The safe-haven hunt in 2022 : is Bitcoin the answer?

By Chadi El Adnani, Crypto Research Analyst @SUN ZU Lab

July 2022

Is bitcoin a safe-haven? Powered by SUN ZU Lab

We revisit in this article a question studied by Sun Zu Lab in 2020 during the financial crisis caused by the Covid-19 pandemic: did bitcoin resist the market downturn better than other assets in 2022, and would it have been strategically interesting for investors to shift some of their positions to bitcoin before the downturn? the answer to these questions is still negative, as it was the case in 2020. We study in this analysis the behavior of various assets over the year 2022, specifically bitcoin, ether, equity markets (S&P 500), bond markets (US interest rates) and gold.

This result does not constitute an absolute answer to the intrinsic value of digital assets, but rather provides insights into a specific situation.

Economic context

2022 has been marked so far by the Russian invasion of Ukraine which, added to an economic context already weakened by the Covid-19 pandemic, has accentuated the slowdown of the world economy which could enter a long period of stagflation (low growth and high inflation). According to World Bank figures, global growth is expected to fall from 5.7% in 2021 to 2.9% in 2022, significantly lower than the 4.1% figure announced last January. We cannot help but notice the very visible parallel with the 1970s stagflation period. The comparison is striking: persistent supply disruptions that fuel inflation (Russian gas shortages, the effects of the prolonged severe lockdown in China on various value chains, etc.), coupled with the end of a long period of very accommodating monetary policy in major advanced economies: key interest rates close to 0%; Fed balance sheet in excess of $8.5 trillion (35% of US. GDP, an all-time record), etc. Added to this are projections of a slowdown in global growth and the fragility of emerging and developing countries in the face of the urging need to tighten monetary policies to curb inflation. 

In this unique context, we wanted to put ourselves in the shoes of investors to understand whether it is in their best interest to move from one asset class to another, and especially whether cryptos represent an effective safe haven in times of crisis. We model the S&P 500 by its most liquid ETF: Spider (ticker SPY, NAV as of 06/17/22: $378 billion). Gold is modeled by its most liquid physical ETF (ticker GLD, $63 billion NAV). U.S. government bonds are modeled by the iShares 7Y-10Y ETF (ticker IEF, $18 billion NAV). Prices are closing prices and all execution issues are neglected. Access considerations are also neglected: the products used here are easy to access, anyone can open a securities account with an online broker or a crypto exchange in a few days. Data is extracted from Yahoo finance. 

Finally, the « safe haven » concept reflects the idea that certain assets, financial or otherwise, provide a safe haven in the event of economic and financial turmoil. We often find in this category the US and German bonds, due to the almost absolute confidence in the strength of their economic fabric and their ability to always repay their debts. The Japanese Yen has often been considered a safe haven as well.


Without further ado, here is the relative performance of the 5 assets during 2022:

Bitcoin performance

The numbers speak for themselves: only gold managed a stable performance in 2022 (0.2%), while BTC or ETH under-performed the bond and equity markets (-55.8% and -70.5% respectively). 

Another way to answer the original question is to calculate the “flight to quality” percentage of investors who switched asset classes. Indeed, this type of behavior is extremely common; cautious investors forecasting the increase in interest rates and inflation at the beginning of the year might have chosen to move some of their positions to safer assets, such as gold, US sovereign bonds, or even Bitcoin? Let’s look at the results:

Bitcoin performance vs benchmarl

The red curve reads as follows: investors choosing to switch their position on 12/31/21 from gold to Bitcoin would have realized a loss of 56% between 12/31/21 and 6/17/22 (compared to a situation where they would have remained invested in gold). The graphs show exactly how much gain/loss was received for switching, depending on when the switch took place.

It appears that the choice to “pivot” from another asset to BTC has never paid off in 2022. Gold, on the other hand, has well played its role as a safe haven, providing positive gains at almost any time of the year on S&P > gold and bond > gold pivots.


Rather than analyzing the assets’ volatility as defined by the classic financial formula, i.e. the annualized standard deviation of daily returns, let’s look at a more intuitive measure: the intra-day variation. We compute the 30-day moving average of daily amplitudes for the five assets.

The graph shows that over the year 2022, Bitcoin and Ether have varied on average between 3% and 8% from their highest to lowest price on a single day. In contrast, the S&P 500, gold and bonds only vary by 1% to 2.5% (or even less). Investors should keep in mind then that the amplitude of movements in crypto markets is 4 to 5 times greater than in traditional markets, which requires careful monitoring to deal with these risky assets.

Bitcoin's volatility


Finally, let’s analyze liquidity as characterized by daily volumes. This is a post-trade measure of liquidity, i.e. the liquidity that has been achieved through transactions. We could also study a pre-trade measure: the liquidity available before execution in the exchanges’ order books , which is a little more complex to compute.

The graphs below show average trading volumes (30-day moving average) in 2022, with 1-month volatility (annualized standard deviation) as the second axis:

The S&P 500 ETF is one of the most liquid instruments in the world, with $30 to $60 billion traded every day. The causal relationship between volatility and volume is immediately apparent.

Liquidity of Bitcoin by SUN ZU Lab

For the gold ETF GLD, we have daily trading volumes between $1 and $3.5 billion, but the causal relationship is still perfectly visible.

Liquidity of Bitcoin analysed by SUN ZU Lab

Regarding Bitcoin, we have first of all a confirmation of its very volatile character, with annualized volatility varying between 40% and 80%. This graph also raises discrepancies already made by Sun Zu Lab in 2020: it appears that the volatility/volume causality is still not respected, with peaks of volatility in February-March that are not accompanied by any increase in volume, and on the contrary periods like April when the volume seems to grow by itself!

The two circled areas on the chart are anomalies, likely due to the fact that the officially announced volumes are greatly overestimated and that the magnitude of phantom volumes varies over time. The S&P 500, gold and the bond ETF, not included here, show a rather stable “structural” liquidity: when the volatility peaks stop, the average volume goes back down to a base level.


The answer to the question “is BTC a credible alternative to the volatility of traditional markets?” is negative, again, over the year 2022. Unquestionably, gold and sovereign bonds are still the “safe haven” they have been for a long time. On the other hand, the liquidity of bitcoin (and ether) is still problematic; the volumes traded do not follow the same logic expressed historically by investors in the traditional markets.

Questions and comments can be addressed to or

About SUN ZU Lab

SUN ZU Lab is a French Fintech that aims to become the leading independent provider of digital asset market quantitative analytics tools and services. Leveraging the founding team’s 70+ years of experience in international capital markets and trading technology, SUN ZU Lab provides crypto professionals with unprecedented liquidity analytics in the form of quant reports, dashboards, real-time augmented data feeds, and bespoke studies.

Demystifying the Terra debacle

Terra Luna debacle

By Stéphane Reverre and Amine Mounazil

A stablecoin is a cryptocurrency whose value is “pegged” to the price of a reserve item, the US dollar being the most commonly used reserve asset. Stablecoins appeared for the first time in 2014, and have been gaining popularity since. Today, they are considered the backbone of the crypto ecosystem by providing an “on-risk” and “off-risk” alternative for cryptocurrencies. Moreover, their adoption is driven by the demand of traditional financial institutions and the larger crypto sector for a standard approach to leverage blockchain technology while avoiding related risks.

Thus, stablecoins address one of the fundamental issues with many mainstream cryptocurrencies: their extreme volatility, which makes them inadequate for real-world transactions. Altough competition is nothing new among stablecoins, “de-pegs” are an unwelcome and novel eventuality as different projects fight tooth and nail to source the liquidity required to keep their coins close to the promised pegged value ($1 most of the time).

In this piece, we first give a brief overview of stablecoin issuance, followed by an analysis of stablecoins from a macroeconomic standpoint, before introducing quantitative insights about the recent activity that led UST to depeg and spread contagion in the digital asset market.

