Tether - Is It as Stable as Thought. What Might the $10 Billion Contraction Mean?

Stablecoins, with a market capitalization of over $170 billion, comprise a significant portion of the crypto market. Until recently, it was believed that this type of cryptocurrency is completely stable and able to keep our funds safe from market fluctuations. The recent UST collapse has proven that this is far from the truth, at least in terms of algorithmic stablecoins that are not backed by stable liquid assets.

But what about coins that are backed with fiat? Based onCoinMarketCap data, the leaders are Tether, USD Coin, and Binance USD.

Tether is the largest stablecoin based on market capitalization. If you have followed the coin for a while, you might know that it has had some issues in the past. 

Tether Has Never Been 100% Backed with US Dollar

In 2021, Tether was fined by the Commodity Futures Trading Commission for lying about every stablecoin being 100% backed by fiat money. During the investigation, it was discovered that Tether reserves were not fully backed the majority of the time, and in a 26-month sample time period from 2016 through 2018, Tether only had enough fiat reserves to back 27.6% of tokens in circulation. 

Tether was required to complete routine audits to prove that the stablecoins in circulation were backed with fiat. The company hired Friedman LLP, an auditing firm, to assess whether Tether has enough reserves in fiat to back USDT. Friedman LLP published a preliminary report in which the security auditor stated that the company had $442.9 mln of fiat funds in its reserve as of September 15, 2017. If you check the USDT market capitalization, you will notice that the coin was almost 100% backed with fiat at that time.

Even though it looks like there was no reason for Tether to worry, the company announced that its relationship with Friedman LLP had ended and that a full audit had not been performed. It looked suspicious, to say the least, especially considering that the preliminary results were positive. 

The only reason for Tether to cancel the requested audit was that the company wanted to hide something. Later, in the course of an investigation performed by the Commodity Futures Trading Commission, it was revealed that Bitfinex had transferred $382 million to Tether's bank account right before the auditing. This explains why the company wasn’t willing to allow Friedman LLP to complete the auditing process: it would be revealed that USDT was backed for less than 30% of its circulating volume.

Other attempts to perform audits were also questionable. For example, the next audit was performed by the law firm Freeh Sporkin & Sullivan, LLP (FSS) instead of an auditing firm. Their report is a legal report, not auditing results. The company simply states that the amount of fiat money in Tether’s bank accounts is sufficient to back USD Tethers in circulation at the given moment. 

Further auditing reports also stated that USDT was 100% backed. But instead of USD, consolidated assets were mentioned.

Only later Tether did admit that approximately 15% of Tether’s assets are allocated to corporate bonds and funds, secured loans, and other investments. This raised additional concerns among users. 

The main question was whether Tether would be able to handle the redemption requests if they increased in number. What if “other investments” of Tether fell in value to the extent that the company wouldn’t be able to manage all the redemption requests? In the conditions of the recent bearish market, this question couldn’t be ignored anymore, and users started preparing for the worst-case scenario - Tether insolvency. They started redeeming their tokens and as a result, Tether market capitalization decreased by more than $10 bln (from over $83 bln to approx. $73 bln) between May 9 and May 28.

Even with the assurance of Paolo Ardoino, Tether CTO, that “Tether has maintained its stability through multiple black swan events and highly volatile market conditions and, even in its darkest days, Tether has never once failed to honor a redemption request from any of its verified customers” didn’t stop users from fleeing. The market capitalization graph shows clearly that Tether is losing its position as the leading stablecoin.

Meanwhile its competitors BUSD and USDC are consolidating their positions in the market. 

While the number of USDT in circulation dropped by more than 10 bln, the number of BUSD and USDC has increased from 16 bln to 18 bln and from 49 bln to almost 54 bln respectively. To me, it appears as though Tether's main competitors are taking over the stablecoin market.

Will Tether Keep the Leading Position?

In my opinion, the stablecoin market is unique in the regard that stablecoins do not offer any commissions, rewards, etc. to their users. They serve as a safe hub that protects user funds from volatility. That’s why users are confident that the stablecoin has the necessary resources to keep its peg to USD, EUR, or whatever it is backed with. It means that a stablecoin will be transparent.

Tether isn’t transparent, and for now, it is unclear what assets the company holds in its reserves to back USDT. Meanwhile, its main competitors BUSD and USDC are 100% backed with cash and treasury bills that are as secure as cash. The only way for Tether to keep its leading position is to sell its risky assets and invest in USD and treasury bills. When Tether users know that every USDT is absolutely backed with USD, they will not rush to sell USDT.