Monday, January 10, 2022

Tether vs the New York stablecoins

Stablecoins are the world's newest payments option. But not all stablecoins are the same. There are safe stablecoins and there are sketchy stablecoins.

The safest ones are the New York stablecoins: Paxos Dollar, Gemini Dollar, and Binance USD (BUSD). The New York stablecoins are issued by financial institutions supervised by the New York Department of Financial Services. Measures such as segregation, bankruptcy remoteness, and a trust company structure are used to protect customers funds. Customer money is invested in low-risk securities such as short-term U.S. government debt.

The risky stablecoins best represented by BVI-based Tether invest customer funds in higher-risk instruments like long-term commercial debt, loans to affiliates, or cryptocurrencies. They do not have clear protections for customers should an adverse event occur, nor do they have a regulator looking over their shoulder to make sure that they are running their stablecoin operations in a robust manner.

[For a more complete description of the differences between the New York stablecoins and other stablecoins, see my post here.]

Riskier assets should always offer investors a higher interest rate than safer assets. Interest is the extra carrot that we get for incurring financial danger. But interest doesn't exist in the world of stablecoins. That is, the risky stablecoins and the safe ones all pay holders the same 0% rate. Given the absence of a reward for bearing risk, one would expect a reverse Gresham's law effect to kick in: the community of stablecoin holders should gravitate to the safest stablecoins, the good money displacing the bad.

As the above chart suggests, this shift to safety is occurring. Since 2020, the three New York stablecoins have grown much faster (up by a factor of 60) than Tether (up by a factor of 17).

However, as the second chart below indicates, Tether still remains the largest stablecoin... by far. There are around $80 billion in outstanding Tethers circulating through the cryptoeconomy compared to $16 billion in New York stablecoins. This suggests to me that more stablecoin rationalization will occur.

Why is this reverse-Gresham process proceeding so slowly?

Tether has been around since 2014. The New York stablecoins didn't arrive until 2018. In that interim period of Tether dominance, a Tether standard of sorts emerged. Given a lone stablecoin option, the cryptoeconomy built up a dependence on Tether. Like any standard, once everyone is plugged in it's hard to shift to a superior standard. 

But just because it is difficult to switch standards doesn't mean it won't happen. Over the long term, there is no reason for the community of stablecoin users to continue using the riskiest 0%-yielding stablecoin. Either everyone will shift away from Tether, or Tether will be forced to adapt by becoming just as safe as the New York stablecoins, or Tether will start to pay interest in order to compensate for being the riskiest product.


  1. Thanks for this very interesting post. The crypto market constantly reminds me of Keynes' quip that "the market can stay irrational longer than you can stay solvent".

    Another reason why this transition is not taking place rapidly is that most of the participants in the crypto-sphere are not financially sophisticated so do not understand the risks posed by Tether relative to the NY stablecoins. I think the transition will be big bang instead of gradual transition.

    1. "...are not financially sophisticated so do not understand the risks posed by Tether relative to the NY stablecoins."

      Yep, I think there's some of that.


  2. Thanks JP for yet another great post. I wonder whether one difference is that Tether has greater utility value. For example, it can be used to access DeFi platforms. I suspect that rather fewer platforms accept the New York stablecoins. As a consequence, people are willing to accept greater stablecoin risk in exchange for a potentially high return in the DeFi market. I guess this idea is just putting some colour on your idea of a 'Tether standard'.

    1. Hi Peter,

      From a technical perspective, the New York stablecoins are just as usable on DeFi as Tether is. That is, There is nothing preventing a DeFi smart contract from engaging with them. In practice, I have observed some DeFi protocols not bothering to add functionality for some of the New York stablecoins. They're too small. I also see some protocols not bothering to add functionality for Tether. Too dangerous.

  3. Tether is the smartest company ever. Genius. Tether has already made the evolutionary jump of stablecoins- no backing or dollars are required.