Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

We take a look at the reserves of the USDT stablecoin backing Tether and compare it to other similar assets in DeFi and TradFi. The debacle of TerraUSD (UST) has raised doubts about all stablecoins, stable or not, and raised new questions about what reserves underpin the value of these stablecoins. Investors and users, as well as politicians and regulators, are expressing these concerns. Many believe that stablecoins pose risks to both consumers and the wider economy.

Before the collapse of UST, the value of all UST in circulation was approximately $18.6 billion, of which over $17 billion (90%) was deposited into Anchor. While the value of Terra’s ecological losses is enormous (over $40 billion), its impact is relatively limited, accounting for less than 2% of the market. Tether’s USDT case is quite different. The current circulating supply of USDT is $74 billion, which is 4 times the peak value of UST. Below we show the relative market capitalization of TerraUSD (UST) and Tether (USDT) over the past 180 days.

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

UST’s market cap dropped rapidly as it decoupled. The incident spooked some USDT holders, causing their tokens to be exchanged for USD, amounting to as much as $10 billion. For context, Tether redeemed more than half of the entire circulating supply of UST in just over a week, and it didn’t decouple (did not fall below $0.99). This was the largest batch of redemptions to date without any systemic issues.

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

Aside from volatility and redemption, what is the immediate support for USDT, and is it safe? Well, these doubts prompted Tether to release an audited quarterly report on the breakdown of its reserves. These reserves are currently audited by the Cayman Islands-based accounting firm MHA Cayman. We highlight the latest audit details below.

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

We see that USDT is not financially backed by cash (or cash equivalents) 1:1, but more like 0.85:1. A closer look at cash and cash equivalents shows that just over half is allocated to US Treasuries and about 30% to commercial paper (CP) and CDs. The remaining 16% is allocated to money market funds (about 10%), cash and bank deposits (about 6%), non-U.S. Treasury bills (about 0.4%), and reverse repos (0.15%).

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

As for the remaining 14.36%, the audit did not provide further clarification. The allocation to corporate bonds, funds and precious metals (4.52%) did not provide details on corporate bond type (investment grade, country) and fund type. Types of precious metals are also excluded, and the percentage breakdown of these three categories is also opaque. Secured loans (3.82%) were not disclosed, but it was mentioned that other investments (6.02%) did include digital assets, but to what extent was unclear.

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

history

Since 2017, Tether has hired the services of several different banks, law firms and accounting firms to demonstrate the size and effectiveness of its reserves. These companies include MHA Cayman, Moore Cayman, Deltec Bank, FSS and Friedman LLP. Below we discuss a brief history of these relationships.

In 2017, as pressure on USDT reserves mounted, Tether invited accounting firm Friedman LLP to conduct a reserve audit, but critics emphasized that the study had methodological flaws and did not represent a complete audit. Shortly after the first audit, Tether reported that Friedman did not complete the audit in what they believed to be a “reasonable time” and terminated the partnership. Tether then turned to Washington-based law firm FSS. The FSS report was not a full audit of Tether, but said the law firm received sworn and notarized statements from Tether’s two (unnamed) banks. To help build confidence, Tether gave Bahamas-based bank Deltec a report confirming the amount of cash Tether had in their accounts there, but again this didn’t provide the full picture as it was only the value of cash from one of its banks . In 2021, the New York Attorney General’s Office completed an investigation that found Tether inflated its reserves and hid losses of roughly $850 million. This resulted in an $18.5 million fine and was required to publish quarterly reports on its holdings within two years. Around the same time, Tether announced a partnership with Moore Cayman, an accounting firm in the Cayman Islands. Moore provided the assurance report, proving the full backing of USDT, and later provided a more detailed breakdown of the reserves. However, from January 2022, MHA MacIntyre Hudson said its Cayman Islands branch, MHA Cayman, will handle Moore Cayman’s clients. It should be noted that MHA MacIntyre Hudson is currently under investigation by the UK Financial Reporting Council following a previous audit of an unrelated company.       

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

As mentioned above, the breakdown of reserves will not be available until June 30, 2021 (after other stablecoins start to be released). For the most part, the weighting of allocations has remained relatively stable since June 2021, with cash and cash equivalents rising slightly from 85% to 86%, while secured loans remain at 4%. However, other investments, including digital assets, have doubled from 3% to 6%, increasing the risk level of reserves. Growth in other investments came at the expense of corporate bonds, funds and precious metals, which fell from 8% to 5% over the period. In dollar terms, cash and cash equivalents rose 7% in the most recent quarter, while secured loans fell 24%.

