Explore whether Tether's trust crisis will become a black swan in the encryption market
Original title: "Tether is a black swan? "; Author: Bernhard Mueller, Security Researcher; Editor: Nanfeng
Tether’s USDT stablecoin has experienced massive supply growth since the start of the most recent bull cycle. Compared to the peak of the 2017-2018 cycle, the current USDT in circulation has increased by an order of magnitude. Therefore, it is necessary to re-examine whether the cryptocurrency market can withstand a potential Tether-related liquidity shock.
In this article, I try to answer the following questions:
If the market loses confidence in Tether, what will happen in the short term?
Who would be hit the hardest when a Tether-related crash happens?
Will Tether's crisis of confidence become a black swan event that seriously affects the market?
For the purposes of this article, we use "black swan" to refer to a major event that surprises most people. After all, 95% of people in the crypto space think Tether is good. If you are not satisfied with this definition, you can also think of it as a white swan event.
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— Nassim Nicholas Taleb
The shape of USD stablecoins in the cryptocurrency market
In 2018, Hasu found that USDT accounted for 29% of Bitcoin liquidity. Since then, things have gotten a lot more complicated.Not only are there currently 12x more Tethers in circulation, USDT-based trading pairs also dominate the spot markets of all centralized exchanges (CEXs), accounting for approximately 65% of trading volume.Additionally, the complexity of the market has increased significantly due to the proliferation of cryptocurrency-related TradFi (traditional finance) products, DeFi protocols, and derivatives collateralized by USDT. Having said that, the analysis in this article focuses on the CEX and DeFi markets that are directly affected by the Tether shock.
Stablecoin landscape
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Above: Market share of major USD stablecoins in the crypto market as of June 17.
So, where is all this USDT? CryptoQuant tracks USDT reserves on exchanges at $7.25 billion. However, this does not include USDT issued on the Tron blockchain,The USDT issued on Tron accounts for half of the total USDT supply.According to the rich list of Tether holdings, Binance alone holds 17 billion Tron USDT. The list also shows that Huobi Exchange also holds more than 2.68 billion USDT in its wallet. The USDT held by these two exchanges has reached almost 20 billion. Considering these figures, the value given by CryptoQuant seems to be an underestimate. A more realistic estimate is thatAbout 70% of Tether's supply (43.7 billion USDT) is located on centralized exchanges.
Interestingly, only a fraction of USDT from these exchanges shows up in spot order books. One possible reason is,A large part of exchange USDT is stored in wallets as collateral for derivatives positions, especially perpetual futures contracts.The CEX futures market is essentially a casino, where traders bet on the price of cryptocurrencies using insane leverage. It's a huge market: Binance's futures trading alone generated $60 billion in trading volume in the past 24 hours at the time of writing. It is important to know that the implementation of the USDT perpetual futures contract is 100% USDT-based, including the use of USDT for collateral, funding and settlement. The price of the perpetual contract is tied to the price of the crypto asset through clever incentives, but in reality, USDT is the only asset that changes hands between traders.This use case has created a huge demand for USDT.
As for DeFi, according to Glassnode, 2.19% of the USDT supply is locked in DeFi smart contracts. However, since it is impossible for Glassnode to track all DeFi protocols on all blockchain platforms,Actual figures may be higher. Therefore we assume that there isAbout 5% of the USDT supply is locked in DeFi, a ratio that appears to be consistent with the amount of USDT locked in major DeFi protocols on Ethereum: USDT cumulative liquidity on Aave, Compound, and Uniswap is $1.73 billion.
Other USD Stablecoins
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Above: The FTX exchange distinguishes U.S. dollars and stablecoins (including USDC and BUSD) from USDT.
