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Monthly Market Review - February 2021

Updated: Mar 8, 2022

In this update, we will look at the controversial 'stablecoin' Tether in more detail.

Tether Limited created tether (symbol USDT) in 2014 as the first significant stablecoin. It is pegged 1:1 to USD and it can be tradeable freely like other cryptocurrencies. Importantly, all USDT in existence are supposedly backed by dollars held by Tether Limited, with a redemption/issuing process in place for maintaining the peg.

USDT immediately became popular with early crypto exchanges and exchanges based outside of the USA. It has allowed these exchanges to offer USD-like pairs without requiring a USD bank account (which remains tough for non-US exchanges to acquire), so many exchanges offer BTC:USDT instead of BTC:USD. One of the first exchanges to use USDT was Bitfinex, which shared the same founders as Tether Ltd.

USDT has two implicit requirements. Firstly, the ecosystem trusts that Tether Ltd maintains enough USD deposits to cover the USDT issued. Secondly, Tether Ltd. maintains banking relationships (which the exchanges can't) to store the USD backing USDT.

Since 2017, there have been questions regarding whether USDT was indeed backed by USD and, if so, where the bank accounts were; this was especially concerning given its rapid growth around the time. The amount of USDT in circulation rose from $10m to $1.4bn during 2017.

The primary driver of this growth was BTCs increase in price; as the BTC price rose, traders would take profits and sell them into USDT, which would drive USDT to be at a premium to USD. So, more USDT was issued for arbitragers to eliminate the difference. In theory, the issuance was done through authorised traders, who would sell BTC for USD and then send USD to Tether Ltd.'s bank account. Once received, Tether Ltd would issue more USDT and deliver it to the trader (who could then sell it at a slight premium). However, as the volume of USDT grew and the banks involved become increasingly harder to track, many people believed that USD deposits did not entirely cover the issued USDT.

If Tether Ltd were issuing more USDT without holding the equivalent USD, then it would be printing USD out of thin air, and if the newly issued USDT were being used to purchase BTC, this would cause the Bitcoin price to rise. A higher BTC price would increase the demand for USDT, allowing more USDT to be printed (and the process repeats). This feedback loop would be particularity effective due to Bitcoin's relatively low liquidity at that stage. The US Department of Justice is currently investigating Tether Ltd for potential market manipulation around this time.

Tether's claims of being fully backed and their lack of transparency caught the New York Attorney General's attention, who started investigated tether in 2019. A settlement with the NYAG was released on the 23rd of February and had some damning findings, including that Tether Ltd didn't hold enough funds to cover USDT at certain stages. Additionally, in 2018, USDT was only partially backed by USD. It was also backed by a $400m loan to the Bitfinex exchange (same equity holders as Tether Ltd) after Bitfinex lost access to the $500m of client's deposits it had at a 'payment processor' called Crypto Capital.

The entire settlement report shows the misrepresentation and abnormal practices conducted by Tether Ltd and Bitfinex between 2017-2019. During this time, USDT's market cap kept growing from $1m in 2016 to $10bn in 2020 and now > $34bn in 2021.

This settlement reached between Tether Ltd and the NYAG ensures a minimum level of transparency moving forward, as part of the settlement:

  • Tether Ltd must pay an $18.5m fine to the NYAG

  • Tether Ltd must provide transparency reports every quarter, proving their reserves for the next two years. Hopefully, this encourages them to maintain an adequate level of transparency moving forward.

  • Tether Ltd cannot conduct business with New York residents.

The market initially reacted positively to the settlement. The NYAG settling the case means that Tether Ltd now holds cash or cash equivalents to back the over $34 bn of USDT's been issued, which is very positive for other market participants.

Moving forward, we believe that the risk of USDT is still high (given their history of poor practice) but that this risk should steadily decrease as regular transparency reports are released.

Luckily, regulated stablecoins are now growing in popularity (although still lag USDT). In time, we expect that these might remove USDTs dominance. The offshore exchanges may continue to prefer USDT as it doesn't expose them to United States regulators, so time will tell how much market share these can wrestle away from a reformed USDT.

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