Confidence in stablecoins isn’t what it used to be. With the recent depegging of TerraUSD (UST) from the US dollar, many investors have flocked towards stablecoins that are asset-backed, such as USDT, USDC and BUSD.
In theory, you should be able to exchange $1 of the asset-backed stablecoin that you own and receive $1 USD in return.
However, the reserves of all of these stablecoins are not fully backed by US dollars in cash, and USDT’s reserves have always been in question.
Here’s what you need to know about this stablecoin.
What is USDT?
USDT is a stablecoin that mirrors the value of a US dollar, and it is issued by Tether.
In the past, Tether claimed that 1 USDT is always equivalent to 1 USD.
However, that wording has now changed and Tether mentions that they are “100% backed by our reserves”, which include:
- Traditional currency
- Cash equivalents
- Other assets and receivables from loans made by Tether to third parties
The change in this wording was due to greater scrutiny on Tether’s reserves for USDT, and there were no audits that could back the claim Tether made that they were fully backed 1:1.
The latest report released on March 31st 2022 showed that less than 5% of Tether’s reserves were in cash!
Cash and bank deposits were only 5.81% of the entire make up of the category Cash & Cash Equivalents & Other Short-Term Deposits & Commercial Paper. This constituted only 85.64% of Tether’s full reserves of USDT, which results in ~ 4.97% of the total reserves being in cash.
Some audits have been done on Tether’s reserves, and you can view all of them here.
What’s so important about USDT’s reserves?
USDT’s market cap has been increasing by a significant amount, particularly in 2021.
This growth was extremely high, particularly when the crypto markets were bullish during that year.
Crypto investing continues to grow as Tether surpassed $40 billion in market capitalization. Compared to other stablecoins, $USDT is four times larger than $USDC, which has a market cap of around $10 billion. https://t.co/mlt2JxfFpI
(Reporting via @CointelegraphMT)
— Cointelegraph (@Cointelegraph) March 25, 2021
However, there are concerns when the crypto markets are bearish, and a bank run starts to occur due to the fear of Tether collapsing.
A bank run occurs when there are huge volumes of withdrawals from the bank (in this case, redeeming USD from USDT) as depositors lose faith in the institution.
If there are a huge amount of withdrawals of USDT for USD at the same time, Tether may not be able to process all of them simultaneously since their reserves are not fully in USD.
This will lead to even more withdrawals of USDT as more depositors rush to get their money out, eventually going into a downward spiral like what happened to UST.
Ultimately, this will result in USDT losing its peg to the US Dollar, and 1 USDT will be worth less than 1 USD.
A depegging occurred in 2022
Such a scenario happened during the depegging of UST, and there were fears in the market which led to USDT also losing its peg.
Tether’s CTO, Paolo Ardoino, claimed that the prices on the different exchanges were “off”, as people were selling USDT for less than $1, and there were people that were buying it as well.
— Paolo Ardoino 🍐 (@paoloardoino) May 11, 2022
During the whole depegging situation, Tether continued to process all withdrawals smoothly.
Tether Continues to Honour All Redemptions from Verified Customers During Market Volatility, On Track To Process 2bn Today https://t.co/p1AugHb9Gn
— Tether (@Tether_to) May 12, 2022
In a blog post, Tether mentioned why USDT’s price dropped below $1.
This was most likely because there was not enough liquidity of USDT in certain exchanges to process the sell orders of USDT to USD, which resulted in the orders with a lower price of USDT being filled.
Eventually, the peg was restored.
Tether takes a victory lap after the stablecoin regains its dollar peg https://t.co/DI4uZm484J
— Bloomberg (@business) May 13, 2022
Despite all of the volatility of the market, Tether was still able to process $10 billion worth of withdrawals to USD.
Tether pays out $10bn in withdrawals since start of crypto crash https://t.co/vNtCGSE53I
— The Guardian (@guardian) May 22, 2022
This is definitely a huge feat. Nevertheless, it will still be good to understand what actually constitutes Tether’s reserves to determine if it can fully back USDT’s circulating supply.
What is found in USDT’s reserves?
Even though Tether’s reserves are not 100% in cash, the remaining assets need to be very liquid so that Tether can cash them out quickly to process huge volumes of withdrawals.
As part of the settlement of a lawsuit between Tether and the New York Attorney General in 2021, they are required to provide quarterly attestation reports on their reserves.
BREAKING: @Tether_to has settled with the New York Attorney General regarding the status of its reserves. The company has committed to publicly issuing a complete report of its reserves each quarter. https://t.co/h4sWxEjnb2
— Cointelegraph (@Cointelegraph) February 23, 2021
Here is a breakdown of the different assets that constitute USDT’s reserves.
