|The not-so-stable price of Tether in 2022 on the Kraken exchange|
[Republished below is my latest article from CoinDesk.]
How Tether Can Be a More Stable Stablecoin
The crypto economy has suffered two major crypto failures this year: the collapse of Luna/TerraUSD in May and the failure of FTX in November. In both instances, the world's largest stablecoin, Tether, was caught in the blast radius as waves of redemptions poured into the company. It shrunk by $18 billion, or 21%, in May and June and by another $4 billion, or 6%, in November.
Stablecoins shouldn't be the instruments that the public sells in a panic. They're supposed to be the opposite; the life vest that people grab on to. Competing stablecoins USD Coin and Binance USD performed as one would have expected. Neither experienced a barrage of redemptions during these two episodes.
Here are four things that Tether can do to ensure that the next time the crypto economy undergoes a shock, tether stays steady.
1) Tether needs to get rid of its corporate bonds, funds and "other investments."
A stablecoin's number one job is to be steady, and that demands holding safe assets like cash and Treasury bills. But some of the line items on Tether's balance sheet – including commercial paper, corporate bonds and funds, secured loans and "other investments” – suggest that Tether operates more like a hedge fund or venture capital firm than a stablecoin.
Tether has been slowly addressing this problem. It spent much of 2022 replacing its massive $30 billion horde of commercial paper with Treasury bills, finally bringing the tally down to zero just prior to the FTX catastrophe.
But even after this cleansing, Tether still suffered from a wave of redemptions in November. Realizing it hadn't gone far enough, Tether executives made a pledge earlier this month to reduce its $6 billion in secured loans to zero.
That's great, but the company has been silent on what many analysts consider to be its sketchiest assets: its $2.6 billion in other investments and $3 billion or so in corporate bonds and funds. What is the rating and duration of these corporate bonds? Who are the borrowers – are they crypto firms? Are its other investments and funds composed of crypto-specific tokens?
Fear that these investments could sour is the best explanation for why the last two general cryptocurrency panics have inspired temporary runs on Tether. Best to get out of Tether now, goes the thinking, in case the company no longer has enough funds on hand to redeem all Tether tokens.
To put an end to this pattern, Tether needs to sell all of its risky assets and move to a 100% safe-asset allocation. Next time a crisis hits, users will be less likely to unload their Tether tokens.
2) Tether needs to cancel its 0.1% redemption/withdrawal fee.
While the prices of competing stablecoins Binance USD and USD Coin are well-anchored to $1 on major exchanges around the globe, the price of Tether tends to fluctuate randomly. This lack of stability hurts the company’s reputation. At heart is Tether's 0.1% redemption fee. Time to get rid of it.
Tether charges anyone who wants to redeem or withdraw Tether tokens a 0.1% fee. So if you own 1 million tether tokens and want to redeem them, you'll only get $999,000 back after paying the $1,000 fee to Tether. Likewise, if you wire $1 million in fiat to Tether in order to get stablecoins, you'll only get $999,000 USD back.
The other big stablecoin issuers, Circle and Paxos, do not charge these fees.
It may not sound like much, but the 0.1% fee leads to the price of tether weaving randomly in a wide band around $1 rather than staying locked.
The price at which any stablecoin trades on exchanges like Binance and Kraken is set by arbitrage. If the price falls too low below $1, arbitrageurs buy stablecoins on the exchange and transfer them to their issuers for redemption at $1, earning a small profit. They execute the inverse when a stablecoin’s price is too high.
Competition among arbitrageurs to execute these trades at a profit is what locks the price of stablecoins on key exchanges at a price close to $1.
Tether's 0.1% fee adds to an arbitrageur's costs of carrying out this trade. Factoring in this cost, it only really becomes profitable to buy tether tokens when they've fallen to $0.999, and sell them when they've risen to $1.001. Tether’s price randomly floats within this relatively wide band.