A brief overview of stablecoin economics

To better understand the issuance of fiat-backed stablecoins, consider each stablecoin protocol as a financial organization similar to a bank with assets and liabilities. The reserve assets (monetary units or investment securities) and liabilities (issued tokens) are matched 1:1.

However, things are different in the case of crypto-collateralized stablecoins because of the volatility of the collateral. If the value of cryptocurrency reserves falls, the system may become undercollateralized. As a result, if liabilities are in dollar-equivalent, the 1:1 backing will not hold. One way to solve this problem, and to keep the entire system safe, is to make reserve assets significantly larger than liabilities (over-collateralize). Although their exact mechanisms differ, this is how the Maker (DAI) and the Synthetix
(sUSD) protocols manage their risk.

As for algorithmic stablecoins, they are based on the idea that maintaining the value of the stablecoin over time is possible through the right set of incentives offered to market participants, in response to market conditions. In other words, the protocol itself contains provisions to defend the peg directly, as in the case for Celo Dollar (cUSD) and TerraUSD ($UST).
When it comes to non-custodial stablecoins (i.e. stablecoin that do not hold physical collateral), there are five key hazards:

Each of these can cause the stablecoin value to fall, possibly to zero. Because they are not formally backed by collateral, algorithmic stables like $UST are especially vulnerable to collateral risk. When there is a loss of confidence, such as when the general crypto markets falls, it may lead to a bank run or “death spiral”.

The robustness of a stablecoin depends on its ability to maintain the peg by reducing the spread between its “market value” and its “theoretical value“, i.e. the value of the currency the coin is pegged to. This ability is supported by two elements: the quality of market makers and the depth of the orderbook.

Stablecoin macroeconomics

In legacy markets, a currency peg is a means of securing a currency’s stability by tying its exchange rate to another currency. A notable example is the peg of the Chinese Yuan to the dollar, managed by the Chinese Central Bank, or the Swiss franc, whose peg to the Euro snapped in 2015. Currency pegs allow governments to develop a stable trading environment free of volatility, and to effectively operate an active control of monetary flows (e.g. balance of payments, foreign direct investment etc). As a general rule, government’s foreign currency reserves must be large in order to maintain a peg. This is because, if the government has to appreciate/depreciate its own currency, it may have to do so in the open market with its own reserves, in addition to traditional tools such as raising/decreasing interest rates.

A stablecoin is in essence a digital asset designed to keep its value by being pegged to a fiat currency such as the dollar or the euro, a commodity such as gold or silver, or another crypto currency. To keep the peg, the money supply of stablecoins is extended and contracted. When the price of a stablecoin rises in relation to the peg, the stablecoin’s money supply expands. Similarly, if the price of a stablecoin falls in relation to the peg, the stablecoin’s money supply contracts.
One recurrent risk for stablecoins, or any pegged currency, is the threat of an attack aimed at breaking the peg and profiting from price discrepancies (Soros’ 92). This risk has been present in legacy markets long before the emergence of blockchain technology and decentralised finance (DeFi), and is illustrated in modern economic theory by the concept of the “impossible trinity”. The impossible trinity (or unholy
trilemma) states that an authority (say a central bank) can only have two of the following at the same time, but never all three:

  1. Free capital movement (i.e. absence of capital controls): citizens of a country can diversify their assets by investing overseas, thanks to capital mobility. It also invites foreign investors to invest in the country by bringing their resources and expertise.
  2. A fixed foreign exchange rate (i.e. a peg): a fluctuating currency rate, which is sometimes influenced by speculation, can be a cause of larger economic unpredictability. A steady rate also makes it easier for households and businesses to participate in the global economy and develop long-term plans.
  3. An independent monetary policy: when the economy is in a recession, the said authority can raise and lower interest rates, and when the economy is overheated, it can cut the money supply and raise interest rates.

Source : Wikipedia

We turn now back to our crypto eco-system. It is crucial to understand the tokenomics behind both assets before diving into a quantitative analysis of the $LUNA and $UST debacle. The underlying protocol, Terra, operates with two tokens ($LUNA and $UST), and incorporates a virtual automated market maker (AMM). The objective is to keep those tokens in balance to maintain the $UST stablecoin’s peg. In addition to the “algo” part, Terra is supported by the Luna Foundation Guard (LFG) and its reserves.

Market participants can mint (e.g. create) $UST on Terra by burning (e.g. destroying) an equal dollar-amount of $LUNA and are incentivized to do so. Consequently, the price of $LUNA rises as the demand for stablecoins rises: the change in $UST demand dictates how much $LUNA must be burned. As this amount is subsequently burned, supply decreases.

As it happens, $UST’s adoption since the end of 2021 has been parabolic, thanks to Anchor, Terra’s lending and borrowing protocol, which offered annual percentage yields (APY) as high as 19.5% on deposits. This, of course, has resulted in a reduction of $LUNA’s supply, which decreased by 5% in January 2022 alone:

Market activity quantitative insights

Now that we are somewhat familiar with the tokenomics of these protocols, we can better understand the market behavior by first reading market activity then looking at anomalies and microstructure analytics on [include venues & pairs].

Earlier this year, the Luna Foundation Guard (LFG) raised $1 billion through a sale of $LUNA (its native token) to form a $BTC reserve, in order to maintain Terra’s stability and fund future developments. The establishment of a $BTC reserve was meant to reduce the possibility of a death spiral. So, instead of having to mint $LUNA to arbitrage the price of $UST, users can now exchange $UST for $BTC on Terra.

Swap BTC and UST

In April again, the LFG acquired an additional 37,863 $BTC for ~$1.5 billion, while the Anchor APY was reduced to 18%. During the same period, a massive $UST sell-off happened on Curve and Binance resulting in a small depeg that was aggravated by the withdrawal of roughly $2 billion from Anchor. The unfavorable timing has led many participants to speculate this was a coordinated attack to drive the stablecoin to depeg in order to either cripple the Terra ecosystem or trigger some sort of contagion that would result in $BTC to dip.

Historically, every known stablecoin has broken its peg at some point. Moreover, statistical evidence* shows that $BTC volatility is statistically stable with a finite theoretical variance, whereas stablecoin volatility is statistically unstable and responds to $BTC volatility synchronously.

(*) “On the stability of stablecoins”, Journal of Empirical Finance, vol. 64, 2021, Grobys et al. – Source

During the crash, the biggest volatility peak was observed at the beginning on May 9th at 6:20 pm. Many sale trades were observed, bringing the price down but immediately the market reacted and pushed the price back up, hence the high volatility. This selling pressure lasted exactly 1 min. The charts below show market activity for LUNA and UST on FTX, Kraken and Gemini over a few days prior to the crash (from May 5th to May 9th). Markets are still in “rebound mode” i.e., they tend to come back up even after severe down-moves, especially for UST:

Terra Luna price on FTX
Terra Luna price on Gemini
Terra Luna price on Kraken
Terra Luna price on Kraken UST

After May 9th, this “rebound” behavior disappears entirely, markets just “give-up” for LUNA, and UST trades at levels much lower than its peg value:

Terra Luna price on Gemini

When zooming closer at periods where activity is very surprising (to the point where our filters identify them as “anomalies”), here is one example of what we find on May 9th:

Terra Luna traded price and net traded volume with anomaly number 1

The biggest orders were sent in the middle of the crash. At 19:07 and 21:57:

Terra Luna traded price and net traded volume at 19:07
Terra Luna traded price and net traded volume

Following the crash, we observe a strong desynchronization between prices on FTX and Gemini, as can be seen below, where prices differed by more than $8 for several minutes. In addition, Gemini suffered a dramatic 9-fold decrease in market share on the LUNA-USD pair:

Terra Luna traded price on 05 10 2022
Terra Luna traded price on 05 10 2022 22:51
Terra luna rolling revenues

At the beginning of the crash, Gemini had a book twice as full as that of FTX, which can explain the large trades and other strange events observed on FTX. Logically, it was easier for manipulators to move the price on the market where the book was the thinnest. Following the crash however, the liquidity available in Gemini’s order book was almost non-existent.

