Tether coin – is it really stable?

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There is a view that crypto was a low-interest-rates phenomenon, but stablecoins are really a low-interest-rates phenomenon. The idea of the most popular (“fully backed,” non-algorithmic) stablecoins is:

  1. You give some company $1.
  2. It promises to give you back the $1 when you want it.
  3. That promise lives on the blockchain; it can be traded on the blockchain, and it represents $1 on the blockchain.

This description is very, very close to the standard story of banking: You put one paper dollar in the bank, you get back a receipt saying you’ve got $1 in the bank, and you can use that receipt for $1 in the bank to transact with because it is a dollar. Your money in your bank account is not a claim on money, not an IOU for money; your money in your bank account is money. A stablecoin is money, in the specific context of some blockchain.

However, two other things that bank accounts have are:

  1. Branches, tellers, customer service, compliance, stuff like that; and
  2. Interest — not all of the time, and not so much over the past decade, but in an environment of high interest rates it becomes reasonable to expect to get paid interest on at least some of the money you keep in the bank.

Stablecoins can be like three guys in an undisclosed location who provide good customer service to a dozen big counterparties and have an inscrutable website for everyone else. And they tend not to pay interest.

This was a minor omission when banks also tended not to pay interest, but as rates have gone up, stablecoins seem like an incredibly good business to be in? You have a giant pile of money, you can park it somewhere quite safe and earn like 5% interest, you pay $0 of that interest to your depositors, you pay not very much more than $0 of that interest to your compliance department, you do not have much in the way of operating costs, and you collect 5% of a giant pile of money basically for having come up with this idea a few years ago. Of course the downside is that if crypto was a low-interest-rates phenomenon eventually people might lose interest in crypto and the demand for stablecoins would dry up. But Tether is fine I guess?

Crypto company Tether pledged to buy more bitcoin for its stablecoin reserves, adding to the $1.5 billion of bitcoin already backing its dollar-pegged token.

The company said starting this month it planned to use up to 15% of its net operating profits to purchase bitcoin. It didn’t indicate how long or consistently it planned to make the purchases. Rising interest rates boosted Tether’s profits to $1.48 billion in the first quarter. …

Tether said it plans for its bitcoin investments to be part of the company’s “excess reserves,” which is what it calls additional reserves beyond the value of its liabilities—the market cap of the tether stablecoin. On May 16, Tether’s excess reserves amounted to over $2.4 billion, according to its website. …

Last week the stablecoin issuer reported that it held more than $69 billion in cash and cash equivalents at the end of March, including $53 billion invested in U.S. Treasury bills, $7.5 billion in overnight reverse-repurchase agreements and $7.5 billion in money-market funds. The crypto company had billions of dollars in precious metals, secured loans and other investments that include digital tokens.

Tether’s latest reserves report shows roughly $79.4 billion of Tether stablecoins outstanding, backed by “at least” $81.8 billion of assets, for an excess of $2.4 billion, or, roughly speaking, a capital ratio of about 3%. When we talked about Tether a year ago, that ratio was 0.2%. A 3% capital ratio for a bank with mostly very safe short-term assets like Treasury bills would be pretty normal; a 0.2% capital ratio for any sort of bank at all is hair-raising. Tether has gone from alarmingly thinly capitalized to reasonably well capitalized over the past year, because it is a pile of money invested in short-term money-market instruments and rates have gone up a lot. Now Tether earns a lot of interest — it earned more than half of its excess reserves last quarter — and it puts that interest in the bank, and that means it has more than enough money to pay back all the Tethers out there.

Well, no, I mean, it doesn’t put the interest in the bank; it puts it in Bitcoin. (Or it puts 15% of it in Bitcoin.) Still, currently, that is all house money:

“Every single token in the market is and would remain fully backed even if the bitcoin price were to go down to zero tomorrow,” [Tether Chief Technology Officer Paolo] Ardoino said in an email. “Tether could distribute the entire amount invested in bitcoin to its shareholders, and the peg to USD will not be affected. In such a scenario, Tether would still have $1B of excess reserves.”

The ideal way to run Tether, for the people running Tether, would be:

  • Have like $80 billion of Tethers outstanding.
  • Put $80 billion into the safest possible stuff, short-term risk-free instruments, Treasury bills and reverse repos with strong counterparties collateralized by Treasuries.
  • Earn like $4 billion of interest on that stuff??
  • Put $1 billion of the interest into more safe stuff, just to be safe.
  • Put $1 billion of the interest into crazy stuff, to try to grow your assets and make more profits.
  • Pay yourself $2 billion of bonuses, you’ve earned it.

People are very suspicious of Tether, for basically good reasons:

  1. It does a long-running comedy routine where it constantly promises to provide audited financial statements any day now, and never does.
  2. It has a history of saying that each Tether is fully backed by safe US dollar assets, while in fact some of them were sometimes backed by dodgy loans to Tether’s affiliates.
  3. It seems clear that some Tethers have been created, not by customers depositing $1 and getting back one Tether, but by customers depositing $2 worth of Bitcoin (or less?) and getting back one Tether as a loan. This is sort of fractional reserve banking for crypto, and it means that if the price of Bitcoin drops and the borrower can’t pay back the loan, Tether could be partially unbacked.

The counterargument is that this is such a good and easy business it would be silly for Tether to take any risk: If you can earn more than a billion dollars of interest per quarteron safe assets with no real expenses, why do anything else? 

I suppose part of the answer is that, if you run Tether, you do not want this business to go away. If you are the bank of crypto, the main risks to your business are:

  1. People do not trust your reserves, so they take their money out, or
  2. People do not trust crypto, so they don’t need any Tethers, so they take their money out.

If you’ve got some spare cash to buy Bitcoin and support the system, that might be a good use of it.