Is Tether a black swan?

  • How would a loss of confidence in Tether play out in the short term?
  • Who would get most rekt if a Tether-related crash happens?
  • Would a Tether confidence crisis be a black swan event* that would severely impact the market?

1. The shape of US dollar liquidity in the crypto markets

In 2018, Hasu found that USDT made up for 29% of Bitcoin’s liquidity. Since then, the situation has become a lot more complicated. Not only is there 12x as much USDT in circulation. USDT trading pairs dominate spot markets on centralized exchanges (CEX) where they account for roughly 65% of trading volume. Furthermore, the complexity of the market has increased significantly due to the proliferation of crypto-related TradFi products, DeFi protocols and USDT-collateralized derivatives. That said, this analysis focuses on CEX and DeFi markets which would get directly impacted by a Tether shock.

The stable coin landscape

As of June 17th, 2021, USD stable coins have an aggregate market cap of $106.2 billion and USDT has a 61% share of that pie.

Stablecoin market share. Total supply is 106B, TheBlockCrypto. Also, pie charts are awesome

The rest of the pack

The market perceives USDT differently from other stable coins. This distinction is sometimes made explicit at exchanges. For example, FTX considers USD, USDC, and BUSD to be equivalent while USDT is treated as a separate asset.

FTX separates USD tokens into USD and stable coins (includes USDC and BUSD) and USDT
USDC/USDT Order books on Binance and Digifinex, LiveCoinWatch on June 17th, 2021

Fiat liquidity

Ties between the cryptocurrency markets and the “legacy” fiat world have always been shaky. Just recently, Binance lost its USD banking partner. Consequently, fiat trading is only available on a subset of exchanges.

Analysis

There are some salient differences between stable coin distributions. Notably, a larger share of the USDT supply is located on centralized exchanges. USDT is by far the most liquid stable coin in the CEX world and is essential to cross-exchange market makers. It also serves as a “casino chip” that grants entry into the perpetual futures market. On the other hand, USDT is largely shunned by DeFi protocols and gets less usage in that area.

Mechanics of the Tether peg

The main reason why USDT price could conceivably collapse is that the majority of USDT holders can’t directly “run to the bank”. According to itself, Tether only does business with “professional investors”. Retail traders can only sell their USDT in the CEX spot markets and DeFi markets, either for other crypto assets, stable coins, or fiat. As the March 2020 “COVID crash” has shown, traders will mostly buy stable coins and fiat in times of uncertainty. And we already know there’s not a lot of liquidity available for doing so.

Why Tether’s peg is fragile

To fully understand why the price of USDT might collapse under pressure, let’s first look at how the peg is normally maintained. Demand for USDT is driven by its usefulness in the CEX world. In times of high demand, the USDT peg breaks upwards which creates an arbitrage opportunity where traders can purchase freshly minted USDT from Tether at $1 and buy crypto or USD at a discount.

Tether TOS: Tether can delay redemptions or redeem securities and other assets instead (not USD).

3. “This is good for Bitcoin”

We have seen that there’s plenty of real fiat money and stable coins in the system. So after all, even if USDT crashes overnight, how bad can it be? Won’t USDT just be flushed out and all that value move into other assets like Bitcoin? Well, let’s think this through.

A severe case of ngmi

When liquidity evaporates

Imagine what would immediately happen if half of all US dollars in the real world would be declared fake. As Bitcoiners remind us at least 1,000 times per day, price is a function of scarcity. Naively, if US dollars suddenly become twice as scarce they’d also become twice as valuable. In other words, people who own dollars could buy everything twice as cheaply (the wonders of deflation!).

Quote: JPM Bitcoin Report, February 2021, page 6
Credit: W O J A K

4. How USDT issuance works

We have seen that it’s important that the market keeps confidence in Tether. The second question is how much Tether’s reserves would actually be worth in the event of a severe downturn of the cryptocurrency markets.

Hypothetical money printer
Alex Mashinsky spilling the beans on Twitter
The motto of the cryptocurrency market with respect to Tether

5. The casino always wins

The question remains, why would Tether and exchanges potentially put the whole market at risk?

6. Conclusion

In my opinion, a Tether confidence crisis would likely result in a massive shock to the market followed by a significant re-pricing of all crypto-assets.

7. Data Sources

The data used in this article was gathered from the following websites between June 14th and June 17th, 2021:

--

--

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store
Bernhard Mueller

Bernhard Mueller

1.8K Followers

Hackers (1995) fan • “Best Research” Pwnie Awardee • Former degen trader • P(G(F)) = ∀y q(y, G(F))