Tether ($USDT), the crypto market’s largest stablecoin, also displayed symptoms of stress as Terra’s UST stablecoin imploded. It abruptly lost its $1 USD peg in early morning trading, falling as low as $0.95 before going back to $1.


On May 13th, block production on Terra was temporarily paused to prevent second-order consequences on network stability and governance caused by hyperinflating supply. Trading of $LUNA pairs was also suspended on some exchanges like Binance and Coinbase as it traded at less than a tick’s value.

In an effort to preserve the community and the developer ecosystem, Do Kwon (CEO of Terraform Labs, the company behind Terra) came up with the Terra Ecosystem Revival Plan. In order to significantly strengthen the liquidity around $UST peg, the LFG Council voted to loan $750M worth of $BTC to trading firms to help protect the $UST peg, and to loan $750M UST to accumulate $BTC as market conditions normalized. In addition, the foundation is looking to use its remaining assets to compensate current and past holders of $UST.

Distribution of LFG’s Reserve Assets as of 16 May 2022

On the 16th of May, Do Kwon published the Terra Ecosystem Revival Plan 2, where he imagines a fork in the Terra chain that will lead to a new chain without the algorithmic stablecoin. While the entire crypto-currency market has mixed opinions on this new experiment, it is clear once again that more scrutiny is needed to protect the small holder and protect the market from counterparty risk.

About SUN ZU Lab

SUN ZU Lab is a leading independent provider of liquidity analysis for investors already active or crypto-curious. We provide quantitative research on the liquidity of all digital assets to help investors improve their execution strategies and source the highest level of liquidity at the lowest cost.

Our product line includes research reports, software tools, and bespoke developments to fulfil the needs of the most demanding digital investor.

Liquidity Primer: an overview of Liquidity in Crypto Markets

The various types of crypto liquidity powered by sun zu lab

By Chadi El Adnani, Crypto Research Analyst @SUN ZU Lab

All seasoned investors know this for a fact: the first and foremost characteristic of a financial instrument is its liquidity. In its 4 th annual global crypto hedge fund report published recently, PWC confirmed that liquidity is indeed the most common consideration for crypto funds when choosing a trading venue (cited by 39% of respondents, see below). This percentage is significant and far above the next consideration, trading opportunities, at 18%. In the wake of this finding, we felt an overview of market liquidity with a focus on crypto markets was a good idea. Too often is the concept of liquidity overlooked or taken for granted, whereas in real life it is not only critical but difficult to quantify or elicit. In this article we provide general foundations about what liquidity is, its variations and manifestations

What are the most common considerations for crypto funds when choosing a trading venue?

Source: PWC 4 th annual global crypto hedge fund report 2022

What is liquidity ?

We focus in this article on market liquidity, which is a different concept from monetary liquidity: a company’s ability to meet its current liability commitments. Liquidity is defined as the ability to buy or sell large quantities of an asset without significant adverse price movement. It is an important factor that investors need to assess before executing their trades, since it is a clear constraint on how quickly they can gain access to the market and subsequently how fast they can lock in a profit from a particular asset.

There exists different types of market liquidity:

We identify at SUN ZU Lab three different types of market liquidity: transaction liquidity (post-trade), order book liquidity (pre-trade) and invisible liquidity. Those notions are additive, in the sense that all three exist at the same time for a given instrument. Yet there is a timing dependency between them: invisible liquidity needs to become visible (pre-trade) before it can be consumed (post-trade).

Derivatives markets, whether in crypto or TradFi, enjoy far more liquidity than spot markets. The Bitcoin futures market, for example, saw average monthly turnover of $2 trillion at its peak, a far greater figure than BTC spot markets’ volumes. Liquidity is not only variable in time, it is also distributed in space across multiple venues. Our data shows for example that BTC trading volumes are fragmented across exchanges, as seen in the graph below (limited to 5 exchanges, and in reality there are many more creating an even higher degree of fragmentation).

Crypto Liquidity | turnover repartition powered by SUN ZU Lab

Source: SUN ZU Lab data

Transaction liquidity:

Transaction liquidity refers to liquidity that has been expressed through actual trading volumes. This is an important indicator as high trading volumes usually imply less difficulty to buy or sell large quantities. Among the most liquid markets we can cite the forex market, thought to be the most liquid in the world as major currency pairs are traded by governments, banks, and even individuals. The stocks and commodities markets are very liquid as well, although intuitively no large cap or bond will ever be as liquid as a national currency.

Source: data from Yahoo Finance

In the graph above, we show daily trading volumes in 2022 for the S&P 500’s most liquid ETF, Spider SPY, as well as BTC-USD and ETH-USD. The S&P 500 ETF is one of the most liquid instruments in the world, with $30 to $60 billion traded every day. Data shows that Bitcoin and Ether’s daily trading volumes vary in range between $10 and $40 billion.

These figures however need to be taken with a grain of salt due to various sources reporting that officially announced crypto trading volumes are greatly overestimated with the magnitude of fake volumes varying over time.

Order book liquidity (pre-trade):

Order book liquidity represents the total nominal (price * quantity) visibly offered across all available trading venues. This liquidity materialises as different buy/sell quantities sent by investors at different prices. Across all buy orders, the best price is referred to as “best bid”, and the “best offer” on the other side across selling orders. The mid price is quite logically the middle of those two.

A visible order book represents the underlying supply and demand of an asset in the form of individual bid and ask orders. To illustrate this, here is a chart compiled by SUN ZU Lab showing how average liquidity aggregates around mid-price for BTC-USD on three main exchanges: Bitstamp, Kraken and Binance-US on the 22 nd of June, 2022.

Crypto Liquidity | Average market depth powered by SUN ZU Lab

Source: SUN ZU Lab data

The chart reads as follows: each bar represents the average quantity of BTC (in number of BTC) offered for buy/sell orders. For example, there were on average 200 BTC offered for sale at 80bps from mid-price on the three exchanges against around 210 BTC bid offers at -80bps from the mid-price.

Order books communicate information about investors expectations and appetite. In particular there appears a new concept to qualify liquidity: the bid-ask spread, which is the difference between the highest price a buyer is willing to pay for an asset and the lowest price a seller is willing to accept. The magnitude of this spread gives a good indication about an asset’s liquidity. For example a large spread indicate poor offer and/or demand, and incidentally may drive the volatility higher. Conversely a narrow spread is an indication of a deeper market where investor’s interest is high, and volume potentially abundant for buyers and sellers to execute their trades. Bid-ask spreads for Bitcoin, for example, used to be higher than 10% in the early days of crypto, but they have dropped massively to as low as 10bps on the main exchanges as crypto adoption, investor interest and trading volumes increased over time.

Invisible liquidity:

We refer to invisible liquidity as all forms of liquidity that is not captured in public trades or order books. Note for example that liquidity exposed to a limited set of investors would qualify here as invisible liquidity (more on this below).
In general terms, the taxonomy of “invisible liquidity” is extremely difficult to establish as it depends on the structure of the market. In markets where OTC activity is high, those trades and the interaction of brokers with their client are compartments of invisible liquidity.
One could argue that those compartments divert liquidity away from other pools, yet not all investors have access to it. In markets where OTC is not developed, those liquidity pools simply do not exist.

In the world of crypto, we distinguish the following categories:

Non-communicated, invisible orders: quantities available for trading that are yet to be communicated by investors to the markets. There is virtually no way to quantify these volumes as they only exist in a theoretical state in strategy books of portfolio managers.

Communicated, invisible orders: we put in this category for example trading activity of dark pools, also known as Alternative Trading Systems (ATS). These are private marketplaces where investors place buy and sell orders, without the venue disclosing available prices or volumes. Liquidity has found its way to the marketplace, it is just not visible (by anybody).