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

Digging into cash and cash equivalents, we show below that U.S. Treasury bills have started to become a larger portion of reserves (24% to 48%), replacing the dominance of commercial paper and CDs (49% to 24%). The reduction in commercial paper holdings has somewhat eased concerns about the riskiness of these instruments. Cash and bank deposits were reduced from 10% to 5%, and reverse repurchase notes were reduced from 2% to 0.1%. Money market funds also increased, now accounting for 8%, as did non-U.S. Treasury bills (0.3%) in the most recent quarter.

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

The quality of Tether’s commercial paper continues to be questioned, even as its distribution is reduced. Below we show the rating breakdown for Tether’s commercial paper as of March 2022.

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

From June 2021, when Tether began reporting a breakdown of its reserves, to March 2022, Tether’s reserves have grown from $63 billion to $83 billion, a 31% increase. The increase included a 32% increase in cash and cash equivalents, a 25% increase in secured loans, a 23% decrease in corporate bonds, etc., and a 141% increase in other investments (possibly due to higher digital asset prices).

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

However, since March 31, 2022, there have been approximately $10 billion in redemptions (down from approximately $84 billion to $74 billion) with no adverse impact. The redemption process involves a one-time $150 verification process and a 0.1% fee, while the current minimum redemption amount is $100,000. Those limits could slow things down in the event of a run on assets, but evidence suggests that Tether can already process billion-dollar redemptions in just over a week.

Compared

So, how does Tether’s reserves compare to leading money market funds? As stated in the audit report, 8% of Tether’s reserves are made up of money market funds, although the details of these funds were not disclosed. We examine the portfolios of several top money market funds by AUM and compare their holdings through the last quarter. We see that while commercial paper repurchase agreements and certificates of deposit appear to be popular options, mutual funds can vary widely in their holdings of fixed income.

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

While it’s useful to compare the difference between money market funds and stablecoin reserves, it’s not exactly a like-for-like comparison. Below we highlight the reserve breakdown of the last two largest stablecoins by market cap, Circle’s USDC and Binance’s BUSD.

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

Founded by Binance and Paxos, BUSD does not break down the weighting between cash and U.S.-backed debt. The reserves of BUSD are audited by Withum (which also audits other stablecoins).

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

Tether was the first mainstream stablecoin and had market dominance within a few years. In recent times, however, Circle’s USDC and Binance’s BUSD have gained significant market share among mainstream stablecoins (~37% and ~13%, respectively).

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

Additionally, Tether has around 33% market share of all stablecoin/BTC trading volumes on trusted exchanges, although this is also waning. The relative importance of USDT is clearly declining.

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

All three stablecoins are pegged 1:1 to the U.S. dollar, Circle and Binance/Paxos both accept and publish monthly audits, while Tether reports quarterly. While USDT always shows its reserves, it does not provide public information on audits, which may be a concern for investors. Despite differences in transparency reporting, there are some differences in reserves between these stablecoins. We’ve highlighted some more differences between the three stablecoins below.

Coinshares Research: Will Tether Bring Systemic Risk to Crypto Markets?

The world’s most popular stablecoin, Tether, has withstood many trials and some black swan events since its inception in early 2015. The advantage of the first mover coupled with the real-world test has increased people’s confidence in USDT, as evidenced by the growth of circulating supply. The real test may not yet come, however, with a renewed focus on stablecoin reserves that have led to a 12% reduction in USDT circulation through recent redemptions.

Additionally, competitors like Circle have more transparent reporting in a more trustworthy regulatory environment. This sense of security for USDC (and other stablecoins) continues to lead to a decline in Tether’s market share.

As seen before, this trend could lead to Tether adopting stronger reserves, greater transparency, and more diligent auditing practices.

Of course, Tether can also lie flat, regardless of credible transparency, market share, and the reduction of supply scale, but this will greatly reduce Tether’s market influence.

If it is the first direction, it reduces the risk for everyone, but if it is the second direction, then the question “Is Tether a systemic risk to the cryptocurrency market?” becomes less important.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/coinshares-research-will-tether-bring-systemic-risk-to-crypto-markets/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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