Tether Trading – The Achilles Heel of Crypto
2021-10-08 | Sam Shames
This is the third and likely final installment in the Tether series of blogs. We now have enough information to guess how this turns out.
We have covered Tether and its risks in previous posts . My first article was about tether and its hidden risk. A month later I revisited the risk discussion and how tether was impacting the market. Be sure to check out those articles too.
In this blog, I will look at add additional information on the hidden risk in Tether that hits the entire crypto market.
What is Tether?
Quickly, Tether is essentially the “e-dollar” of the crypto market. Because U.S. dollars are difficult to get into crypto exchanges, Tether has been the solution to this problem for years.
The way it works is I would give $1 to Tether and Tether gives me one USDT in return. That USDT allows me to easily place it on many exchanges and it works as a 1:1 dollar convertible within the crypto market.
How Tether Trading Works
I can buy any crypto with Tether, and when I am ready to sell or sit on the sidelines in a flat position, I can sell that crypto for Tether and have zero market risk. Therefore, I effectively create a “cash position” in the crypto ecosystem.
It is an innovative idea that solves the problem of limited dollar liquidity in the crypto market.
Tether Risk and Crypto
The question we have posed many times over the years at Simpler Trading is whether or not Tether actually has the dollars in a bank account to cover all the Tether that has been printed.
Very similar to a virtual run on the bank, if enough people were to try to convert their Tethers back to dollars, would Tether be able to do this? The answer I always proposed was “no.”
Over the years that I have studied Tether, nothing has indicated to me that they indeed hold the dollars in an account that they say they do.
Why does this matter?
Because if Tether is insufficiently capitalized, and the market eventually accepts this fact, there are no exit doors in the crypto market. When the exit doors shut, the only missing element is someone shouting “fire” in a crowded theater to commence the stampede for the non-existent exit door.
In effect, Tether is the underlying bedrock of the current price of all cryptocurrencies.
So, what underlies Tether?
Tether traders themselves admit that they may or may not actually have the dollars to back up the Tethers they have issued, but they are quick to point out that they do have the assets. These assets are largely comprised of commercial paper – short-term bonds issued by companies.
So, allegedly, Tether is now tied at the hip to the commercial paper markets… not a big deal some may say.
However, what if the commercial paper that underlies Tether’s “value” comes under fire? Wouldn’t that have the effect of quickly driving down the value of the asset side of their balance sheet while the liabilities side (# of Tether printed and issued) stayed the same?
Tether and Commercial Paper Loans
So, let’s go a step further and try to understand potentially who Tether has been making commercial paper loans to in understanding where the risk may be.
This is where it gets murky as Tether is largely unaccountable, offshore and their finances are a black box.
But, we can make some guesses based on the size of the loans.
The chatter on the street is that Tether’s commercial paper is mostly Chinese and very likely tied to Chinese property developers.
What Chinese property developer has been the topic du jour in the news for being unable to pay its $300B debt?
There is a very decent probability that Tether has become one of the biggest property developers by buying their short-term commercial paper debt.
This isn’t a problem if the Chinese property market continues growing at the pace it has been. Then, the developers can pay the debt and Tether gets an outsized return for the risk.
However, as we all know now, this is not the case. Evergrande is one example, but there will be more. If Evergrande and other Chinese developers begin to lose money because of forced fire sales of property as Evergrande and others raise cash they need, that has a contagion effect on the value of the entire Chinese property market.
If the Chinese property market stops growing at the rate it has been and property prices fall, that begins to pressure all Chinese property developers and banks in a feedback cycle of lower prices and greater pressure to unwind leverage and sell properties, which in turn forces prices lower and starts the cycle again.
If Chinese property developers are unable to meet their obligations, that will drive down the value of the commercial paper (debt) that they have outstanding as the market perception of risk that it carries shoots higher.
If the commercial paper market in China is perceived to be riskier, the value of all Chinese debt drops.
If the value of all Chinese debt drops, and Tether is holding a huge bag of it, the value of the “assets” on Tether’s balance sheet will take a large hit.
If the value of the asset side of their balance sheet takes a material hit, but their liabilities remain constant (which they would), that increases the likelihood that Tether will not have the necessary funds in the event of traders redeeming their Tethers back to U.S. dollars.
And finally, if that happens, that closes the exit doors on the crypto market and will create a mass panic of liquidations as Tether is the highest source for stable liquidity in the crypto system, and without a large source of liquidity the market will panic and sell everything.
This affects all cryptocurrencies, not just Bitcoin, as Tether is the underwriter (in effect) for the liquidity and price of the entire crypto market.
And What Does this Mean for the Crypto Market?
So, tying it all together, if we remove the middleman and get right to the direct correlation, at this moment the value of the entire crypto market is riding on the back of the Chinese property market.
If China is unable to contain the fallout of Evergrande and the numerous other property developers, suppliers, banks, and thousands of businesses tied to the property market, the result is Tether taking losses on their alleged holdings.
If Tether takes those losses, they will be unable to meet redemptions back to U.S. dollars and effectively that will be a run on the virtual bank.
Be aware of these dynamics going forward. We have warned of the problems within Tether for years at Simpler Trading, but never did I imagine they would be so reckless as to tie their fate and the fate of all cryptocurrencies to the highly indebted, highly leveraged Chinese property market.
Until something changes, understand that the value of the entire crypto market rests on the back of the Chinese property market continuing to grow.
With that said, once this happens, the subsequent flush in the value of crypto (expecting 50-80% flush from these levels) will be the buying opportunity of a lifetime.
Although Bitcoin and crypto still remain sound, Tether was always a cancerous growth on the system that at some point would need to be excised.
If you like the crypto market, this chaos will be your opportunity to buy in for the real move to $100k+ that could not have been sustainable in a system where an allegedly irresponsible company like Tether was at the center of the crypto universe.