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Monthly Market Review - May 2021

Updated: Mar 8, 2022

In this note, we look at Tether and its recent disclosures after reviewing the performance of Bitcoin and Ethereum.

Pricewise, both Bitcoin and Ethereum suffered significant drawdowns from their all-time highs. Ethereum touched $4,300 during the middle of the month and finished the month 40% off this high.

Tether ('tethered' to USD) has been a constant theme of this newsletter and is a Stablecoin cornerstone of the crypto market. Many offshore exchanges use Tether as a proxy for USD as they don't have access to USD banking facilities. It now accounts for between 50%-60% of all BTC trades in the main offshore BTC-USDT markets, making it an outsized participant within the crypto space.

The New York Attorney General (NYAG) has been investigating Tether for the last two years as they doubt its claim of being backed 1:1 by physical dollars. In February, the NYAG settled with Tether (after finding that it was, at times, not backed sufficiently by USD). As part of the settlement, Tether is required to pay a fine and produce quarterly transparency reports, with its first report to the NYAG due on May 19. Ahead of this, Tether released a very vague public breakdown of its holdings in the form of the below pie chart.

At first glance, it appears that the majority of Tethers are backed by Cash or Cash Equivalents; however, on closer inspection, over 65% of this segment (49% overall) is actually "Commercial paper". With $60 billion of Tether in circulation, this indicates that Tether is a holder of approximately $30 billion of commercial paper. JPMorgan released a report which puts the scale of Tether's commercial paper in perspective: it is now the fifth-largest holder of commercial paper globally. This is a company with approximately 10-30 employees.

Assuming this is not blatant fraud (which the NYAG should have discovered by now), one must wonder how the quality of this paper is being assessed? And can one assume it is as safe as USD? We speculate that most of this paper is from the big offshore crypto exchanges (Binance, Huobi, FTX). Binance and Huobi hold $20 billion between them. As JP Morgan indicated in their report, the danger is if there is a bank run on Tether and it cannot redeem the required tethers. If this is the case, this could severely threaten the liquidity within the crypto space. For now, we can only speculate the precise breakdown of this commercial paper. If Tether's submission to the NYAG is made public, then the market will have an indication of the exact composition and will react accordingly. Luckily, some of Tether's more regulated competitors have been growing much faster throughout 2021 (See the chart below). USDC, created by the Centre (a combination of Coinbase and Circle), has already issued over $20 billion in coins. It will soon challenge Tether as the largest Stablecoin if it maintains its current growth rate.

It appears that the market is voting with its feet, and participants are choosing more reputable partners. However, Tether remains a systemic risk. Hopefully, the NYAG disclosures will force the company to become more transparent, or the market will continue its transition to USDC and other well-audited Stablecoins. Either way, resolving the Tether issue is a good thing for the broader crypto market.

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