#1 Cash and bank deposits
This constituent of Tether’s reserves can be considered as ‘cold, hard cash’. This has the highest liquidity, and depositors easily redeem USD for their funds in USDT.
The concern occurs when Tether’s cash reserves run out, and it will depend on the liquidity of the other assets to support such withdrawals.
#2 US Treasury Bills
This means that Tether lends out a proportion of its reserves to the US Government.
Due to this short maturity date, T-Bills can be considered to be “highly liquid”. In theory, Tether should be able to quickly convert these bills into cash.
#3 Money Market Funds
Money Market Funds are mutual funds that invest in highly liquid, near-term instruments.
Instead of just owning T-Bills, these funds also invest in other rather liquid debt-based securities. However, these securities are not just with the US Government, and can even include securities from companies.
Similar to T-Bills, these should be rather liquid as well.
#4 Commercial Paper
Commercial paper is a commonly used type of unsecured, short-term debt instrument issued by corporations.
These are different from the T-Bills, which are issued by the US Government.
Compared to T-Bills, commercial papers are seen to be more risky, where the corporations may not be able to pay back the debt owed.
As a result of greater scrutiny, Tether has been reported to have reduced its commercial paper holdings (by 17% from $24.2 billion to $20.1 billion)
Assurance Opinion Once Again Re-affirms Tether’s Reserves Fully Backed; Reveals Significant Reductions in Commercial Paper and Increase in U.S. Treasury Bills https://t.co/8qVSQFQBeY
— Tether (@Tether_to) May 19, 2022
Tether has also mentioned that it will continue to reduce its reserves in commercial papers and shift towards US Treasuries instead.
#4 Certificates of Deposit
Meanwhile, Certificates of Deposit (aka fixed deposits) are deposits that you leave with a bank, and they will be locked up for a period of time.
If the funds are redeemed before the end of the lockup period, Tether may need to pay a penalty for doing so.
As such, the funds placed in Certificates of Deposit may not be as liquid compared to the other assets in Tether’s Reserves.
#5 Corporate Bonds, Funds & Precious Metals
The assets that are in these category tend to be riskier, since the price of these assets can fluctuate.
At the point in time that Tether sells off these assets to process USDT withdrawals, the total value of these assets may be lower than the original buying price.
This does pose a risk as Tether may not have enough cash to fully back USDT with USD.
Tether also does not disclose the specific investments that they make under this category, and only mentions that it makes up about 4.52% of Tether’s entire reserves.
As such, we do not know for sure what Tether has used its reserves to invest into.
#6 Secured Loans (None To Affiliated Entities)
Some of the funds in Tether’s reserves have been used to loan out to other entities. Some of these loans have allegedly been given out to large Chinese companies and even other crypto companies, such as Celsius.
The worry is when these companies go bankrupt and are unable to pay back their loans to Tether. When Tether needs these funds to process withdrawals, it may be hard to get back their money to give to its customers.
#7 Digital tokens
Another part of Tether’s holdings lie in digital tokens. This is the most volatile composition of the reserves, especially since crypto prices fluctuate a lot.
Similar to the corporate bonds, funds and precious metals, we do not know for sure what digital tokens Tether has invested in, and whether they have been generating a return for Tether or not.
In particular, investors will flock to redeem USDT for USD during a bear market, where the prices of cryptocurrencies are usually much lower.
If Tether sells all of its digital tokens, it could be at a loss as well, and they won’t be able to fully back all of the USDT in circulation!
The USDT’s reserves have always been in question, and they previously asked the court to block the New York Attorney General (NYAG) from releasing documents regarding their reserves to news outlet CoinDesk.
Tether asks court to block request by CoinDesk for NYAG disclosure documentshttps://t.co/MdGVKjmyo7
— The Block (@TheBlock__) August 31, 2021
This is definitely really suspicious, and it may suggest that Tether has something to hide!
While Tether has started to give out attestation reports, these are only done quarterly.
Other competitor stablecoins like BUSD and USDC already give out monthly attestation reports.
TrueUSD (TUSD) even gives out 24/7 attestation reports!
— H.E. Justin Sun🌞🇬🇩🇩🇲🔥 (@justinsuntron) August 18, 2021
If Tether really wants to gain full credibility and trust, much more can be done to increase the transparency of its reserves.
The amount of the reserves that are found in cash and Treasury bills should be able to meet the demands of a significant amount of withdrawals.
However, what if more people want to withdraw their funds when Tether’s cash and Treasury bills run out?
This is the question that most critics of Tether are asking, and it remains to be seen if Tether can withstand such a test on its reserves.