intermediation of Bitfinex. In a 2021 article. Alameda Researcha crypto trading firmspoints to a set of Tether redemptions that it claims to have completed. They were all processed through Bitfinex rather than Tether. (ht @ Matt Ranger)

To get a feel for how Bitfinex manages its Tether balances, I've charted out the quantity of Tether balances held in Bitfinex's #2 wallet below. The chart covers May 1 to June 15, 2022. 

Admittedly, this was an unusual period of time for Tether due to record-high redemptions. (At one point in May it had built a balance of over 1.7 billion Tether units!) In any case, you can see how Bitfinex steadily accumulates Tether tokens as traders redeem Tether units. In the chart, each dot is a transfer into Bitfinex's #2 wallet. Once Bitfinex deems that balance to be large enough, it sends it all back to Tether's Ethereum treasury wallet for cancellation. The large collapses in the chart are when these transfers occur.

If you are interested in investigating Bitfinex's involvement in the redemption process closer, I've noticed that Bitfinex's #2 and #3 Ethereum wallets work together to manage Bitfinex's inventory of Ethereum-based Tether tokens.

The #3 wallets interfaces with the public. When the public wants to withdraw Tether units, Bitfinex sources the Tether units from its #3 wallet. Conversely, when the public makes deposits of Tether units they flow into Bitfinex's #3 wallet. When the balance of the #3 wallet rises above 105 million units, Bitfinex waterfalls all amounts in excess of $105 million into its #2 wallet. The inventory in the #2 wallet builds until it is deemed large enough by Bitfinex to be sent to Tether's treasury. (It's not always that cut and dried. I've seen Bitfinex transfer Tether units out of its #3 wallet to Tether's treasury wallet, thus bypassing the #3 wallet.)

Note that while Bitfinex manages its Ethereum-based Tether units using two wallets, it only uses one for Tron, which makes Tron-based analysis of Tether much more simple.

So let's sum up the on-chain Tether redemption process. There appear to be two routes by which Tether units can be redeemed. Some redemptions get sent directly to one of the Tether treasury wallets. Others get sent to Bitfinex. After a period of accumulating redeemed Tether units, Bitfinex eventually transmits the entire batch to Tether's treasury wallets for cancellation. At this point they fall out of circulation. After a period of time passes the quantity of Tether units sitting in treasury reaches a high enough trigger point that Tether burns it all, leaving its treasury wallets close to empty.


To finish off, I want to provide a quick look at who is doing the redeeming, and why.

From May 12 to June 30, Tether has contracted by almost 17 billion units, or 20%, which means that a massive amount of redemptions have occurred. A single Tron wallet has been responsible for 3.3 billion worth of redemptions alone. We'll call it the 6DNE wallet after the last four digits in its address.

We can surmise why these redemptions have been occurring by looking more closely at 6DNE's transactions. 

Created on May 12, 2022, the 6DNE wallet has made 3.3 billion worth of transfers to Bitfinex in 108 separate deposits (as of June 30). The average deposit size is 30.5 million Tether units. Most of the Tether units that 6DNE acquires are sourced from wallets associated with three major exchanges: Kraken, Binance, and FTX. (It also acquires Tether units from these two wallets, which I suspect are Binance-satellite exchanges.)

Through much of May and June 2022, the U.S. dollar price of Tether units has regularly fallen below $0.999 on major exchanges like FTX and Kraken. Put differently, one Tether unit is worth a little bit less than an actual U.S. dollar. Prior to May 2022, Tether had clung quite closely to $1.00. To illustrate, I've included a chart of the trading price of Tether units in terms of U.S. dollars on FTX:

Tether's fall in price occurred because large amounts of Tether units were being desperately sold on markets like FTX as the crypto-economy deflated. Tether sets a redemption minimum of $100,000, which means that most Tether owners can't directly redeem unwanted Tether units via Tether's treasury wallets. That leaves them with no choice but to sell on exchanges.