This lack of rigidity attracts bad press, rumors, innuendo and speculation. It makes Tether look particularly bad during broader crypto meltdowns when its price inevitably falls to the bottom of its trading band, mirroring the performance of other risky crypto tokens rather than holding strong at $1. Meanwhile, other stablecoins like USD Coin and Binance USD, which don't have redemption fees, hold strong.
It's time for Tether to get rid of this fee in order to create more confidence-inspiring trading patterns on third-party exchanges.
3) Tether needs to open redemptions up to more people by removing its $100,000 floor.
Tether is unique among stablecoins in putting a $100,000 floor on the amount of tether that can be redeemed or withdrawn at source. Other stablecoin issuers like Circle and Paxos allow people to withdraw or deposit any amount.
This floor creates perverse trading patterns on exchanges like Binance and Kraken, which further exacerbate fears about Tether.
In short, Tether's $100,000 minimum pushes the majority of USDT users who want to sell en-masse on exchanges. In theory, well-heeled arbitrageurs are supposed to buy these users' unwanted tokens on these exchanges and redeem them at Tether, thus anchoring Tether's price close to $1.
But it is precisely during broad crypto panics that this arbitrage mechanism breaks down: arbitrageurs back off out of fear of losing their capital, exchanges halt withdrawals as activity overwhelms them, and blockchains get congested. And so panicked on-exchange sales of tether overwhelm the mechanisms that are supposed to anchor tether, and its price falls below the lower end of its $0.999 band.
Far below. In May, Tether fell to 92 cents on Kraken. In October, it fell to under 93 cents. These depegging events engender more fear, leading to more sales of tether, leading to larger declines in price and more panic.
If Tether removed its $100,000 minimum and allowed everyone to redeem at source, then tether users wouldn't have to flock en masse to exchanges in order to offload their tether. They could simply send their 100 tether directly to the company and get $100.
This would relieve price pressure on exchanges and bring an end to Tether's crazy on-exchange price movements.
4) Tether needs to be more transparent.
Lack of transparency is an old criticism of Tether, but it deserves to be re-enunciated. Tether falls short of the current standard for stablecoin transparency. This lack of transparency helps create a trust gap that leads to Tether selloffs during market panics.
The stablecoin industry's current transparency standard has been established by the New York Department of FInancial services (NYDFS). Auditors attest to the state of the stablecoin's investments on a monthly basis, these reports being published on the issuers' websites. In addition to an end of month test of an issuers’ investments, the NYDFS requires stablecoins operating under its framework to be tested on one random day during the course of the month.
That's 24 tests per year. Alas, Tether reports on a quarterly basis. So its auditor is only testing the company’s investments four times per year. That's not good enough.
The NYDFS also requires stablecoin issuers to have an auditor examine its internal controls once a year. Internal controls are the rules and procedures that companies adopt to prevent mistakes and fraud such as separation of duties, verification of invoices and controlled access to financial reporting systems.
Tether's auditor has not examined the company's internal controls.
By bringing its disclosure practices up to industry standard, Tether will grow trust and users will be less likely to dump Tether tokens come the next crypto panic.
To sum up, tether has become that stablecoin that everyone sells when panic hits. But this doesn’t have to be the case. By selling its risky assets and only holding safe t-bills, removing its 0.1% redemption fee, allowing all users to redeem at source and improving transparency, tether can transition into a much more stable stablecoin.
Did you consider the need for Tether to hold capital as well. Is a super safe asset requirement enough to make Tether money like?ReplyDelete
Fair point about capital. Tether has around $250mm in capital which is far too low given its exotic assets. If it shifted into 100% t-bills then I suspect that amount would be sufficient, or at least close to it.Delete
Which then begs the question of whether the return on these super safe assets is sufficient to cover the costs of running Tether plus whatever profit the business owner requiresDelete
At the moment, the return is high enough. Tether pays 0% to holders of Tether, but collects the 4.4% interest rate on t-bills for itself. On $65 billion in tether outstanding, that's a whopping $2.9 billion in revenue. But interest rates could go back down to below 1% again. Or maybe competitive pressure will force Tether to pay interest to tether holders.Delete