Communicated, partially-visible orders: quantities available for purchase or sale, expressed through an Indication of Interest (IOI), which refers to an investor’s non-binding interest in a security, usually communicated to a broker. In traditional markets, IOI are heavily regulated because, depending on applicable rules, they constitute visible or invisible liquidity. The regulators’ particular interest on this
compartment stems from the fact that liquidity visible only by a few agents is easily manipulable.

DeFi liquidity: this is liquidity placed on decentralized exchanges (DEXs) without being incorporated into order books. We will dive more in detail into how liquidity pools in DEXs work in another article.

On-Chain Liquidity: centralized exchanges (CEXs) rely on the “order book” mechanism to enable off-chain transactions: aggregate positions are “written” on chain only when investors transfer their positions out of exchanges (and de facto reclaim ownership of those on their wallets). Pure on-chain transactions today account for a relatively small percentage of total volumes. Decentralized exchanges (DEXs) are another form of on-chain liquidity, that relies on smart contracts to execute trades automatically, recorded directly (and immediately) on blockchains.

Data from Chainalysis shows that DEXs have surpassed CEXs in terms of on-chain transaction volume in January 2021, with a $175 billion volume sent on-chain to CEXs from April 2021 to April 2022, vs. a $224 billion volume sent to DEXs during the same period.

Peer-to-Peer Liquidity: P2P is a type of crypto exchange trading that allows traders to trade directly with one another without the need for a centralized third party to facilitate the transactions. This method allows exchanging parties to select a preferred offer and trade directly without using an automated engine to execute transactions.

Liquidity risks

The main liquidity risk associated to markets is for investors not to be able to enter/exit their positions due to a lack of sellers/buyers offering a fair price. One of the markets where this type of risk is the most visible is the real estate market. During times of economic turmoil or bad real estate market conditions, it could become impossible to find a buyer at the right price even though the property may have obvious value. A perfect example for this is the experience of NBA superstar Michael Jordan in trying to sell his Chicago mansion that has been on the market for 10 years already! The over-equipped luxurious house was originally listed for $29 million, before the owner was obliged to cut the price nearly in half overtime to try and match market expectations.

There is also another psychological effect that comes into play with illiquidity; the longer an asset is listed for sale, the more potential buyers are keen to second-guess their decision as the lack of interest and competition over the asset drives its value lower.

All of this has been extensively studied in traditional finance, and has become known as the “liquidity premium”: there is a clear relationship between price and liquidity. The higher the liquidity, the higher the price. This is the reason why real-estate prices are often subject to discount when economic conditions are under stress. We provide links to research articles about this subject in the appendix.


Liquidity is one of the most important concepts for individuals, institutional investors as well as exchanges and market makers. Despite holding high-value assets, any of these entities may experience a liquidity crunch if such assets cannot be sold within a short period. This is turn create heavy pressure on prices.

Top crypto projects’ tokens such as BTC, ETH, BNB or SOL appear to have reached a reasonable level of liquidity, but this is not the case for the vast majority of tokens that are only listed on one or two exchanges, with very low daily trading volumes and market depths. Above all, liquidity of the entire crypto market is still nowhere near liquidity levels visible in traditional markets.

Questions and comments can be addressed to or


About SUN ZU Lab

SUN ZU Lab is a leading independent provider of liquidity analysis for investors already active or crypto-curious. We provide quantitative research on the liquidity of all digital assets to help investors improve their execution strategies and source the highest level of liquidity at the lowest cost.
Our product line includes research reports, software tools, and bespoke developments to fulfil the needs of the most demanding digital investor.

Transaction Cost Analysis: the answer to all hidden costs behind crypto trading (1/2)

Transaction Cost Analysis by Sun ZU Lab

By Chadi El Adnani, Crypto Research Analyst @SUN ZU Lab

The “odd-eighth quotes” phenomenon

To introduce this article about Transaction Cost Analysis, we first revisit a very famous historical case. Before decimalization, the US stock market tick size used to vary by increments of 12.5 cents. This means that all prices were quoted in eighths of a dollar (ex. $12 or $12 1/8). However, on May 26 and 27, 1994, several US national newspapers reported an article that first appeared in the Journal of Finance (“Why Do NASDAQ Market Makers Avoid Odd-Eighth Quotes?”, by Christie, Harris and Schultz) raising the question of the width of the range of prices quoted by NASDAQ market makers. The researchers had found that the prices quoted to investors were almost systematically 1/4 ($0.25) apart, thus avoiding the minimum allowable 1/8 spread ($0.125)

To get a first grasp of the implications of this situation, we need to highlight that the range quoted by market makers is a good indication of the maximal margin they intend to capture. So by quoting a stock at $12 – $12 1/4 (i.e. they are willing to buy at $12 and sell at $12.25), instead of the allowed $12 1/8 – $12 1/4 range, market makers are refusing to decrease their margin bellow $0.25. So what would prevent market makers from avoiding odd-eighth quotes on 70 out of 100 actively traded NASDAQ securities, including Apple Computer and Lotus Development? The authors found no explanation and concluded that the situation was probably the result of implicit collusion among the participants to maintain wide spreads.

Surprisingly, On May 27, dealers in Amgen, Cisco Systems, and Microsoft sharply increased their use of odd-eighth quotes leading effective spreads to fall “magically” by nearly 50%, this pattern was repeated for Apple Computer the following trading day. Noticing these weird trends, the same authors published a new article a few months later to reconduct their investigation (“Why did NASDAQ Market Makers Stop Avoiding Odd-Eighth Quote?”). Using individual dealer quotes for Apple and Microsoft, the authors found that virtually all dealers moved in unison to adopt odd-eighth quotes.

These strange findings led thousands of individual investors to file a class-action lawsuit against 30 brokerage firms, including Merrill Lynch, Goldman Sachs and Morgan Stanley, which agreed in 1997 to pay about $900 million in what was called at the time the biggest settlement ever of a price-fixing lawsuit. 

What is Transaction Cost Analysis?

What the researchers behind the article have provided is part of what is known nowadays as Transaction Cost Analysis (TCA). Transaction costs have become a relevant issue in Europe for example since 2007 with the implementation of MiFID (Markets in Financial Instruments Directive). The introduction of the best execution obligation gave TCA a central role, aiming for investment firms to “take all reasonable steps to obtain the best possible result when executing orders for their clients”. Moreover, MiFID’s Article 21 of Level 1 and Article 45 of Level 2 require investment firms to provide their clients with “appropriate information” about their execution policies. Clients wishing to select a firm to deal with from among a competing group need to have sight of the relevant firms’ execution policies in order to evaluate whether a particular investment strategy is suitable. By requiring ex-ante disclosure of the execution policy, MiFID addresses clients’ information needs; they should always be able to pay the lowest possible net cost (or receive the highest possible net proceeds).

Transaction Cost Analysis (TCA) is the study of trade prices to determine whether trades are arranged at favourable prices (low prices for purchases and high prices for sales). The difference between the cost of the transaction at the time the manager decided to execute it and the actual cost is at the heart of TCA, including all operating charges, spreads, commissions and fees. The resulting differential is called “slippage”.

There are usually 9 components identifiable when dealing with transaction costs, they can be classified as per the following chart:

Implicit transaction costs by SUN ZU Lab

Implicit transaction costs:

Market Impact and various Opportunity costs detailed as follows:

Explicit transaction costs:

Brokerage Commisions, Market fees, Clearing and Settlements costs, Missed Trade opportunity costs, Bid-Ask spread detailed as follows:


The same transaction costs exist for crypto trading as well but suffer from a severe lack of transparency. The Markets in Crypto-assets (MiCA) regulation in its latest version comes however with a “best execution” obligation that should force digital assets service providers down the same path as their TradFi peers. This obligation should come with extensive quantitative analytics of order execution prices, leading to increased competition among trading venues and liquidity providers. When that day comes, institutional and retail crypto investors should be able to rely on Sun Zu Lab’s advanced and completely independent liquidity analytics to provide much-needed transparency to the crypto ecosystem. 