With this in mind, let’s take a look at the distribution of the second largest stablecoin USDC and the third largest stablecoin BUSD. According to CryptoQuant's data, there are a total of 1.59 billion USDC and 5.02 billion BUSD in the current exchange reserves,As can be seen,
As can be seen,The USDC shares stored in centralized exchanges account for less of its total circulation.Aside from this fact, I find it worth noting that USDC/USDT and BUSD/USDT order books on offshore exchanges are generally less liquid on the sell side, that is, for those who want For USDT holders who "cash out" USDT into a safer stablecoin such as USDC,image description
Above: USDC/USDT order books on Digifinex and Binance as of June 17, 2021. Screenshot source: LiveCoinWatch
Let's look at the DeFi data again. Glassnode reports that 17.22% of the USDC supply is locked in smart contracts. Likewise, Glassnode only considers data from the Ethereum blockchain, but USDC also circulates on other blockchain platforms, including a USDC-pegged version on Binance Smart Chain (BSC), which has a supply of 1.8 billion. The total USDC liquidity on Aave, Compound, and Uniswap is 8.14 billion, which is 4.7 times higher than the USDT liquidity (1.73 billion) on these three major DeFi platforms. Given these figures, it seems reasonable to assumeAt least 25% of USDC is locked in DeFi smart contracts.
In contrast, Glassnode data showing only 0.55% of BUSD locked in smart contracts looks much lower, but Binance Smart Chain (BSC) data is still missing here. 768 million BUSD is locked in PanakeSwap, an exchange on BSC, and Cream Finance, a lending platform on BSC, has 226 million BUSD available for lending, which means that a large amount of BUSD is being used on the Binance Smart Chain. Therefore, 30% of the BUSD supply locked in smart contracts seems like a reasonable estimate.
Fiat Liquidity
The link between the cryptocurrency market and the "traditional" fiat world has been shaky. Just recently, Binance lost its USD banking partner, Silvergate Bank. therefore,Fiat currency transactions can only be carried out on some exchanges.
Looking at the USDT/USD, BTC/USD, and ETH/USD order books on Bitfinex, Coinbase, Binance US, Kraken, FTX, and Gemini (these exchanges account for 60% of the fiat trading market share), I found that between 0% and The order book at 2% depth of trade totaled $203 million. Note that I'm not considering EUR (Euro) and South Korean Won (KRW), and buyers may be looking to buy cryptocurrencies at a discount as USDT plummets. Therefore, on fiat exchanges, the total fiat liquidity of cryptocurrenciesLikely closer to $1 billion or less.
How much fiat liquidity is there in the market as a whole? It's hard to say. Perhaps, institutions are queuing up at over-the-counter desks with billions of dollars ready to buy the dip (although recent outflows from digital asset funds suggest otherwise). Adding to the murkiness is the fact that institutional investors can also gain exposure to cryptocurrencies through regulated markets such as Grayscale Trust Shares, MicroStrategy stock, Crypto ETFs, and CME Futures, among others. Coinshares weekly digital asset flows report provides some insight into these markets. But I think it's safe to say,"Real" fiat liquidity plays a relatively small role in crypto spot marketsanalyze
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While the above estimates are not terribly precise, there are some notable differences among stablecoin distributions.so far,so far,USDT is the most liquid and stable asset in CEX, so USDT is very important for cross-exchange market makers.USDT also acts as a “casino chip,” allowing people to enter the perpetual futures market. on the other hand,The USDT locked in the DeFi smart contract only accounts for a small share,Therefore, it is relatively less used in this field.
Instead, USDC serves as a dollar substitute and a safe-haven asset in DeFi, with a large supply of USDC locked in smart contracts and blockchain wallets.
BUSD is somewhere in between. Binance — the largest cryptocurrency exchange — offers a perpetual futures with BUSD as collateral and many BUSD-based trading pairs, so a large portion of the BUSD supply is used on the Binance exchange. On the other hand, BUSD is also popular on Binance Smart Chain (BSC) and has a better reputation than USDT, soBUSD is also used on BSC as a store of value and "DeFi dollar"。
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Tether's anchor structure
The main reason why USDT price may crash is,Most USDT holders cannot go directly to "bank run". According to Tether itself, Tether only does business with “professional investors.” If an event that widely affects people's confidence in Tether occurs, such as Tether being suppressed by the authorities, or a major disclosure in its regulatory process, or a flash crash of USDT prices, thenRetail traders can only sell their USDT in the CEX spot market and DeFi market to exchange it for other cryptocurrencies, stable coins or fiat currencies. As the March 2020 "COVID crash" showed, during times of uncertainty, traders will primarily buy stablecoins and fiat currencies. But we already know that there is not enough liquidity for retail investors to do that.
