Will Tether be the next black swan?

Since the beginning of the continuous bull market cycle, Tether’s USDT stablecoin has experienced tremendous growth. Compared with the peak period of the 2017-2018 cycle, the current USDT circulation has increased by an order of magnitude. Therefore, it is necessary to re-investigate whether the crypto market can withstand potential liquidity shocks related to Tether.  In this article, I will address the following issues:

  • In the short term, how will the loss of confidence in Tether behave?
  • If there is a crash related to Tether, who will be the most concerned?
  • Will Tether’s confidence crisis become a black swan event that seriously affects the market?

* In this article, we use “black swan” to refer to a major event that surprised most people. After all, 95% of people in the encryption field insist that Tether is good. If you are not satisfied with this definition, you can regard it as a white swan event.

“For the turkey, it may be a surprise for the black swan, but for the butcher it is not a surprise for the black swan.”

—Nassim Nicholas Taleb

The form of U.S. dollar liquidity in the cryptocurrency market

In 2018, Hasu found that USDT accounted for 29% of Bitcoin’s liquidity. Since then, the situation has become more complicated. Not only the circulation is 12 times that of Tether. The USDT base currency pair also dominates the spot market on the Centralized Exchange (CEX), and they account for approximately 65% ​​of trading volume. In addition, due to the proliferation of TradFi products, DeFi protocols and USDT mortgage derivatives related to cryptocurrencies, the complexity of the market has increased significantly. In other words, the analysis focuses on the CEX and DeFi markets, which will be directly affected by the impact of Tether.

  • Stable currency pattern

As of June 17, 2021, the total market value of US dollar stablecoins was US$106.2 billion, and USDT accounted for 61% of the market share.

1624273619199123Stablecoin market share: total supply is 106B Source: TheBlockCrypto

Where are all the USDT now? CryptoQuant tracks 7.25 billion USDT reserves in foreign exchange. However, this does not include USDT on the Tron blockchain, which accounts for half of the USDT supply. According to Tether’s rich list, Binance alone holds 17 billion Tron USDT. The list also shows that there are 2.68 billion USDT in Huobi exchange wallets. This is almost 20 billion USDT held by the two exchanges. Considering these figures, the valuation given by CryptoQuant seems to be underestimated. A more realistic estimate is that approximately 70% of Tether’s supply (43.7 billion USDT) is located on centralized exchanges.

 Interestingly, only a small portion of these USDTs appear in the spot order book. One possible reason is that a large number of representatives than hold wallets to collateralize derivative positions, especially perpetual contracts. The CEX futures market is essentially a casino where traders bet on cryptocurrency prices with crazy leverage. This is a huge market: Binance’s futures trading alone has generated $60 billion in trading volume in the past 24 hours. It is important to understand that the implementation of USDT perpetual contracts is 100% based on USDT, including mortgage, financing and settlement. The price is linked to the price of crypto assets through clever incentives, but in fact, USDT is the only asset that changes hands between traders. This use case has generated a lot of demand for USDT.

 Regarding DeFi, according to Glassnode data, 2.19% of USDT supply is locked in smart contracts. Since it is impossible for Glassnode to track all DeFi protocols in all blockchains, the actual number may be higher. We assume a value of about 5%, which seems to be compatible with the numbers shown by the mainstream Ethereum DeFi protocol: the cumulative USDT liquidity on Aave, Compound and Uniswap is $1.73 billion.


  • Other categories

The market’s view of USDT is different from other “safer” stablecoins. This distinction is sometimes evident in exchanges. For example, FTX considers USD, USDC, and BUSD to be equivalent, while USDT is treated as a separate asset.

1624273618913824FTX divides U.S. dollar tokens into U.S. dollars and stable coins (including USDC and BUSD) and USDT

With this in mind, let us look at the distribution of the second and third largest stablecoins USDC and BUSD. According to CryptoQuant data, there are 15.9 billion USDC and 50.2 billion BUSD in foreign exchange reserves, accounting for 6.7% and 52% of the supply, respectively. Less issuance on the blockchain, it should be easier to track).

 In addition to the relatively small share of USDC in centralized exchanges, I found that the liquidity of the USDC/USDT and BUSD/USDT order books of overseas exchanges is generally low in terms of selling, that is, there is not much liquidity available to “cash out” “Used by USDT holders into a more secure stablecoin.