In the next part of this article to be published, we will look at pre and post-trade TCA and analyse how this process actually works and how it helps an investment manager save money.

Questions about this article can be addressed to or


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SUN ZU Lab is a French Fintech that aims to become the leading independent provider of digital asset market quantitative analytics tools and services. Leveraging the founding team’s 70+ years of experience in international capital markets and trading technology, SUN ZU Lab provides crypto professionals with unprecedented liquidity analytics in the form of quant reports, dashboards, real-time augmented data feeds, and bespoke studies.

What is Tokenomics and why does it matter?

A brief historical perspective to better understand the stakes behind tokenomics

Let’s start this article with the famous experience of Philip II, King of Spain in the 16th century, with the Eldorado discovery and the massive rise in inflation that followed throughout the entirety of Europe!  

In the 16th century, Spain conquered Latin America and discovered an immeasurable wealth within gold and silver mines. The kingdom hit the jackpot and its financial deficits appeared long behind it. This wasn’t the case nevertheless; the problem came from the fact that the Crown of Spain was over-indebted to many European creditors, leading the massive silver and gold discoveries to only make a quick passage through Spain before enriching the coffers of its French and Dutch neighbours. The European market ended up being flooded with coins, so that the immense Spanish wealth was diminished relative to other European kingdoms.

In the end, the excessive amount of silver and gold imported, and above all distributed, in Europe caused an important devaluation of what Philip II could think of as his Eldorado. A better financial management could have allowed him to preserve his reserves of invaluable minerals and thus be able to develop on a more important scale of time his fabulous treasure.

This story shows the importance of the quantity put into circulation on the valuation of an asset. This analysis works perfectly for the cryptocurrency market as well, any analysis of an asset’s ecosystem requires careful attention to the notions of quantity in circulation, total quantity and inflation management.

Inflation and the importance of tokenomics

While the media usually describes inflation as a rise in the price of everyday consumer goods, it is in reality the value of money that tends to fall rather than prices getting higher. This notion of inflation is at the heart of tokenomics, a merger of “token” and “economics” used to refer to all the elements that make a particular cryptocurrency valuable and interesting to investors. In this regard, there exist two predominant models: deflationary and inflationary tokens.

This is the model used by Bitcoin, i.e. a fixed total supply and less and less money issued over time. Many cryptocurrencies are governed under this model, like Solana, Litecoin, Tron, and many others alongside the king of cryptos.

In the case of Bitcoin, for example, a block is mined about every 10 minutes, rewarding the miner 6.25 BTC (when Bitcoin started it was 50 BTC per block, then 25, 12.5, 6.25, etc). The reward is halved every 210K blocks, leading to a halving every 4 years with the 10 minutes mining-time per block assumption. Without changes to the protocol, the final Bitcoin will be mined around the year 2140.

Many blockchains have been coded without incorporating a limited amount of token issuance. This choice can be made for a variety of reasons, usually involving the use to be made of the blockchain in question. The Ethereum protocol for example operates under this model. However, some mechanisms are put in place to limit inflation, or even to create a deflationary system.

This is the objective of the implementation of future updates of the Ethereum network: while the annual rate of ETH tokens issuance is currently equal to nearly 4.5%, the switch from Proof of Work to Proof of Stake should allow developers to reduce this rate to less than 1%. The network introduced as well a burn mechanism, meaning that part of the fees paid by Ethereum users in the future will not be returned to validators, but will be removed altogether. This could not only achieve a balance with the issuance rate, but potentially lead to a decrease in the number of tokens in circulation in case of high network usage.

Both models have their strengths and weaknesses with good justifications behind their use. For example, the Ethereum white paper indicates that a stable issuance rate would prevent the excessive concentration of wealth in the hands of a few actors/validators. Whereas Bitcoin’s deflationary system, as previously stated, allowed for the growing development of its ecosystem by paying miners large amounts of Bitcoin when it was not worth the tens of thousands of dollars it is worth today.

More generally, it is always a good idea to look into a project’s tokenomics before getting involved. This can help answer questions like:

Main differences between deflationary and inflationary tokens:

Solana case study

Let’s take a deep dive into one of the most prominent blockchains’ tokenomics. Solana has a native token called SOL that has two primary use cases within the network:

The Solana team distributed tokens in five different funding rounds, four of which were private sales. These private sales began in Q1 2019 and culminated in a $20 million Series A led by Multicoin Capital, announced in July 2019. Additional participants included Distributed Global, BlockTower Capital, Foundation Capital, Blockchange VC, Slow Ventures, NEO Global Capital, Passport Capital, and Rockaway Ventures. The firms received SOL tokens in exchange for their investments, although the number of tokens allocated to investors was not disclosed.

The initial distribution of SOL tokens was as follows:

Source: compiled by SUN ZU Lab from web sources

According to Messari data, vesting schedules were as follows: Solana’s three pre-launch private sales all came with a nine-month lockup after the network launched. The project’s public auction sale (held in March 2020) did not come with a lockup schedule, and the SOL tokens distributed in that sale were fully liquid once the network launched. The founder’s allocation (13% of the initial supply) was also subject to a nine-month lockup post-network launch. After the lockup period ends, these tokens will vest monthly for another two years (expected to fully vest by January 2023). This last clause is a good protection for investors as team members’ tokens are locked-up for a longer period. The Grant Pool and Community Reserve (both overseen by the Solana Foundation) contain ~39% of the initial SOL supply combined. These allocations began to vest in small amounts since Solana’s mainnet launch.

Inflation stands at an initial annual inflation rate of 8%. However, this inflation rate will decrease at an annual rate of 15% (“dis-inflation rate”). The inflation decrease is thus non-linear and much more important in the first years. Solana’s inflation rate will continue to decrease until it reaches an annual rate of 1.5%, which the network should reach in about ten years or 2031. 1.5% will remain the long-term inflation rate for Solana unless the network’s governance system votes to change it.

Proposed Inflation schedule curve – Source:

Major identified issues with current projects’ tokenomics

Using the Solana example, we can see that more than 50% of the tokens in circulation are concentrated, during a long period after the project’s launch, in the hands of the core team, VCs and early investors. This is hardly an exception to Solana as similar distributions are very common within the blockchain ecosystem projects. Can we talk seriously about the benefits of blockchain decentralization with such capital and governance concentration, without forgetting technical knowledge concentration as well?

Blockchain projects often come with varying lock-up periods that can last from less than a year to five years for early investors and the founding team, who usually cash out their investments after this period. What we identify as a significant issue after the end of the lock-up period is the huge and asymmetric risk-return transfer between this first group, which realized a pretty good return on their initial investments and are completely de-risked at this stage, and retail investors joining the project at a stage where core decision-makers are no longer incentivised to ensure the well-functioning of the project.

Cryptocurrency projects often use ICOs (Initial Coin Offering), among other fundraising techniques, to raise funds through the issue of crypto-assets in exchange for either fiat currency or an established cryptocurrency like bitcoin or ether. The issuing entity usually accounts for digital assets collected as an intangible asset, or as a financial instrument in the case of stablecoins for example as they are redeemable for cash. The accounting for tokens distributed on the other hand depends on the promise given to investors under the terms of the ICO, which could include: free or discounted access to the entity’s goods or services for a specified or indefinite period of time; a share of the profits of the entity or access to an exchange through which it can transact with other users of the exchange in buying goods or services. Digital asset projects may also offer equity tokens, which are a type of security tokens that work more like a traditional stock asset, giving their holders some form of ownership in their investments. The use of these equity instruments remains restricted nevertheless, raising the question of the rights and guarantees given to retail investors in particular in exchange for the funds given to the cryptocurrency project?   

What we refer to as double-dipping practices, in this case, relates to VCs investing in cryptocurrency projects and realising important capital gains on their equity shares as well as digital token holdings. This privilege is almost unique to the cryptocurrency ecosystem, raising some questions again about asymmetric information advantages against retail investors: compared to traditional VC funding, crypto VC investors enjoy a double economic as well as governance advantage, having control over token and equity.