Why is Tether's anchor fragile?
To fully understand why USDT's price crashes amid high selling pressure, let's first look at how USDT typically maintains its peg to the US dollar. The demand for USDT is driven by its utility in CEX. During periods of high demand, USDT’s peg to the U.S. dollar can break upwards (i.e., the price of 1 USDT exceeds $1), which creates an arbitrage opportunity where traders can buy freshly minted USDT from Tether for $1, thereby trading at a discount Buy other cryptocurrencies or US dollars at the same price.
And when this anchor is broken down (i.e. the price of 1 USDT is less than 1 USD), this also creates an arbitrage opportunity, that is, traders can buy USDT at a cheaper price, which helps to restore its relationship with the US dollar. anchoring.
Under normal circumstances, even if the USDT price falls below $1 for an extended period of time, eventually arbitrageurs will buy the cheaper USDT and restore its peg to the USD.Crucially, this requires trust in Tether: arbitrageurs must trust that USDT can eventually be redeemed for USD at $1 face value, or at least higher than the purchase price. The problem is, according to Tether's terms of service, this is not guaranteed, and Tether is not known for a responsible fiscal management style (Tether has been criticized for its transparency in the asset reserves that underpin USDT issuance). therefore,image description
The picture above is taken from Tether’s terms of service: Tether can delay redemption, or redeem securities and other assets (non-USD).
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This is a good thing for Bitcoin
We have seen that there are a large number of real fiat currencies and stablecoins in this system. So, even if USDT crashed overnight, how bad could that be? Couldn't the market simply phase out USDT and move all the value into other assets like Bitcoin? Uh, we'll have to think about that.
If Tether were to suddenly become worthless, the idea that value would be "transferred from USDT to other assets" is a fundamental misunderstanding of how the market works and the important role that fiat liquidity plays in its functioning.
when liquidity disappears
Imagine what would happen immediately if half of the dollars in the real world were declared "fake dollars"? Bitcoiners remind us at least 1000 times a day that the price of Bitcoin is determined by its scarcity. If dollars suddenly become more scarce, their value will grow accordingly. In other words, it is cheaper for anyone who owns dollars to buy anything at this time (a deflationary miracle!).
Now, let's imagine an idealized cryptocurrency market where there are only two assets that are traded: "crypto tokens" and "dollar tokens". In this model, all crypto tokens are fungible because their USD prices are closely correlated (which is very close to what happens in the real market). DeFi users can also imagine an AMM (Automated Market Maker), in which all encrypted tokens (BTC, ETH...) are stored in treasury 1, and all dollar-anchored tokens are stored in treasury 2.
Let's bring some of the numbers from the first part of this article into this imaginary market. It was a balanced market at first, and all of a sudden, 57.8% of the supply of "USD tokens" was found to be worthless. Since the scarcity of "real" (valuable) "dollar tokens" has increased by 57.8%, they should immediately be able to trade at a premium of 136% (only in this imaginary market! They are still worth in the real world 1). But this is just the beginning. Holders of now worthless "fake" "dollar tokens" will try to dump these tokens on the market, which will push even higherPremium for "real" "dollar tokens". In other words, those other “crypto tokens” denominated in dollar tokens will get cheaper and cheaper.
But that's not all. USD liquidity providers and market makers will flee the cryptocurrency market — after all, no one wants to be the victim of a sell-off by “fake” “USD token” holders. therefore,We will see cases where "true" "dollar tokens" become unavailable as liquidity providers and market makers flee the cryptocurrency market."USD token" needs to guarantee the basic functions of the market: market making, arbitrage, loan repayment, etc. Without these functions, the market will freeze.
