Dr. Stablecoin or: How I Learned to Stop Worrying and Love Tether
I’ve been a vocal advocate of stablecoins for a while, and have written about my belief that they’ll be the first killer application for blockchain. In my talks, I often refer to Tether as “the worst implementation of a great idea,” on account of the persistent lack of transparency, bank hoping and poor communication.
That shadiness, combined with its popularity, has made USDT an industry liability for years. Although I never subscribed to the crazy conspiracy theories, I have always worried that a stablecoin-related scandal would tank prices and make me look bad. When you are passionate about a new idea, the biggest danger is a poor implementation early in the life cycle ruining it in the eyes of others. So imagine my excitement last year when a handful of better designed, more transparent and willingly regulated alternatives showed up. Surely, I thought, all the people who used Tether would now switch to something safer.
Except that they didn’t, and Tether continued to dominate in market cap, even after news of withdrawal issues at parent exchange Bitfinex temporarily collapsed the peg last fall. This should have been the first sign that the world of stablecoins was not as I thought it was, but I wrote it off to a temporary lack of availability of the other coins at major exchanges.
Then came the recent filing from the attorney general of New York, and the worst case scenario was realized. There was now solid proof from an important authority that there were more tokens outstanding than dollars backing them by a wide margin. Surely the UDST peg would now collapse by at least the amount of the missing funds — if not more, and the industry would swiftly move to a better stablecoin. Upon hearing the news, I put several cross-stablecoin markets on my quote screen and waited for the fireworks to start, relieved that the albatross would soon be lifted.
But that didn’t happen, either. Confirmation of Tether not being fully backed had more of an impact on the price of Bitcoin than USDT itself. The peg never fell by more than a few percent, despite Bitfinex effectively admitting that a substantial portion of the collateral was no longer cash, but IOUs of funds that had been confiscated or stolen. Today, Tether’s peg sits back near $1, and the market cap has barely budged. At this point, I have to concede that the market has been trying to teach me something new, and that the world of stablecoins is not as I thought it was.
Having mulled it over for a week, here is what I’ve learned.
Tether Was Fully Collateralized At One Point
Most of the fears surrounding Tether and the crazy conspiracy theories revolved around the idea that its managers minted tokens whenever they felt like it, and that the stablecoin was never fully backed. The NYSAG filing disproves that. Their investigation shows that USDT was fully backed until Bitfinex was more or less robbed and forced to borrow some of Tether’s cash to continue meeting client redemptions. Sometimes, bad news makes a market go up because the reality is not as bad as what was feared.
In a way, we’ve finally gotten the outside audit of Tether we’ve always wanted, albeit from an investigation into whether the funds were wrongly used and the public misled. Presumably, if Tether had been lying about its reserves from the get go, they would have been prosecuted for that fraud as well. We can reasonably conclude that at some point last year, USDT was fully backed by dollars sitting in a bank account, a fact that many never would have expected just a month ago.
The Intent Was Good
Something else that becomes apparent from the court filings is the fact that the people orchestrating all of this at iFinex had good intent, even as they were deceiving their customers. Tether no longer being fully backed is not the result of a Machiavellian scheme to manipulate Bitcoin prices, but rather executives being forced into a corner by a combination of unfair banking practices, shady service-providers and their own history. Deceiving your customers is wrong and should be prosecuted, but how that deception began — the intent — still matters.
In this case, cash that technically belonged to USDT holders was swapped for a loan backed by a combination IOUs on the frozen Bitfinex funds, equity in that exchange, and rights to some of its future cash flows. The last two “assets” might seem worthless in any other context, but the success of exchange coins like BNB proves otherwise. So the collateral backing the loan from Tether to Bitfinex has some value. More importantly, this was all done in a desperate bid to not destabilize the crypto market.
Finance in the abstract tends to be a top-down, “view from 30,000 feet” affair. What I mean is that when we talk theory, we often talk about static conditions and definitions. For example: what makes a good stablecoin?100% collateralization in safe, liquid cash held by a trusted and large balance sheet who facilitates client redemption in a timely fashion.
Finance in practice is far messier. Execution is often dynamic and involves navigating common known unknowns along with the occasional black swan. In other words, it’s less algorithmic and more human, so hard to define concepts like relationships, perception and history matter more than an abstract academic might think.
I myself stopped using Tether long ago, so I took for granted that many others didn’t, and that for them, the stablecoin has a long history of working. This seems to be a theme that comes up when reputable reporters go looking for answers to the same questions that I’ve had. Here’s Frank Chaparro from The Block, quoting a source:
“People have tried to redeem even single digital millions (tiny really) and Gemini has failed to allow those redemptions,” one person said. “Whereas even with these events, Tether [redemptions] are working fine.”
The same understanding of history can be expanded to the rest of the Bitfinex universe. As others have pointed out, the exchange has a long history of recovering from attacks and setbacks, including another time when it issued a token to recover lost funds. Investors and their clients have always been made whole, as have the users of Tether.
Crypto people are big fans of the “Lindy Effect,” or the theory that the longer something has been around, the longer it will continue to be around. By blockchain industry standards, Tether is ancient, predating the start of most of our careers. That wouldn’t have happened if it didn’t do what it was supposed to do, far more often than not. In that sense, my attitude towards it is now a lot less critical than it used to be. Despite now being a year old, it’s biggest rivals barely manage 1/10th the market cap. This tells me that operating a proper stablecoin is hard.
During my talks on the potential for stablecoins I usually include a slide with pictures of money orders, cashiers checks and prepaid debit cards to prove that the idea of using proxies for cash being held by a trusted party to make a payment is neither new nor controversial. What is new is the fact that thanks to public blockchain rails, those products can now ride the first truly decentralized and global payment network. The threat of disruption there cannot be understated, and in the short and immediate term is far greater than the disruptive threat of Bitcoin.
But the road to get there is messier than I initially thought. There will be a battle for dominance between Tether, its existing rivals, whatever we get from the likes of Facebook & Telegram, bank tokens like a JPM Coin, and possibly even a central bank digital currency. It’s too soon to predict who will win, but I now believe that two important considerations will be which ones work well, and have a long history of doing so.