1624273618937005USDC/USDT orders on Binance, Digifinex, and LiveCoinWatch on June 17, 2021

Let’s take a look at the DeFi statistics. According to the Glassnode report, 17.22% of USDC supply is locked in smart contracts. Similarly, Glassnode only considers data from the Ethereum blockchain, but USDC is also used in other DeFi chains, including the anchored version of USDC on the Binance Smart Chain, with a supply of 1.8 billion. The combined USDC liquidity on Aave, Compound and Uniswap is 81.4 billion, which is 4.7 times higher than USDT. Given these numbers, it seems reasonable to assume that at least 25% of USDC is “locked up” in DeFi smart contracts.

 In the case of 0.55%, the percentage of BUSD locked in the smart contract appears to be much lower, but again there is a lack of data from the Binance smart chain. There are 768 million BUSD locked in PancakeSwap and 226 million BUSD available for borrowing cream.finance, showing that BUSD is widely used on the Binance Smart Chain. 30% of the BUSD supply in the smart contract sounds like a reasonable estimate.

  • Fiat currency liquidity

The connection between the cryptocurrency market and the “traditional” fiat currency field has been unstable. Just recently, Binance lost its dollar banking partner. Therefore, fiat currency transactions are only applicable to some exchanges.

 Looking at the USDT/USD, BTC/USD and ETH/USD order books on Bitfinex, Coinbase, Binance US, Kraken, FTX and Gemini, these orders account for 60% of the exchange’s market share. I found that a total of 203 million US dollars of bids are in- Within 2%. Please note that I did not consider the Euro and the Korean Won, and there may be buyers who want to buy cryptocurrencies at a discount when the USDT crashes. The total amount of legal liquidity bids on cryptocurrencies by fiat currency exchanges may be close to 1 billion or below ten digits.

 How much fiat currency liquidity is in the overall market? It’s hard to tell. Perhaps institutions are holding billions of dollars in line at the over-the-counter trading desk, preparing to buy on dips (although the recent outflow of Crypto asset funds suggests that this is not the case). Since institutional investors can access cryptocurrencies through regulated market tools such as Grayscale Trust stocks, MicroStrategy stocks, crypto ETFs, and CME futures, this fact has further confounded this field. The Coinshares weekly Crypto asset flow report provides some insights into these markets, but I think it is safe to say that “true” fiat currency liquidity plays a relatively small role in the cryptocurrency spot market, and during major USDT sell-offs , Most actions will take place in this market.

  • analysis

Even if the above estimates are not very accurate, there are some significant differences between stablecoin distributions. First, a larger proportion of USDT supply is located on centralized exchanges. It is by far the most liquid stablecoin in the CEX world, so it is very important for cross-trading market maker. USDT also acts as a “casino chip” that allows access to the perpetual contract market. On the other hand, USDT is largely evaded by the DeFi protocol and is less used in this field.

 On the contrary, USDC acts as a substitute for the U.S. dollar and a safe-haven asset in DeFi, where a large part of the supply is locked in smart contracts and stored in a blockchain wallet (intuitively, the safest way to store value in cryptocurrency) Is holding USDC on the ledger).

 BUSD is a combination of the two. Binance, the largest cryptocurrency exchange, provides a BUSD mortgage version of perpetual contracts and many BUSD trading pairs, so a large part of the BUSD supply is used in Binance. On the other hand, BUSD is also very popular on Binance Smart Chain and has a better reputation than USDT, so it is also used as SOV and “DeFi USD”.

 As we have seen, if USDT holders on a centralized exchange choose to withdraw, the USD/USDC/BUSD liquidity they can immediately obtain will be relatively small. The approximately 44 billion U.S. dollars held on the exchange will be matched with approximately 10 billion fiat currencies and USDC/BUSD (regardless of the fact that liquidity providers will flee the market during the panic-it will be described in detail later).

 Tether’s mechanics

The main reason why the USDT price can collapse is that most USDT holders cannot directly “run to the bank”. According to itself, Tether only conducts business with “professional investors”. In the event of an event that seriously damages confidence in Tether—such as the repression of the authorities, ongoing regulatory blockbusters or random flash crashes in the price of USDT—retail investors can only sell their USDT in the CEX spot market and DeFi market for other use Encrypted assets, stablecoins or fiat currencies. As the “COVID Crash” in March 2020 showed, traders mostly buy stablecoins and fiat currencies during uncertain times. We already know that there is not much liquidity to do so.