Of course, real markets are much more complex and will not behave exactly as described above. But the basic argument is:If all USDT were found to be worthless tomorrow, fiat prices for all cryptoassets would plummet and the market would experience a liquidity shock as most USD liquidity disappeared.
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Tether is a Fractional Reserve?
If the market does crash because of a loss of faith in Tether, what happens next? That depends on how much Tether's reserves are worth in this case. After all, if Tether can really come up with $62.7 billion in cash after the crash, then this panic is unwarranted, confidence in Tether may be restored, and the market will eventually recover.
This begs the question: How much would Tether's reserves be worth if Tether's price crashed? To answer this question, one must first know how the 62.7 billion USDT in circulation was generated.
Usually, the supply of USD (reserve) and USDT flowing into Tether's bank account should be 1:1. But if you look at Tether's reserve classification (see the figure below), especially the large proportion of "commercial paper", you can easily find that,Tether May Be Involved in Fractional Reserve Bankingimage description
Above: Tether's reserves as of March 31, 2021
The USDT issuance process might look like this. Consider a hypothetical company called "Paolo Co." whose subsidiary called "Delta Bank" is co-owned by Tether executives (just like Tether and Bitfinex ultimately have the same owners). Tether uses newly minted USDT to purchase commercial paper from Paolo Corporation. Paolo Co. then invests the borrowed USDT in the cryptocurrency market. As a result, commercial paper goes into Tether's reserves, which will make all USDT "100% backed by reserves", and it will make Tether's reserve basket look like a money market fund, making most of the crypto community People feel at ease.
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The crypto market's motto on Tether: "Based on trust, not verification"
I have no doubt that some investors have minted USDT and redeemed USDT for USD (anecdotally suggesting they have done so), but given Tether's history of banking problems and legal troubles, I find it hard to believe that institutional investors really transferred $62.7 billion to Tether.The explanation for Tether's implementation of fractional reserves seems more realistic to me.
Remember, just like TradFi (traditional finance),The cryptocurrency market is a game where everyone's goal is to maximize profits. Tether sits in an opaque corner of an unregulated market where people tend to believe anything it says, so it has a lot of leeway to bend the rules. Tether has also been caught lying on multiple occasions. In the words of the New York Attorney General:
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The casino always wins in the end
The question remains, why might Tether and exchanges put the entire market at risk?
In TradFi (traditional finance) markets, Moral Hazard is a well-known cause of financial crises: Banks are always profitable during bull markets, butBailed out by taxpayers when markets crashed,They therefore have little incentive to act responsibly. Presumably, this would be worse in an unregulated (cryptocurrency) market due to lack of regulation and accountability.
Summarize
Summarize
In my opinion, Tether's crisis of trust could have a huge impact on the market. While the big players may be able to offset this crisis by repurchasing large amounts of USDT to restore their peg to the U.S. dollar, or by successfully assuring the market that all USDT can be redeemed at par, there is no certainty that this will Happens, unless you trust Tether and its affiliates very much.
Tether is based on fractional reserve issuance, creating hidden leverage in the "bottom" of the crypto market. In my view, the resulting systemic risk is unacceptable.The fact that most players in the market simply do not acknowledge this risk and sometimes defend Tether rather than hold it properly accountable speaks to the immaturity of the market and the inability to self-regulate.
Regardless of how you fundamentally view the cryptocurrency space, as long as Tether remains systemically important, it is unlikely that cryptoassets will be viable long-term investments.Getting rid of USDT (black swan or not) will lead to a more mature and robust market in the long run.
One can be bullish on the value proposition of DeFi long-term while still viewing this market as a casino. The two are not contradictory.
Thanks to Frances Coppola, Gerhard Wagner, and several others on condition of anonymity for their contributions to this article.
Data Sources
Data Sources
The data used in this article was collected from the following websites between June 14 and June 17, 2021:
TheBlockCrypto
Glassnode
CryptoQuant
Coingecko
Livecoinwatch
