Preface: How to see the direction of USDT? The author of this article analyzes why the price is still anchored at $1 after the New York Attorney General’s Office lawsuit? Where will the future go? The author of this article, theblock, was translated by "Leo" of the "Blue Fox Notes" community.
Last week, the price of USDT fluctuated violently between $0.96 and $1.06 due to the New York State Attorney General’s Office’s lawsuit against it. At the time of writing, it was trading around $0.98. (Note from Blue Fox Note: Currently around $1)
Some questions remain: why is the price still at $1? What will change in the future? If so, what systemic risks are there?
To answer these questions, it is important to understand exactly what is Tether? Tether is a digital token issued by a centralized company that holds reserves in U.S. dollars in excess of the tokens issued. It was originally created in 2014 by former Mighty Ducks star Brock Pierce as "Realcoin" and was renamed Tether later that year. The head of the company behind Tether has also changed during the rebrand — Bitfinex CEO Jan Ludovicus Van der Velde and CFO Giancarlo Devasini, by the way.
Tether's core use case is the same motivation behind today's fiat tokens: to provide an easy way for exchange users to transfer and store dollars on the blockchain. This is especially useful for some "crypto-native" exchanges that don't have consistent fiat banking access, opting instead to rely on Tether's intermittent correspondent banking services. (Blue Fox Notes: Intermittent here means that it has changed banking services many times.)
Despite looking like a bank, that doesn't mean Tether is a "fractional reserve bank," as some maintainers claim after 5 minutes of browsing on Wikipedia. Banks have strict regulatory scrutiny and credit risk limits that allow banks to operate on fractional reserves, in addition to being restricted to normal business matters such as audits. Tether is an asset from a central issuer, backed by a series of guarantees.
A lot has happened between 2014 and now. Bitfinex was hacked in 2016, resulting in a loss of $75 million. Bitfinex socialized its losses by offering customers $BFX tokens, which are tradable and represent $1 worth of Bitfinex shares.
These tokens were later repurchased in full and burned. Conspiracy theorists, most notably the anonymous troll "Bitfinex'ed," have come up with a number of theories about potential deception, saying that Bitfinex uses USDT to pump up the cryptocurrency's spot market, and more.
Bitfinex's wild ride, while somewhat relevant to their relationship with Tether, isn't very relevant today beyond pointing out some creative business and accounting processes by management.
Following the crash, amidst widespread speculation, last week’s legal filing made it clear that this is contrary to some crypto-optimist arguments that USDT is backed by a 1:1 reserve of the U.S. dollar. The documents show that USDT is partly backed by accounts receivable, which comes from loans it provides, with a lending rate of 6.5%, secured by the equity of Bitfinex’s parent company, iFinex.
What is certain at the moment is that:
1. Tether was definitely backed by full USD reserves at some point in 2018, consistent with its historical claim that Tether is backed by "traditional currencies in its reserve pool".
2. After switching banks frequently, Bitfinex chose to work with a middleman called Crypto Capital. And Crypto Capital then ran into its own legal problems, which resulted in them losing control of $850 million.
3. The Bitfinex/Tether team tried to solve this problem by inverting the loans of the left and right hands.
4. At some point in time, Tether’s public statement changed to: Tether is backed by reserves, which include “traditional currency and cash equivalents, and may from time to time include other assets and receivables from loans made by Tether to third parties ". This statement is updated after the Article 3 loan has taken place.
It is important to note here that Bitfinex and Tether are still distinct entities. This is important, not the least of which is that Bitfinex's long-term maintenance, while relevant, is not a very important factor in determining whether Tether holders can be backed by full reserves. Debt flow is one-way: solvent or otherwise, Bitfinex still has the burden of borrowing $900 million in debt from Tether.
