Tether, the largest stablecoin, had a major wobble. Pegged to the U.S. dollar and widely used throughout the cryptocurrency ecosystem, even a fractional cent deviation from its peg can have enormous ramifications. Tether spent six hours below $0.99—at one point slipping down to $0.95—in the most significant deviation from its peg in recent history.
The world’s most popular stablecoin on Thursday posted a letter from MHA Cayman, an offshore outpost of UK mid-tier accountants MHA MacIntyre Hudson, that attests for consolidated total assets of just over $82.4bn. ...Leaving aside the question of how credible these "attestations" are (they are not audits), there remains the question of why anyone would sell their USDT for 95 cents on the dollar?
MHA’s snapshot is from March 31, so it doesn’t capture the USDT coin’s subsequent $8bn drop in market value. It shows less than 5 per cent of reserves in cash, a sum eclipsed even by the mysterious and undefined “other investments” category.
Nevertheless, higher weightings of money-market funds and US Treasury bills meant more than half Tether's total reported assets were in categories considered highly liquid
The explanation starts with this observation from Elder:
Tether’s closed-shop redemption mechanism means it cannot be viewed like a money-market fund. Processing delays can happen without explanation, there’s a 0.1 per cent conversion fee, and the facility is only available to verified customers cashing out at least $100,000.Elder quotes a report from Barclays that takes up the story:
The only way to get immediate access to fiat is to sell the token on an exchange, regardless of the size of holding . . . [W]hile redemption is ‘guaranteed’ at par, the secondary market price of tether can trade lower, depending on the willingness of holders to accept a haircut in return for access to immediate liquidity. As last week’s price action suggests, some investors were willing to accept a nearly 5 per cent discount to liquidate their USDT holdings immediately.Barclays continues:
We think that willingness to absorb losses, even though USDT is fully collateralized and has an overnight liquidity buffer that exceeds most prime funds, suggests the token might be prone pre-emptive runs. Holders with immediate liquidity demands have an incentive (or first-mover advantage) to rush to sell in the secondary market before the supply of tokens from other liquidity-seekers picks up. The fear that USDT might not be able to maintain the peg may drive runs regardless of its actual capacity to support redemptions based on the liquidity of its collateral."pre-emptive runs" are another way of saying metastability. Partly the problem is that, even if you believe the quarterly attestations, they are published after a significant delay. The most recent one was seven weeks out-of-date when it was published. During that time, BTC had fallen from around $47K to around $30K, a 36% drop. Elder writes:
The lack of a realtime view in combination with the short-dated nature of the whole portfolio can raise suspicions about end-of-quarter window dressing.Barclays wraps it up:
All of which makes stablecoins more like ETFs than money-market funds, says Barclays. The issuer is selling a token, after which secondary markets take control. But with ETFs, there is full transparency on the underlying portfolio, which enables market-makers to keep ETF shares trading in line with their benchmark. In the case of stablecoins, market liquidity and sentiment determine how close to realisable net asset value the token will trade
There is, in theory, an arbitrage to be made via the token’s creation and redemption processes. This is analogous to ETFs, which trade around their NAVs, while market makers use the create/redeem processes to maintain prices at levels close to the underlying collateral. Overall, there are several reasons why even this layer of arbitrage may fail, for example, if there are no willing arbitrageurs, if they do not have enough balance sheet to absorb all the selling flows, or if they fear that their requests to redeem will not be honoured in time or in full. Ultimately, full collateralisation helps to reduce stablecoin risk, but does not eliminate it.There are two parts to the problem, even if the backing is more than enough to cover all redemptions:
- Arbitrageurs do not have unlimited capital to devote to maintaining the peg.
- Any delay in redemption consumes arbitrageurs' capital.
The Consolidated Reserves Report alleges assets of $82,424,821,101 and liabilities of $82,262,430,079. This implies approximately $162 million in equity, via standard balance sheet math. You can think of $162 million as the overcollateralization cushion of Tether. If the value of its assets declines by more than $162 million, it requires recapitalization or will, with mathematical certainty, become undercollateralized.
The Consolidated Reserves Report alleges that Tether’s reserves included, as of March 2021, $4,959,634,446 of “Other Investments (including digital tokens).” A 3.27% decrease in the value of these investments wipes out all Tether equity and causes their tokens to be undercollateralized.
even if we believe Tether’s reserves report for the sake of argument, and we grant them very favorable assumptions as to their asset mixes and sagacity as traders, we still arrive at the result that they required recapitalization of the reserves. Their own numbers indict them.An indication that traders share some of McKenzie's skepticism is that, 12 days after Tether dramatically lost its peg, it has continued to trade marginally below $1.
To sum up, metastability is a dynamic process. A static view of the stablecoin's reserves, let alone a static view that is seven weeks out-of-date, is misleading. The only kind of stablecoin that has unlimited, instantaneously available fiat currency backing, and is thus not metastable, is one issued by the central bank, a CBDC.
Non-CBDC stablecoins do not have unlimited, instantaneously available backing, and are thus metastable. Their arbitrage barriers are, in practice, higher than those of algorithmic metastablecoins, but this is a difference of degree only.