  • Why is linking with Tether vulnerable?

In order to fully understand why the price of USDT collapsed under high selling pressure, let us first look at how the linked exchange rate is usually maintained. The demand for USDT is driven by its practicality in the CEX field. At times of high demand, the USDT peg breaks upwards, which creates an arbitrage opportunity. Traders can buy newly minted USDT from Tether at a price of 1 USD and buy cryptocurrency or USD at a discounted price.

 When the pegged exchange rate falls and breaks, it also creates an arbitrage opportunity where traders can buy USDT at a cheaper price, thereby helping to restore the pegged exchange rate (detailed analysis by Frances Coppola).

 Under normal circumstances, even if the USDT price drops below 1 U.S. dollar for a long time, arbitrageurs should eventually buy the discounted USDT and restore the exchange rate system pegged to the U.S. dollar. Crucially, this requires trust in Tether: arbitrageurs must believe that USDT can eventually be redeemed at face value or at least higher than the purchase price. The problem is that according to Tether’s TOS, this does not guarantee this, and Tether is not known for its competent and financially responsible management style. Therefore, arbitrageurs are more risky to help maintain the pegged exchange rate when there is strong selling pressure.


Tether TOS: Tether can delay redemption or redeem securities and other assets (not U.S. dollars).

 Please note that regardless of whether Tether has actual solvency or not, USDT prices may plummet. In the short term, what is important is the market’s perception.

 “This is good for Bitcoin”

We have seen a large number of real legal currencies and stable currencies in the system. So in the end, even if USDT plummets overnight, how bad can it be? USDT will not be eliminated, will all of this value be transferred to other assets such as Bitcoin? Well, let’s think about it carefully.

1624273618946418A serious ngmi case

If Tether suddenly becomes worthless, the idea of ​​“transferring value from USDT to other assets” is based on a fundamental misunderstanding of how the market works and the important role that fiat currency liquidity plays in its operation.

  • When fluidity evaporates

Imagine what would happen immediately if half of the dollars in the real world were declared counterfeit. Just as Bitcoin holders remind us at least 1,000 times a day, price is a function of scarcity. If U.S. dollars suddenly become twice as scarce, their value will also double. In other words, the person who owns the dollar can buy everything for twice the price (the miracle of deflation!).

 Now, let us imagine an idealized toy version of the cryptocurrency market. There are only two types of asset transactions in this market: crypto tokens and U.S. dollar tokens. In this model, all cryptocurrencies are interchangeable because they are highly correlated with the dollar price (which is very close to what happens in the real market). The DeFi brothers might imagine a constant product AMM, in which all crypto tokens (BTC, ETH, etc.) are in pool 1, and all tokens pegged to the dollar are in pool 2.

 Let’s insert some of the numbers from the first part of this article into our toy market. We start with a balanced market. Now, suddenly, 57.8% of the supply of USD tokens (equivalent to Tether’s share of the total USD liquidity in the crypto market) was found to be worthless. Since “real” USD-pegged tokens are now 57.8% scarce, they should immediately be traded at a 136% premium (only in the toy market! They are still worth $1 in the real world). But this is only the beginning. Holders of now worthless fake U.S. dollar tokens will try to sell these tokens into the market, including “real” U.S. dollar tokens, further pushing up the premium of these tokens. In other words, in terms of USD tokens, crypto tokens will become cheaper and cheaper.

 But this is not all. U.S. dollar liquidity providers and market makers will flee the cryptocurrency market-after all, no one wants to be dumped by fake U.S. dollar token holders. We will study the situation where real USD tokens become unavailable. But the US dollar token needs to guarantee the basic functions of the market: market making, arbitrage, loan repayment, etc. Without them, the market would freeze.

 Of course, the real market is much more complicated than this, and will not function exactly as described. But the bottom line is: If tomorrow is found that all USDT is worthless, then the legal price of all crypto assets will plummet, and as most of the dollar liquidity disappears, the market will experience a liquidity shock.

1624273619199384Quote: JPM Bitcoin Report, February 2021, page 6


Is Tether a partial reserve bank?