This is where arbitrageurs like 6DNE step in. The owner of 6DNE appears to be buying Tether units in large multi-million batches on exchanges like Binance and FTX at prices of $0.9985 or so, and sending them to Bitfinex to be redeemed at $0.999. By harvesting the tiny $0.0005 difference between the purchase and sale price, the owner of 6DNE earns a near risk-free profit.

Arbitrage conducted by traders like 6DNE helps to prevent Tether's price from falling much below $0.9982 or $0.9981 on exchanges like FTX and Binance. This process doesn't work perfectly, though. On May 12 the price of Tether collapsed to 95¢ on major exchanges, as the chart above shows.

Note that I said that the trader is redeeming at $0.999, and not $1. This is because Bitfinex and Tether both charge a 0.1% wire fee. This fee reduces Tether's effective redemption price from $1 to $0.999.

Let's work out an actual trade. If the owner of the 6DNE wallet purchases 30 million Tether units on FTX at $0.9985 and sends them to Bitfinex to be redeemed at $0.999, the trader earns a profit of $15,000 ($0.0005 x 30 million). The owner of 6DNE may have to pay fees to FTX, which will eat into the bottom line. However, if the trader was making liquidity rather than taking it, fees may be zero to negligible

6DNE completed 3.3 billion in redemptions, which assuming a profit of $0.0005 per Tether unit translates into around $1.5 million in gains. Not bad for a two month's work.

After 6DNE's Tether units arrive at Bitfinex, Bitfinex holds them for a while and ultimately sends them to Tether's treasury wallet. At this point 6DNE's formerly-owned Tether units are officially out of circulation. And then after a few days or weeks, Tether burns them. They have ceased to exist.

And that, in short, is how and why Tether tokens flow from the market back to their issuer.

Monday, June 6, 2022

Thoughts on Tether's $10.5 billion contraction

As the world's largest stablecoin, Tether has attracted its share of critics. There are several strains of Tether criticism.

Under one strain, Tether is a black box used to manipulate the price of bitcoin higher. I've never subscribed to this critique. It seems far-fetched to me, much like the theories about gold price suppression.

Other critics see Tether as a fraud, say like Madoff or Enron. They stress many of Tether's documented past transgressions. They could be right. But I hope they're not, since that would inevitably mean a lot of people getting hurt.

For my part, I'm not a skilled enough financial bloodhound to be able to sniff out fraud. I've generally started from the assumption that the public information that Tether has disclosed, most importantly its attestation reports, is accurate. A stablecoin attestation report is an examination of a stablecoins reserves, or assets, by an external auditor.

Having generally based my analysis of Tether on its assets, that analysis has always suggested that Tether (in its current incarnation) is doomed, at least in the long term. I suppose that this gets me to a similar ending-point as the Tether-as-fraud critics, albeit via a different route.

The stablecoin competitive dynamic is best characterized as a jog to the top (rather than a race to the bottom). Over a long enough period of time, the safest and most transparent issuers will be the winners. Let me explain why.

Because stablecoins don’t pay interest to customers, customers aren’t compensated for bearing the risk of the issuer’s underlying investments. This incentivizes users to migrate towards the stablecoins with the safest investments and most transparency, the good money eventually displacing the not-so-good.

Of the big three stablecoins (Tether, USD Coin, and Binance USD), Tether has always had the riskiest investment profile. As of Tether's last attestation report, for instance, 14.4% of its assets were comprised of an opaque collection of secured loans, other investments, and corporate bonds & funds (see list below). Meanwhile, Tether's competitors USD Coin and Binance USD are currently 100% invested in Treasury bills, cash, and money market funds.

List of Tether's assets from its March 2022 attestation report [pdf]

In addition to a difference in asset quality, I'd argue that USD Coin and Binance USD have better legal protections for users in the event of failure. Binance USD in particular operates under the New York stablecoin regulatory framework, which obliges Binance USD's issuer, Paxos, to operate as a trust. Trusts are effective mechanisms for ring-fencing customer funds from an issuer's other creditors.

Given Tether's outsized allocation to risky assets and fewer protections in the case of insolvency, Tether was always destined to be a victim of a jog to the top. That is, as the riskiest stablecoin it was fated to drip-drip market share to USD Coin and Binance USD until it shrunk into irrelevancy. And that's what has been happening. In the chart below, Tether's dominance has been steadily declining.

