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:
- The market knows something that I don’t. Fair enough. Then again, a lot of people appear not to know anything, to the point where you start wondering whether there is something to be known.
- People don’t care. This is another way of saying that the market is inefficient to the point that Tether holders neglect the risk entirely. This is not so difficult to believe: a large fraction of crypto-investors are non-professional, and as such do not approach risk analysis the way professionals do. The opportunity to make 100% in a few weeks could sweep any restraint away. As for those who do understand what risk is about, they may choose to use Tether as a means to an end, namely to access other digital assets. In doing so they would choose to hold Tether only for short periods thereby mitigating their risk significantly.
- People choose not to care. That’s a subtler one. What would happen if tomorrow Tether announced that it holds only 75% of its total issuance? 60%? 40%? The shockwave through the crypto ecosystem would be disastrous. There would probably be numerous public inquiries and lawsuits, who knows if the digital asset economy would even survive such a tsunami. Better not ask a question you don’t want an answer to.
- Finally, another option to consider: some market participants may be willing to buy Tether (also known as USDT) aggressively any chance they get when it “breaks the buck” below $1. Some of those buyers might be interested in quick arbitrage profits, but some may just be trying to bring it back to $1 because it is in their best interest. Now, who would have a vested interest in keeping the USDT at $1? Tether itself. If more USDT have been issued than the reserves allow, the excess has almost certainly been invested in other digital assets, bitcoin first and foremost. If Tether were to trade below $1, it would be fairly easy to sell those bitcoin back against USDT to maintain the level of USDT. The more Tether has been issued without reserves, the more ammunition it gives manipulators to intervene and bring the USDT back to $1.
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.