Hidden Risk in Crypto – Tether
2021-06-17 | Sam Shames
In this post:
- What is the biggest risk to the crypto markets long term?
- What is a stablecoin?
- What is Tether and why is it important?
If you took a poll of most crypto traders and asked them what they think is the biggest risk to the crypto markets long term most would likely answer “government intervention/regulation.”
That would be a good answer as government intervention, where they can intervene at the point of entry, is certainly a big risk long term.
However, we have only seen a growing acceptance of crypto, even if reluctantly, by governments and institutions. The amount of value at stake for the crypto market has grown tremendously and now Wall Street and others are “bought” in and may have too much to lose if governments were to intervene.
So what other risks remain in the market?
The main one that I see rarely discussed in polite company is the role Tether plays in the crypto ecosystem.
Tether is the largest “stable coin” in the crypto market. A stable coin is a coin whose value should be 1:1 reflection of a U.S. Dollar within the crypto ecosystem.
The reason stable coins have a role is because of the regulatory difficulty crypto exchanges have had in accepting dollars for tradable funds. This leads them typically to accept crypto and stablecoins as deposits.
Stablecoins have a role as well in that they allow crypto traders to go “flat” in the market if they ever wish to sell their crypto they can sell it for a stablecoin and essentially that puts them in the crypto equivalent of dollars which are not subject to the volatility up or down in the market.
So, stablecoins are designed to be a 1:1 reflection of the U.S. Dollar within the crypto ecosystem and they can be used as dollar proxies while traders wait to buy or sell.
Tether is the largest stablecoin in the market at the time of writing this with a market capitalization of around $60 billion.
The potential problem with Tether that has been an issue for years, but remains unresolved, is the question of whether they actually have the U.S. Dollar funds to cover the $60B in market cap.
Meaning that Tether would need to have around $60B in U.S. Dollar assets at any given time to cover in the event traders wished to exchange their Tether back to Dollars.
My bias for a number of years, again despite the market not having called it out yet, is that Tether does not in fact have the funds they state.
In my estimation Tether only has a fraction of the funds available.
Because of this, I believe that Tether has been acting as a central bank for crypto of sorts.
Meaning that in the same way banks, through the blessing of the Federal Reserve, employ fractional reserve lending… meaning they are allowed to lend $10 for every $1 in deposits they hold, my belief is that Tether is also doing something similar.
The reason that may eventually be a big deal for the crypto market is that if the market ever calls Tether out, forces them to prove the status of their reserves and they are unable to, that would likely lead to a large-scale and broad-based sell off in all crypto coins.
Essentially, Tether (and all stablecoins, but mostly Tether) act as both dollar & liquidity proxies within the crypto market. If the largest source of stable liquidity in the market, Tether, were to have any issues that would lead to a bit of panic as folks would immediately question the value of all crypto assets.
So far, the market has not seemed too concerned with the prospect of Tether having any issues with their dollar reserves. The value of Tether remains 1:1 to the Dollar however we certainly want to be aware of this risk.
In the event the market was to call out Tether and it was unable to meet the demands given its current reserve levels, we would see a large scale and likely long-lasting bit of selling hit the market.
After the shakeout however, I would think that something like that would be the healthiest thing that could happen to the crypto market with a long-term view as that would clear the forest of uncertainty around the issue and would allow new, more trustworthy stablecoins to step in to the lead role that Tether currently holds.
The topic discussed here does not seem to be an immediate issue as Tether has had these questionable problems for years and the market has not put them to task to prove the reserves, but it is a topic to be aware of for anyone looking at the crypto market for the next 5-10 years.