The crypto economy has suffered two major crypto failures this year: the collapse of Luna/TerraUSD in May and the failure of FTX in November. In both cases, the world’s largest stablecoin, Tether, was caught in the blast radius as waves of buyouts poured into the company. It fell by $18 billion, or 21%, in May and June and by another $4 billion, or 6%, in November.
Stablecoins should not be the instruments that the public sells in panic. They are meant to be the opposite; the life jacket that people cling to. Competing stablecoins USD Coin and Binance USD performed as one would expect. Neither had a barrage of redemptions during those two bouts.
CoinDesk columnist JP Koning worked as an equity researcher at a Canadian brokerage firm and a financial writer at a major Canadian bank. He runs the famous Moneyness blog. This article is part of CoinDesk Crypto 2023 series.
Here are four things Tether can do to ensure that the next time the crypto economy takes a hit, Tether remains stable.
1) Tether needs to get rid of corporate bonds, funds and “other investments”.
The number one job of a stablecoin is to be stable, and that requires holding safe assets like cash and treasury bills. But some of Tether’s balance sheet items — including commercial paper, corporate bonds and funds, secured loans, and “other investments” — suggest Tether operates more like a hedge fund or venture capital firm. than as a stablecoin.
Tether slowly tackled this problem. He spent much of 2022 replacing his massive $30 billion horde of commercial paper with Treasuries, eventually bringing the count down to zero just before the FTX disaster.
But even after this cleanup, Tether still suffered from a wave of takeovers in November. Realizing that hadn’t gone far enough, Tether executives pledged earlier this month to cut its $6 billion in secured loans to zero.
That’s great, but the company has been silent on what many analysts consider its most sketchy assets: its $2.6 billion in other investments and about $3 billion in bonds and investment funds. company. What is the rating and duration of these corporate bonds? Who are the borrowers – are they crypto companies? Are his other investments and funds made up of crypto-specific tokens?
The fear that these investments will deteriorate is the best explanation for why the last two general cryptocurrency panics have inspired temporary runs on Tether. Best to exit Tether now, it is thought, in case the company no longer has enough funds to buy back all the Tether tokens.
To end this pattern, Tether must sell all of its risky assets and move to a 100% safe asset allocation. The next time a crisis hits, users will be less likely to offload their Tether tokens.
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2) Tether needs to waive its 0.1% redemption/withdrawal fee.
While the prices of competing stablecoins Binance USD and USD Coin are well anchored at $1 on major exchanges around the world, the price of Tether tends to fluctuate randomly. This lack of stability damages the company’s reputation. At its core is Tether’s 0.1% redemption fee. It’s time to get rid of it.
Tether charges anyone who wants to redeem or withdraw Tether tokens a 0.1% fee. So if you own 1 million Tether tokens and want to trade them, you will only get back $999,000 after paying the $1,000 fee to Tether. Similarly, if you transfer $1 million in fiat to Tether in order to get stablecoins, you will only get back $999,000.
The other major stablecoin issuers, Circle and Paxos, do not charge this fee.
That might not seem like a lot, but the 0.1% fee drives the price of Random Weave in a wide band around $1 rather than staying locked in.
The price at which any stablecoin trades on exchanges like Binance and Kraken is set through arbitration. If the price falls too low below $1, arbitrageurs buy stablecoins on the exchange and transfer them to their issuers for redemption at $1, making a small profit. They perform the reverse when the price of a stablecoin is too high.
Competition between arbitrageurs to execute these trades for profit is what locks the price of stablecoins on key exchanges close to $1.
Tether’s 0.1% fee is in addition to an arbitrageur’s costs to complete this transaction. Taking this cost into account, it only really becomes profitable to buy tether tokens when they have fallen to $0.999 and sell them when they have reached $1.001. The price of Tether fluctuates randomly within this relatively wide range.
This lack of rigidity attracts bad press, rumors, innuendo and speculation. This makes Tether particularly bad during broader crypto meltdowns when its price inevitably falls to the bottom of its trading band, mirroring the performance of other risky crypto tokens rather than holding steady at $1. Meanwhile, other stablecoins like USD Coin and Binance USD, which have no redemption fees, are holding their own.
It’s time for Tether to get rid of these fees to create more inspiring trading patterns on third-party exchanges.
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3) Tether needs to open redemptions to more people by removing its $100,000 floor.
Tether is unique among stablecoins in putting a $100,000 floor on the amount of tether that can be traded or withdrawn at source. Other stablecoin issuers like Circle and Paxos allow people to withdraw or deposit any amount.
This floor creates perverse trading patterns on exchanges like Binance and Kraken, which further exacerbates fears about Tether.
In short, Tether’s $100,000 minimum pushes the majority of USDT users who want to mass-sell on exchanges. In theory, well-heeled arbitrageurs are supposed to buy unwanted tokens from these users on these exchanges and buy them back from Tether, thus anchoring the price of Tether at nearly $1.
But it is precisely during large crypto panics that this arbitrage mechanism breaks down: arbitrageurs back down for fear of losing their capital, exchanges halt withdrawals as activity overwhelms them, and blockchains are congested. And so, panic selling of tether in exchange overwhelms the mechanisms that are supposed to anchor tether, and its price falls below the lower end of its $0.999 band.
Well below. In May, Tether fell to 92 cents on Kraken. In October, it fell to less than 93 cents. These depegging events breed more fear, leading to more tether sales, leading to bigger price drops, and more panic.
If Tether removed its $100,000 minimum and allowed everyone to redeem at source, tether users wouldn’t have to flock to exchanges in droves to unload their tether. They could just send their 100 tethers directly to the company and get $100.
This would relieve price pressure on exchanges and put an end to the crazy price movements of Tether on the exchange.
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4) Tether needs to be more transparent.
Lack of transparency is an old criticism of Tether, but it bears repeating. Tether falls short of the current standard for stablecoin transparency. This lack of transparency helps create a trust gap that leads to Tether selling off during market panics.
The current stablecoin industry transparency standard was established by the New York Department of Financial Services (NYDFS). Auditors attest monthly to the state of the stablecoin’s investments, these reports being published on the websites of the issuers. In addition to a month-end test of an issuer’s investments, the NYDFS requires stablecoins operating within its framework to be tested on a random day during the month.
That’s 24 tests per year. Alas, Tether reports on a quarterly basis. Thus, its auditor only tests the company’s investments four times a year. It’s not sufficient.
The NYDFS also requires stablecoin issuers to have an auditor review their internal controls once a year. Internal controls are the rules and procedures that companies adopt to prevent errors and fraud such as segregation of duties, verification of invoices and controlled access to financial information systems.
Tether’s auditor did not review the company’s internal controls.
By bringing its disclosure practices up to industry standards, Tether will build trust and users will be less likely to dump Tether tokens during the next crypto panic.
In a nutshell, tether has become that stablecoin that everyone sells when panic strikes. But that doesn’t have to be the case. By selling off its risky assets and holding only safe Treasuries, waiving its 0.1% redemption fee, allowing all users to redeem at source, and improving transparency, tether can move to a much more stable stablecoin.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.