Whether extending this loan is a "good idea" for Tether holders is a separate question. When it extends the loan, it may expect the missing funds to be restored within a reasonable time frame. Bitfinex has a very strong exchange business -- one of the largest in the world -- that is not at risk of disappearing anytime soon. With these factors in mind, a 6.5% interest rate on USD deposits is quite reasonable, especially given the large number of claims Tether holders have on their Bitfinex stake, which gives Bitfinex an incentive to avoid this from happening.
So, the question now is: why is Tether still trading at $1?
The simple explanation is that those who hold large amounts of USDT have astutely assessed the risks of holding the token asset and have determined that:
1. Bitfinex has the ability to repay its debts through its exchange business and will remain public. In a filing last week, the New York State Attorney General’s Office strongly stated that the main claim of its lawsuit is consumer protection, and that they will allow Bitfinex to operate on that basis. In this way, the fates of Bitfinex and Tether are intricately linked.
2. By cooperating with the authorities, Bitfinex can retrieve the funds currently seized by the US, Spanish and Portuguese authorities. (Blue Fox Note: There is a saying that the United States, Portugal and Poland, not Spain.)
3. If neither Article 1 nor Article 2 can be realized, the equity and asset value of Bitfinex are sufficient to support the shortage of Tether currency reserves. While they may have some U.S. dollars and crypto assets on their balance sheets, it's unclear how much the company was worth at the time of the trading halt.
Since Tether's ToS was updated at the beginning of the year, those who hold a large number of USDT may know that uncertainty is happening. Despite this, Tether is still trading at a price that approximates its convertible value, which shows that USDT's big players have confidence in its overall anchoring ability.
However, there is an additional problem. The largest holders of Tether are exchanges. At the time of writing, Binance has $700 million worth of USDT. While most of this may be held by customers, it is an open secret in the industry that some exchanges use USDT to lock in profits.
For exchanges, whether they like it or not, they will be consistent with the stability of Bitfinex and Tether. This means that exchanges in the ecosystem are offering seemingly permanent bids for up to $1 in USDT in order not to depeg from the dollar until Bitfinex repays its loan.
On the surface, shorting USDT is very attractive: the possibility of a short-term run is very small, which means that if there is a problem with USDT anchoring, there will be asymmetric returns. Structurally, performing this operation is harder than it looks. Borrowing USDT at scale is very difficult, if not impossible. Even for a small amount, the loan interest rate can exceed 15-20%. There are two types of transactions that can be performed:
1. The directional short-selling method is applicable to any scale. Aside from the Bitfinex shutdown, it is unlikely to present a profitable opportunity given the systemic support for Tether and the interest in seeing it unpegged.
2. Soros trading method, in which one (or more) traders sell enough USDT to consume the current cash reserves to break the peg to the US dollar.
On the face of it, the difficulty of large-scale borrowing suggests that the Soros method of trading is exactly what big holders fear. There is no other easily explained reason why someone holding a large amount of USDT would not want to profit from the very attractive 20% interest rate. If they are overly concerned about a USDT price crash, they have very little incentive to hold USDT given that there are currently alternative fiat tokens.
The strongest argument against shorting Tether is: "too big to fail": Because USDT is systemically important, exchanges and other large holders have no good way to reduce their exposure, and they are forced to choose to support the anchor ( as may happen now).
In its current state, Tether presents a Prisoner's Dilemma game: all the large exchanges with exposure may want to sell, but none of them can - if any exchange does (possibly using the OMNI-provided any privacy features), then the selling pressure would hit the $1 bids pretty hard.
what does that mean?
what does that mean?
Bitfinex looks unstoppable, like a cat with nine lives that bounces back from hacks and bad business deals. Even if Tethers aren't backed by the cash reserves everyone had hoped for, they're backed by the confidence of the crypto community, beyond the exchange's Prisoner's Dilemma, that the exchange's customers are trying to do the right thing.
A large group of community members believe that Bitfinex embodies the spirit of the ecosystem, providing free market solutions to various business problems. The same group of people who opposed the bank bailout may support the Bitfinex I EO bailout (equity financing), which allows them to remain a core part of the industry.