If the market really collapses because it loses confidence in Tether, what will happen next? It depends on how much Tether’s reserves are worth after all the dust settles. After all, if Tether can really come up with $62.7 billion in cash after the collapse, then this panic is unreasonable. Confidence in Tether can be restored, and the market will eventually recover.

 This begs the question: What is the value of Tether’s reserves if there is a severe economic recession? To answer this question, we must first know how the US$62.7 billion came into being.

 Normally, the amount of U.S. dollars flowing into Tether’s bank account matches the supply of USDT 1:1. However, if you look at Tether’s reserves details, especially large positions in “commercial paper”, you can easily see that Tether may be engaged in part of the reserve banking business. In this case, “partial reserve” means that Tether has received only a small portion of the $62.7 billion in customer deposits. Part of the USDT supply is generated through the issuance of USDT loans, and there is no corresponding inflow. Essentially, Tether will use the deposits of its customers, which is exactly how commercial banks create fiat currency in TradFi. You can also think of it as a leveraged money market fund.

 The release process may be as shown in the figure below. Imagine a fantasy company called “Paolo Co.”. It is a subsidiary of “Delta Bank” and is jointly owned by Tether executives (just like Tether and Bitfinex originally had the same owners). Tether uses the newly minted USDT to purchase commercial paper from Paolo Co. Paolo Co. then invested the borrowed USDT in the crypto market. Commercial paper enters Tether’s reserve. This will result in all USDT being “100% backed by reserves,” and it will make Tether’s reserve basket look like a money market fund, which will put most people in the crypto space at rest.

1624273619246637Hypothetical money printing machine

We have no concrete evidence that this is what is happening, but then again, it is certainly possible. In my opinion, we should ask Tether to provide appropriate supporting evidence and assume the worst-case scenario when no evidence is provided. Not the other way around!

1624273619290554The motto of the cryptocurrency market about Tether

I don’t doubt that some investors have minted and redeemed USDT (there is anecdotal evidence that they have), but considering Tether’s history of banking issues and legal issues, I find it hard to believe that institutional investors have actually transferred 62.7B US dollars to Tether. To me, the partial reserve explanation seems more realistic.

 Remember, just like TradFi, the crypto market is also a game, and everyone’s goal is to maximize profits. Tether operates in an opaque corner of an unregulated market, and people tend to believe everything it says, so it has a lot of room to change the rules. And Tether has been found lying many times. In the words of the New York Attorney General:


Casino always wins

The question remains, why might Tether and exchanges put the entire market at risk?

 Moral hazard is a well-known cause of the financial crisis in the TradFi market: Banks always profit during the bull market, but are rescued by taxpayers when the market crashes, so they have little incentive to act responsibly. Presumably, the situation is worse in unregulated markets due to lack of supervision and accountability.

 Part of the problem is that fat-tail risk is largely transferred to USDT holders. Neither Tether nor the centralized exchange is responsible for redeeming USDT at face value. Therefore, if USDT decoupling does occur, then when their assets depreciate, USDT and cryptocurrency holders will be affected first. Of course, the chain reaction may also cause the exchange to go bankrupt, but at least they are in a much better position than the hodlers. While the exchange continued to operate, the holders shared multiple losses.

in conclusion

In my opinion, the Tether confidence crisis may have a huge impact on the market. Although it is possible for large participants to repurchase a large amount of USDT to restore the peg to offset the crisis, or to successfully assure the market that all USDT can be redeemed at face value, it is not certain that this will happen unless you trust Tether and its affiliates very much. the company.

 Tether’s (hypothetical) partial reserve issuance creates hidden leverage in the “base layer” of the crypto market. In my opinion, the resulting systemic risks are unacceptable. In fact, most participants in the market do not recognize risks at all, and sometimes spare no effort to defend Tether instead of making it bear appropriate responsibilities. This shows that the market is immature and cannot adjust itself.

 Regardless of how you fundamentally view the cryptocurrency field, as long as Tether remains systemically important, cryptocurrency assets cannot be a viable long-term investment. In the long run, getting rid of USDT (whether it is a black swan or not) will bring a more mature and strong market.

 People can be optimistic about the value proposition of decentralized finance for a long time, but still regard the market as a casino. This is not incompatible.

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