Tokenomics is an important aspect of cryptocurrency which covers almost anything to do with the token. Professional as well as retail investors should spend a lot of time studying a project’s tokenomics before investing to be well aware of the financial and governance rights attributed to them via the token purchase. There is an absolute need in our view for regulation on this particular topic to evolve in order to provide better transparency and eventually protection levels for investors.

This article has been written by Chadi El Adnani – Crypto Research Analyst @SUN ZU Lab

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Our product line includes research reports, software tools, and bespoke developments to fulfil the needs of the most demanding digital investor.

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Tether Reserves: at it again

So much for “Unrivaled transparency”

As a capital market professional, I have expressed before (here) how skeptical I was about Tether and its so-called “transparency”. For all intent and purposes, Tether looks more and more like a traditional bank with “fractional reserves”, a very ancient and old-fashioned way of operating a banking business, in which the bank doesn’t hold reserves for all the money it has issued (ignoring for a second the underlying fraud that this situation constitutes in the case of Tether). For a newcomer supporting the total disruption of finance as we know it, the resurgence of a centuries-old business model is somewhat ironic. What’s even more ironic is that the old way in banking is fundamentally built on trust. Remove trust and the entire system collapses through bank runs. The blockchain technology is supposed to take us away from traditional trusted third parties. And yet here we are, asking questions about Tether reserves, which fundamentally Tether cannot answer without the certification of…a trusted third-party.

As requested in the settlement with the Attorney General of the State of New York, Tether just disclosed the breakdown of its reserves as of 3/31/2021, here. The reader will appreciate the conciseness of this report,1 single page, 2 charts — no more, no less. We are not lost in details. Considering the annual report of any decent bank today is 400-page long and quite incomprehensible, the fact that Tether operates outside any sort of regulation simplifies the task. It has been said before: the list of gaps is staggering — no risk analysis, no indication of yield, no performance measurement, no mention of who is in charge, etc, etc. And still, no audit certification, no contact information, no signatory. Good luck to all of us with questions.

The story has been picked up by mainstream media, for example, the Financial Times a few days ago (“Tether says its reserves are backed by cash to the tune of . . . 2.9%”). That anybody would buy Tether in these circumstances is extraordinary. And this is exactly what one of our clients asked us last week: “if Tether is such a big concern, why does it still trade at $1? If markets were even somewhat efficient, its value would have adjusted with the perceived risk no?”. Indeed, this is a legitimate question. After reflecting on this for a few days, here are some answers, the only ones I can provide in fact:

Where is the truth? What is going on with Tether, and more importantly do we really have a way of knowing? Probably no without the help of a proper due diligence process, and only regulators have the power to make this happen. 

Crypto Risk Assessment: Way to Go

Last autumn I had the pleasure of giving an introductory course on financial risk management at IAE in Bordeaux. The purpose was to provide students with a general understanding of what financial risk looks like, and what it means to “manage” risk. 

Naturally, as part of the course, I had to offer a typology of financial risks i.e. a list as exhaustive as possible of all risks, their magnitude, likelihood, and to some extent the way to mitigate them. 

The result is the table below: it is naturally a simplification, but not an excessive one. Listed are the risks by type, with the space of instruments they apply to, some simple ideas about possible mitigation, the first order of magnitude, and examples of things gone bad whenever possible:

The magnitude scale is as follows (applied to capital at risk, whether it is a nominal amount for cash products or notional amounts for derivatives):

The individual links do not appear in the image, so here they are with underlying URLs:

Now it is beyond the scope of this article to go deeply into each risk, but one remark is in order: the table above could be much redder, and was such in fact not too long ago. Indeed, many of the risks have turned out to be manageable because the industry has structured itself to address them. I have written before about the operational governance in capital markets, this governance is the result of a long slow evolution. A lot of money has been invested (and still is) into market infrastructure, to vent several types of risks out of the system.

A few examples to illustrate the point: independent clearinghouses, heavy regulation of depository institutions, SWIFT massaging infrastructure, standardized master agreements (notably from professional organizations such as ISDA, ISLA, ICMA, etc), delivery-vs-payment settlement to name but a few.

What’s the situation in the realm of digital assets? Are we better or worse in an ecosystem that is much younger, and not yet dominated by highly-capitalized international financial institutions? Supposedly fintech are nimbler and consequently more adaptable.

The table below summarizes the main differences (well, at least as I see them): 

Like before the links have disappeared in the picture, here they are:

Naturally the above is subjective, and I am quite certain many bitcoin proponents would object. Regardless, there is little doubt that it is redder than the previous table, and for good reasons: most of the infrastructure in place in traditional markets doesn’t exist in crypto. For example, exchanges are “custodial” i.e. you need to deposit both fiat and crypto before you can trade. There is no single (cash) exchange in traditional markets that accepts deposits from its members and/or participants.

The question of settlement and money flows is addressed somewhere else in the industry (that’s exactly why clearinghouses have come to exist, and those do require deposits from the select firms they accept as members). Even when you settle a trade with a stable coin such as Tether, you still carry the specific risk of Tether. The same applies to derivatives: in the absence of a central clearinghouse, exchanges manage the entire process, and there can be no assurance for an investor that he will be able to recoup his funds should the exchange go under. 

Reward doesn’t go without risk and vice versa. The reason why crypto is such a gold rush right now is exactly this: risk is high, widespread, and probably very poorly understood. Investors who made a lot of money should probably ask themselves: what risk did I really take? Am I out of the woods now? Which one(s) do I want to take going forward?

To end on a positive note, one risk has disappeared, and that’s for the better: the systemic one. If bitcoin went to 0, or if a large crypto participant went under, chances are the overall economy would not suffer much. This incidentally is why regulators worldwide still do not want to intervene. They are vigilant, suspicious because part of their mandate is to protect the “small” guy. But from a risk standpoint, they can still afford to let the crypto space mature and regulate itself.

Tether as a Central Bank

Central banks routinely issue money without any reserve backing it. Could Tether do the same and become the first decentralized central bank?

I have expressed before skepticism about Tether (a.k.a USDT) and the fact that a high level of uncertainty still exists on the actual level of reserves backing the token issuance. For all the bad press this uncertainty has created however, a similar situation has occurred regularly in history. Before central banks became the norm, many commercial banks and governments took liberties in issuing money, if only to finance recurring war efforts here and there. In fact couldn’t the same be said of central banks today after the financial crisis of 2008 and the COVID economic disaster of early 2020?

At the end of WWII, to avoid a repeat of past monetary crises and install stable foundations for reconstruction and international commerce, governments of developed economies formed and adhered to a new monetary pact, the Bretton-Woods system.

The Mount Washington Hotel where the Bretton Woods conference took place from Jul. 1st to Jul. 22nd 1944

The idea was simple: fix exchange rates between the most important currencies, and back every dollar in circulation with a measurable and controllable inventory of physical asset, and you immediately choke inflationary pressures. Furthermore you prevent political agendas to interfere with monetary policy (in the form of trade wars for example).

The asset chosen for Bretton-Woods was gold, a natural choice at the time. With significant yet slow-growing supply, gold was already a commodity actively traded, and for which trade and storage were already well organized. The final element in the equation was convertibility: anybody in possession of gold could obtain dollars (or any other currency) and vice-versa, at a fixed exchange rate. In reality only governments and central banks were able to convert, a restriction which de factor created two distinct marketplaces for gold: one for central bankers, one for private participants. Convertibility was not an easy feat: it took more than 10 years to fully deploy because of its impact on each participant’s ablitity to control its flow of capital on international markets. Western European economies enforced convertibility in 1958, only when they were strong enough to accomodate free-floating capital flows.

