Tether (USDT) is the third-largest cryptocurrency in terms of market capitalization. Additionally, it is the largest stablecoin on the market. However, its popularity does not guarantee that it is a secure investment.
Stablecoins are critical components of the cryptocurrency business. They are pegged to the price of physical items in the real world, such as commodities or traditional currencies. Tether, on the other hand, is pegged to the US dollar.
Stablecoins are used to simplify cryptocurrency trade, money transfers, and earning interest. However, authorities are concerned about the lack of regulation and transparency surrounding these coins, particularly Tether. Several explanations for this include the following:
1. Tether is merely 2.9 percent backed by cash reserves (the rest comes in other forms)
Investing in Tether is not the same as investing in US dollars. While the price is fixed to the dollar, there is no guarantee that the corporation would have enough funds to pay out if there was a run on Tether — that is, if a large number of people attempted to exchange their Tether for dollars.
Initially, Tether claimed that each USDT was backed by a US dollar held in its reserves. However, the reality is more complicated: Tether is backed by a combination of the following:
- Cash equivalents
- Secured loans
- Corporate bonds
- Other investments
It presented a pie chart detailing its reserves in May. The breakdown indicated that it kept 75.9 percent of its assets in “cash and cash equivalents.” However, a closer examination reveals that just a small amount of the 75.9 percent is in cash:
Commercial paper accounts for 65.4 percent of the total. This is over half of Tether’s total reserve base.
Cash makes up 3.9 percent of the total. This represents 2.9 percent of the company’s overall reserves.
Commercial paper is a short-term loan that is typically issued to businesses. The issue is that Tether has not disclosed the types of loans it has made. We have no idea who the borrowers are or what type of debt they are carrying. Most crucially, we have no idea how easily Tether would be able to access that money.
Additionally, the specific breakdown of Tether’s reserves has not been audited independently. Moore Cayman, an accounting firm, verified earlier this year that the statistics are “properly reported,” but it does not constitute a comprehensive audit.
2. Tether has had run-ins with the office of the New York Attorney General.
New York authorities have enacted some of the country’s strongest crypto rules, and its courts have been particularly aggressive in prosecuting crypto criminals.
The New York Attorney General negotiated a deal with iFinex, the parent firm of Tether and cryptocurrency exchange Bitfinex, in February, following a 22-month investigation. Investigators charged the corporations with illegally concealing losses. “Tether’s statements that its virtual currency was fully backed by US dollars at all times were a fraud,” Attorney General Letitia James stated.
iFinex was fined $18.5 million and is no longer permitted to conduct business in New York. It will be required to submit quarterly reports on its reserves, which explains the breakdown we saw above. The corporation maintains its innocence.
3. If Tether collapses, it has the potential to upend the whole cryptocurrency market.
The Federal Reserve is concerned about stablecoins in general, but specifically about Tether. At the end of June, Eric Rosengren, President of the Federal Reserve Bank of Boston, identified Tether as a possible threat to financial stability.
“The reason I mentioned Tether and stablecoins is that their portfolio resembles that of a premier money market fund, but is perhaps riskier,” he told Yahoo! Finance.
Prime money market funds are simply funds that invest in the above-mentioned sort of commercial paper debt – the type that accounts for about 50% of Tether’s total reserves.
The concern is that Tether is acting similarly to a bank or other financial institution, but without the consumer protection and economic crisis prevention laws that banks must follow. That is why there is such a desire for more stringent stablecoin regulation — to safeguard both the economy and the cryptocurrency business.
According to Rohan Grey, an assistant law professor at Willamette University College of Law, “the developing universe of stablecoins arguably underlies the entire crypto community right now; if it crashes, the entire sector may collapse.”
Tether is not the only stablecoin on the market.
There are also additional stablecoins that are more clear about the amount of money they retain in reserve. For instance, the Gemini dollar (GUSD) is entirely pegged to the US dollar. For each GUSD issued, a US dollar is held in an audited bank account.
The Federal Reserve is considering launching its own digital currency, putting pressure on all stablecoins. A government-backed digital dollar that provided the benefits of blockchain-based currencies (quick, low-cost payments) but without the risk and volatility associated with crypto may negate many of the current stablecoin advantages.
If such a scenario plays out, buyers’ trust in particular stablecoins becomes even more critical. Assume the Federal Reserve announces in September that it would launch its own digital currency. At that moment, many people may attempt to sell their Tether – and there is no guarantee that Tether will be able to cover the cost promptly.
Fundamentally, investors must have confidence in the company in which they are investing. And it is reason enough to be wary of Tether.