The Bull Case for Tether
By Jakub Rehor, CIO of Lucy Labs
A peculiar new literary genre has flourished in the last few years: the Tether FUD. Like the sonnet and the haiku, it is rigid in subject and form. The subject is the imminent collapse of the USDT stablecoin; the form is a screed. The most outstanding practitioners of the genre are the Bitfinex’ed account on Twitter and Patrick McKenzie at the Bits and Bytes substack. There are others, of course. I must admit that reading Tether FUD is a guilty pleasure of mine and I look forward to every new specimen. Please forward them to me if you run into them in the wild.
The substance of the FUDsters’ accusation is that USDT, the Tether stablecoin linked to the US dollar, is a Ponzi scheme. They claim that USDT is not backed by real assets, that the Tether team stole them all, and one day (soon!) USDT price will collapse to zero. Tether FUD has a big fan base in traditional finance (TradFi) which would love to see another crypto project fail.
Let’s put aside the fact that the FUDsters completely missed the implosion of UST, a $40 bn competitor to USDT that actually did go down to zero in May 2022 while the FUDsters were barking up the wrong tree like a pack of deranged chihuahuas. Let’s focus instead on what is going on with Tether, what were the historical problems with its business, and what its current health is.
Tether’s USDT was the first stablecoin, launched in 2014, before Ethereum existed. It operated on the Omni layer of Bitcoin network, an early smart contract platform. Those were the early days of crypto. Ross Ulbricht, the founder of Silk Road, was arrested only the year before. Mt. Gox was the leading crypto exchange, handling 70% of global volume before it got hacked and shut down in February 2014. Only a few lunatics (like Lucy Labs’ founding team) used and traded crypto. In this environment, opening and maintaining bank accounts was a cat and mouse game for crypto companies. No matter how innocent you were, banks would shut down your accounts (and sometimes keep your money!) when they found out you were a crypto company.
This was, obviously, a problem for a stablecoin that needed access to the banking system in order to create and redeem tokens in exchange for dollars. Tether was forced to move their operations around the world as they kept being disconnected from the financial system. For a while, they banked in Taiwan, using Wells Fargo as their correspondent bank in the US. In 2017, Wells Fargo cut them off and Tether moved their account to Bank of Montreal while also using accounts held by their sister company, the Bitfinex exchange, at Noble Bank in Puerto Rico.
Tether’s close relationship with Bitfinex (they share the same owners) led them into trouble in 2018. Bitfinex’s payment processor, Panama’s Crypto Capital, came under regulatory scrutiny. Poland and Portugal froze Crypto Capital’s accounts, locking up over $800m in Bitfinex’s funds. Bitfinex needed access to cash in order to service their clients’ withdrawals and pay its expenses. Bitfinex went and took $400m from Tether as an unsecured loan. This related party transaction was not disclosed at the time, even though rumors swirled about troubles at Bitfinex.
In November 2018, Tether opened a relationship with Deltec Bank & Trust in the Bahamas that proved to be more resilient (Deltec remains Tether’s main bank to this day). As crypto adoption grew, and especially as decentralized finance (DeFi) protocols like Compound, Aave, and Uniswap drove increasing use of USDT stablecoin, Tether saw massive inflows. Its assets grew from $51m in early 2017 to $450m by mid 2017, $1.8 bn in November 2018, and $4 bn by the end of 2019. They exploded to $20 bn at the end of 2020 and $75 bn by the end of 2021, before settling in the $65–70 bn range in 2022. If we assume a 2% interest rate on invested assets, Tether should be earning over $1 bn per year in interest income. The $400m loan to Bitfinex has become a non-issue for the solvency of USDT. In any case, it was repaid in January 2021.
In April 2019, the New York Attorney General began a formal investigation of Tether and Bitfinex’s operations and disclosures. The investigation went on for 2 years and examined 2.5m pages of documents. The outcome was a settlement in which Tether and Bitfinex paid $18.5m fine, agreed to a ban on serving New York residents, and agreed to submit regular reports on their banking activities, including mandatory reporting of transfers of assets between Bitfinex and Tether.
The results of the NYAG investigation are often misrepresented in TetherFUD rants, so let’s recapitulate them. Tether did hide related party loans to Bitfinex from the public. Its statements that USDT was backed 1-to-1 by USD cash in bank accounts were misleading. However, the investigation did not find that Tether was a Ponzi scheme, and it did not find a shortfall of assets backing USDT.
Tether’s disclosures are a sore point for its enemies, especially its inability to produce audited financial reports. This inability has a surprising but simple explanation: there is no FASB or IASB standard on digital assets audits. There is no such thing as a stablecoin audit: Circle’s USDC didn’t have one, Paxos’ USDP didn’t have one, TrueUSD didn’t have one. What auditors can do is to issue an attestation that they examined the reserve report and found it fairly stated. Tether has provided attestations on a quarterly basis since March 2021.
The reserve report makes an interesting reading. Cash and cash equivalents represent 80% of USDT reserves as of June 30, with the rest coming from unsecured loans (none to Bitfinex or related parties), corporate bonds, and other investments. The cash includes US Treasury bills (44% of reserves), commercial paper (13%), bank deposits, money market funds and reverse repos (the rest).
What is the worst-case scenario for USDT? If we assume a 40% haircut on commercial paper, loans, and other investments, we get liquidation value of 89 cents on the dollar. That is assuming that 13% of USDT reserves are in commercial paper, which was the case on June 30th. Tether announced that its commercial portfolio rolled off during the summer to $200m or less than 1% of total reserves. If we adjust the worst-case scenario for a lower level of commercial paper, USDT liquidation value rises to 94 cents on the dollar.
There is also a contingent liability arising from the bankruptcy of Celsius. Tether lent $840m to Celsius, fully collateralized by bitcoin (actually, 130% over-collateralized). When Celsius ceased payments to creditors, Tether sold the bitcoin collateral and fully recovered the value of the loan. However, in US bankruptcy law, payments to creditors made prior to bankruptcy filing can sometimes be reversed and reclaimed by the bankruptcy estate. The particular issue at stake for Tether is whether it properly “perfected” its security of the collateral. We may see litigation and potential losses if Tether has to return the collateral to Celsius estate. The highest possible amount is a complete loss of the $840m which would reduce recovery by 1.3 cents on the dollar.
Summing it all up, a reasonable worst-case recovery is somewhere around 93 cents on the dollar.
One can take a bet on the value of USDT by trading USDT perpetual swaps on FTX International. Holders of short positions in the USDT swap pay a funding rate to holders of long positions. The funding rate fluctuates but in recent months it mostly swung between 5 and 10% (annualized). The long position is equivalent to writing a credit default swap on USDT, the short position mimics buying a credit default swap. In Lucy Labs’ opinion, 5–10% annual premium for a CDS with a likely recovery above 90 cents on the dollar is an extremely rich price. We have taken a long position in USDT perpetual swaps in our Rising Tide fund, and we have been collecting the funding rate.