The result was quite remarkable, a period of previously unknown financial stability which in turn paved the way for massive economic growth. For 30 years, the world enjoyed exceptional growth and a quasi-absence of financial crises:

Source: “Banking Crises: An Equal Opportunity Menace”, Carmen M. Reihnart, Kenneth S. Rogoff, NBER Working Paper 14587.

Imbalances were quick to appear though, for reasons intuitively simple: the dollar effectively became the currency of reference and was in high demand. That demand was not fulfilled by a rise in gold supply. The gap between the two created an arbitrage between prices for central bank gold vs. private markets and an unsustainable drain on the US gold reserves:

Author: Alexander Zhikun He, from Wikipedia

In 1971 Nixon unilateraly suspended the gold/dollar convertibility and a system of floating exchange rates progressively imposed itself.

Now what does it all have to do with Tether? Well, Tether is effectively used as a settlement currency for bitcoin transactions. Many crypto exchanges do not even list BTC pairs against fiat money. The rise of bitcoin to $60,000 was accompanied by a massive issuance of Tether (and other stable coins incidentally). [NB: there are two reasons for this: one is technical (it is far easier to settle a BTC/USDT transaction than a BTC/USD one), the other reglementary: USDT being totally unregulated, anybody can conduct business using it, whereas conducting business in USD immediately puts you in the perimeter of US regulators].

In the crypto eco-system, Tether is the equivalent of the US dollar in the financial system at the end of WWII: it is the currency that flows throughout the system and enables participants to trade when and where they want. The actual US dollar is the equivalent of gold in Bretton Woods: the undisputed store of value, from which all other currency units draw their value. We have a fixed exchange rate (1 tether = 1 USD) and convertibility at will: look no further, this is a mini-Bretton Woods.

What if Tether announced tomorrow that they don’t want to enforce convertibility anymore, and oh by the way, “we don’t really have a 1-to-1 reserve pool”? The company could keep issuing USDT as it sees fit, feeding the marketplace with enough liquidity to “keep it going”. If indeed all USDT holders consider they have good reasons to hold Tether, because it helps them trade, there’s is really no reason for them to dispose of it. A “Nixon shock” whereby Tether would announce it will not enforce the 1-to-1 parity anymore could be followed by a new rule of floating exchange rate. Would there be a fundamental problem with that? Abolutely not. When Nixon announced the US would not enforce parity anymore it was a unilateral decision, and there’s no doubt there were immediate winners and losers. It was a shock, economically and politically, yet it was not the end of world. The resulting role of Tether would be that of a de-facto all-powerful central bank, controling the reference currency of the crypto eco-system. Quite an enviable position if you ask me.

So why don’t they? As interesting as it sounds, this idea raises a few issues:

  1. a floating exchange rate means that some people will have lost a lot of money. Contrary to Bretton Woods populated by Secretaries of State and Central Bankers, Tether is a private company and unpegging its USDT from the dollar would amount to nothing less than a fraud if the company was not in a position to repay USDT holders according to the original promise. Now of course, how is that original promise contractualized? What is its legal strength, what could an individual do in front of such a situation? This is difficult to say with certainty, it depends (surprise surprise) on the specifics of Tether situation and on the wording of the (legally binding?) documents behind its token.
  2. Bretton-Woods was a matter of international public policy, Tether is an unregulated private agent. How trustworthy is it? If it changed the rules once, could it do it again?
  3. Central banks are extraordinarily transparent. Their charter dictates what they can and cannot do, their operations are usually referred to as “open market” because they are indeed performed in plain sight on open markets. Rules are disclosed, available to all and applicable to all. Their balance sheet is also pubicly available (even though it is after the fact, but it is difficult to operate otherwise). The standard of transparency is so high because of the power they hold over the economy. Would Tether, entrusted with such power, be willing to hold itself to such a standard? Track record so far is not great to say the least.
  4. In the end, the Federal Reserve is chartered by its national government (the same is true of all central banks). I honestly don’t know if the notion of “public good” is explicit in its charter, but certainly enforcing monetary stability and acting as a lender of last resort both serve public interest. The role of central banks in 2008 and post-COVID is an undeniable testimony to that. Would Tether be willing to commit itself to the promotion of a greater good — as opposed to the promotion of personal interests, whatever those might be? How would we convince ourselves once and for all that it is indeed the case?
  5. The Federal Reserve draws its legitimacy from the confidence the general pbulic puts in the rule of law and military power of the US (the same goes for the US dollar). Where would Tether draw its legitimacy from? Not quite an easy answer there.

A central bank is the ultimate government-sponsored trusted third party. The crypto eco-system was born in part on the rejection of the “government-sponsored” part, on the idea that it would be possible to build an “algorithmic” trusted third party bypassing the existing financial system and devoid of interference from governments. Can Tether rise to the challenge?

Is Tether a $48 bln scam?

Is Tether as scam by SUN ZU Lab

For those who follow the Tether story, there’s been a recent development worth mentioning: the publication of an audit of Tether reserves by a third-party. The statement is available for download on their front page. Tether does have a page with a statement of account (here), but as it is unaudited and uncertified it is not worth much.

There’s been a lot of discussion about whether Tether is a scam of gigantic proportion, but overall those suspicions have had little effect on the rhythm of issuance, reaching today almost $48 bln judging by the latest official figures on coinmarketcap. The immediate and intuitive reaction to this figure is that it’s too big to be anything but real. How could one possibly get away with a scheme of that magnitude?

Unfortunately, it has happened in the past: Madoff (estimated losses $18 bln), Parmalat (when the scandal broke $4 bln were missing), Wirecard ($1.9 bln missing), Enron ($40 bln bankrupcy case following a corporate Ponzi scheme for more than 10 years, during which Enron was celebrated as one of the most innovative US companies). No, size is no guarantee of legitimacy or righteousness.

It is not the intention of this article to state that Tether is or is not a scam, although there are some troubling indicators (see for example the report from New York Attorney General. Tether settled for $18.5 million and was forbidden to conduct business in the State of New York). It belongs to each and everyone of us to build his or her own opinion. I have written before about the typical information an investor should want to acquire about an exchange before opening an account, the purpose of these lines is to apply a similar test to Tether by asking a few basic questions. With 25 years of capital markets experience under the belt, I submit that those questions should be investigated carefully by anybody interested in transacting Tether.

Well, we don’t know. The legal page mentions two legal entities “Tether International Limited” and “Tether Limited”. There is no address, no contact information, no place of incorporation, no regulatory entity. In the privacy policy we learn that Tether is registered in the British Virgin Islands (BVI) under the number 1939633, with a point of contact in Europe at Chaucer Group Limited, whose registered office is at 10 Lower Thames, London, EC3R 6EN. Still no official address or name, no direct contact information.

The management team shows 3 persons: no email address, no contact info, no linked in profile. On LinkedIn Tether lists 9 employees, among which none of the 3 persons listed on the site appears. In fact CEO, CFO and General Counsel do not appear to have a linkedin profile. Granted, not everybody has a linkedin profile, but for a company entrusted with $48 bln from its clients, all of this is a little…light. Or maybe the site is not fully up to date? No comment.

There are two statements of transparency on Tether’s site: one dated June 1st 2018, the latest one dated Feb 28th 2021. Now a closer look at those documents:

The June 2018 statement is issued by what appears to be a reputable law firm based in Washington. Although a name is given on the letter, it is for reference only, there is no identified signatory, nor is there any mention of an individual personally responsible for the document. This incidentally is often a legal if not ethical obligation from auditors and/or accountants. For example after scandals such as Enron, auditors have to sign their name as an acceptance of the responsibilities they bear in certifying corporate accounts. The list of documents made available to the task force in charge of establishing the letter looks exhaustive and convincing. Strangely enough however, the list doesn’t explicitly mention banking statements. It also doesn’t explicitly mention the names of the two banks concerned. The form of the letter is also unexpected: it is not a public announcement, nor is it meant to be. It is explicitly a “client-attorney communication”, marked as “privileged and confidential”. Also, the document states that “FSS procedures performed are not for the purpose of providing assurance…”. What then is the purpose of this document? It is clearly a step in the right direction but almost raises more questions than it answers.