(For more on the jog to the top dynamic, I've written about it here, here, and here.)

On May 12, that slow drip turned into a rush, as the chart below shows. For the prior two years Tether had been growing, albeit at a slower rate than its competitors USD Coin and Binance USD. But over the ensuing two weeks, around 10.5 billion Tethers were quickly redeemed, a reduction of 12.6%. Meanwhile, USD Coin and Binance USD grew by around 5 billion units.

I'd argue that Tether's May contraction wasn't the product of the slow grinding attrition of a jog to the top. It was something more serious: an old-fashioned bank run. 

What might have brought the run on?

Once again, I blame Tether's weakest-link investments: the 14.4% of Tether's assets allocated to secured loans, other investments, and corporate bonds & funds.

What is the makeup of Tether's other investments? We don't know. Tether has never bothered disclosing these details. We also don't know what sort of collateral Tether has accepted for its secured loans, or the rating of the corporate bonds that it hold, or what kinds of "funds" it owns.

Combine this paucity of information with a big drop in cryptocurrency prices over the previous months, and I suspect that by May 12 financial market participants had begun to fill in the blanks with their own worst-case scenarios. A big enough hit to the value of Tether's other investments, for instance, would have meant that Tether was insolvent: that it didn't have enough assets to meet all redemption requests. (Here are Patrick Mackenzie's efforts, for instance, to run the accounting on Tether's solvency.)

For large Tether owners, there would have been two ways to approach a potential Tether insolvency. One option was to just ignore the problem. As long as everyone else does the same and holds on to their Tethers, then a strange sort of let's-all-pretend equilibrium emerges; Tether's peg holds and no one loses.

The other approach is to redeem now while Tether still has a large but limited supply of Treasuries and can easily meet redemption requests. If everyone else follows this same strategy, a run develops. No one wants to be the last one out, since the only assets remaining to support latecomers' redemption requests would be Tether's questionable assets, the ones potentially wiped-out during the prior crypto price crash. Being the last one out could mean only getting paid 30 or 40 cents per dollar.

The second of these two reactions likely took over on May 12, leading to the 10.5 billion contraction in Tether. Luckily for Tether, the big slide in bitcoin and crypto prices has halted. And with the pessimism surrounding all things crypto having dissipated, the run on Tether seems to have ended, at least for now.

Before another crypto market decline hits, I'm hoping that Tether seizes the opportunity to make a few changes.  

First, Tether should immediately disclose details about the nature and value of its weakest-link assets: its secured loans, other investments, and corporate bonds & funds. By doing so it would reassure the market and break the collective urge to flee Tether come the next big drop in crypto prices. Tether should also begin the process of unwinding and selling-off its weakest-link assets, investing the proceeds in Treasury bills and investment grade commercial paper. Without risky assets, Tether would be relatively immune to big falls in crypto prices, and this in turn would reduce the threat of a run on Tether.

If the value of Tether's weakest-link assets has been impaired, then mere disclosure isn't going reassure anyone. Tether needs to fill the vacuum by raising new funds. That is, it is insolvent and needs to recapitalize itself. If people who hold Tether stablecoins know that there's a load of new cash sitting in Tether coffers, that'll end their urge to get out the next time the crypto market falls.

The good things about these measures is that they won't only put an end to Tether's chances of facing another run. They'd also solve Tether's longer-term problem of being the victim of a jog to the top.

In my worst case scenario, Tether doesn't do any of these things. It doesn't disclose the nature of its weakest-link assets nor does it make any effort to sell them off. Then the crypto market begins another slide. Investors once again rush to make worst-case inferences about Tether's weakest link assets. A run on Tether develops, but much bigger than the run in May.

By then it may be too late for Tether to make any of the changes that would be necessary to stabilize. In a market rout, getting a recapitalization from other crypto firms may be difficult, if not impossible, and there may be no one willing or able to buy Tether's weakest-link investments. Better to fix things now than later.