The Feb 2021 statement is issued by an accounting firm based in the Cayman Islands, “Moore Cayman”. Why not call upon FSS to perform an annual review to establish consistency? What happened between 2018 and 2021? No answer is provided to any of those questions. Like the FSS letter, the Moore document is not signed. Like 2018, none of the financial institutions where the money is deposited are named, nor do we know in which jurisdiction they operate or whether they are even regulated. Like 2018 the statement applies to one point in time, not before, not after. No information is provided as to the beneficial owners of the funds, i.e. which Tether entity has legal responsibility on the corresponding bank accounts. Tether Holdings Limited is mentioned, what is the relationship between this entity and the ones mentioned on Tether’s web site? There is no address, no contact, no email address not even for press inquiries (incidentally the press section doesn’t show anything beyond 2015, which is surprising for a supposedly highly successful company). Moore Cayman may be a reputable firm, but it is fair to say that it absolutely unknown. Recent scandals show that calling upon large internationally recognized law and accounting firms doesn’t guarantee that everything will be ok, but still it goes a long way.

Tether is entrusted with $48 bln from its clients, the least you would expect is to have some indication on how this money is managed. Furthermore the token part of the equation is based on public blockchains (ethereum and others). Again the least you could expect is to have up-to-date information on the IT governance, in particular who is in charge and what are the resources dedicated to protecting Tether’s clients and infrastructure?

None of this is available on the site. Are those $48 bln invested? If so under what mandate(s), with which level of risk? Who has responsibility for overseeing performance and compliance for this kind of money? Who has responsibility for ensuring the information system is adequately protected and managed? What credentials do the management and IT teams have that give Tether holders some reassurance that their money will not vanish or be hacked? One might argue that if nothing has happened so far, surely the company has shown its ability to manage itself. Well, has something happened? Has money disappeared from bank accounts? Have tokens been hacked? More to the point: would we know if any of this had indeed materialized?

In its “fees” section Tether indicates that it will perform a “verification” to accept new clients. There is no indication of documents, KYC procedure, no address or contact or indication of anything before you submit to this verification (charged $150). Apparently creating or redeeming Tether requires a minimum of $100,000. In all fairness this is probably a consequence of the fact that Tether doesn’t want to offer its services to clients who are not qualified investors (in the sense of US regulation). But in setting such a high threshold, the company loses the opportunity to interact directly with many smaller holders, and hence improve its communication and reputation.

Really, would you give $100,000 to someone you know nothing about, domiciled in one of the least transparent places on Earth, without any idea as to how the money will be safeguarded, invested or used?

The question remains as to why Tether management still refuses to provide more transparency. If indeed the company has nothing to hide, putting all questions to rest is astonishingly easy: move the money to a select pool of large well-known banks, and have the statements properly audited by a select pool of large well-known auditing firms. Commit to performing and documenting funds certification for example quarterly and that’s it, you’re done. If Tether wanted to go a step further it could also disclose the investment strategy (or lack thereof) it pursues with the cash under its responsibility. In my mind there is only one reason why the firm doesn’t follow those very simple steps.

Physical delivery and what it means for digital assets

If you ever wondered about the difference between “cash settlement” and “physical delivery” in the world of derivatives, 2020 was a crash course on the matter. Yes, this was the year of negative oil prices, and many will remember those painfully. If Y2K was about fixing a trivial shortcut in date formats, you can bet software developers and risk managers alike were never quite ready for negative oil prices in their systems and scenarios. 

What was it about anyway? As always when a situation is more or less “impossible”, there were several converging factors to get to the impossible. The CFTC report names three: an already oversupplied global crude oil market at the beginning of 2020, an unprecedented reduction in demand caused by COVID-19; and concerns about the availability of global crude oil storage.

But what has storage space got to do with this? The missing link is that products exchanged on oil are in fact “physical delivery” futures. That is when a future expires, the buyer physically receives a fixed number of barrels. Furthermore, to standardize the market, deliveries are accepted at only specific locations (see for example the paragraph “delivery procedure” for NYMEX Crude Oil). Any disruption in the flow of oil and storage capacities are easily saturated. In March, this is exactly what happened: a sudden collapse in demand led to a withdrawal from buyers. Markets participants equipped with adequate facilities could collect deliveries and wait it out by keeping their inventory in place. However for participants not properly equipped, holding a future contract meant taking delivery and that was simply not possible because storage at designated facilities was not available. Speculators and traders routinely trading oil without consideration for physical inventory were caught in a “fire sale” spiral in the days leading up to expiry, driving prices in uncharted territory.

You’d be tempted at this point to conclude that physical delivery is a nuisance. Not quite. First of all, it should be pointed out that the commodity market being what it is, physical delivery is the most natural outcome of a transaction between a buyer and a seller. Indeed, “cash settlement” is out of place: it encourages speculation without any consideration for the geographical location of products being traded. And then there’s the other major advantage of physical delivery: it forces convergence between the expiry price of a derivative and the price of its underlying. 

Consider for example a future on a stock, cash-settled at expiry. The final reference price of the future is the closing price of the stock (as is the case in the US for example). If you buy the future at $100, and the underlying stock closes at $110 on expiry, you will receive $10 as a final margin call and that’ll be the end of it. If the future is physically delivered, you will receive the stock upon expiry, and the final price being $110 this is what you’ll have to pay. The $10 margin call in your favor means that you effectively bought the stock at $100 - that makes sense because that was the price of the future when you entered the position.

In a world of cash-settled derivatives, the expiry price is set by reference to the underlying, but it doesn’t mean that you can acquire (or dispose of) the underlying at this price. There can be a divergence between those two prices. In a world of physical delivery there cannot - you automatically get ownership of the underlying at the expiry price. 

To be specific, let’s take BTC as an example, and in particular the CME BTC Future. The future expires on the CME Bitcoin Reference Rate (BRR), defined as “the aggregation of executed trade flow of major bitcoin spot exchanges during a specific one-hour calculation window“. The future is cash-settled. Upon expiry, CME will calculate a price based on its BRR methodology and will settle the final margin call using that price. The problem is: how do you replicate this price? If you hold a delta-neutral position in bitcoin (long BTC, short future), at expiry you need to unwind the cash BTC leg at the exact same price as the future. That means you need to sell your BTC at the BRR price, no more, no less. This is an ambitious proposition: it implies that i/ you are connected to all relevant exchanges, ii/ you are technology-savvy enough to replicate the BRR real-time exchange allocation, iii/ you can place orders and received executions at the right price at the right time on each exchange. If the BTC future was physically delivered, you would have absolutely nothing to do - you would automatically receive proceeds from delivering BTC as part of the short future.

In traditional markets, this is a well-known problem that occurs for all derivatives that are cash-settled on “exotic” references. For example in France, the CAC 40 index futures settle on an average price over 20 minutes (“Exchange Delivery Settlement Price“). Tradability of the EDSP is an issue for all participants, even those technologically equipped are subject to a convergence risk. This risk is vastly mitigated when settlement prices are set through an auction because the fundamental mechanism of an auction means that everybody is fully served at the same price or the auction doesn’t conclude. Nothing of that sort for BTC or other digital assets: no closing auction, no physical delivery which means that future traders must cope with a simply unpredictable convergence risk.

Now you might wonder…why does it matter? After all, this doesn’t prevent trading, nor does it affect the overall level of risk associated with digital assets. Well, it does affect the ability of the digital industry to introduce secured lending and through it credit-mitigated leverage. I have explained before how the convergence formula of a future contract enables un-coupling between market and credit risk. This however is only possible if convergence is certain. If it is not, secured lending introduces a market risk component that is likely to be unacceptable for yield-seeking lenders. Physical delivery would make secured lending much safer and in turn would pave the way for a truly new chapter: securities financing.