There is an old Arabic proverb: “The dogs bark, but the caravan moves on.” It could summarize the journey to date of Tether (USDT), the world’s largest stablecoin.
Tether has been embroiled in legal and financial wrangling through much of its short history. There have been lawsuits over alleged market manipulation, charges by the New York State attorney general that Tether lied about its reserves — costing the firm $18.5 million in fines in 2021 — and this year, questions voiced by United States Treasury Secretary Janet Yellen as to whether USDT could maintain its peg to the U.S. dollar. More recently, investment short sellers “have been ramping up their bets against Tether,” the Wall Street Journal reported on June 27.
But, Tether has weathered all those storms and seems to keep moving on — like the proverbial caravan. On July 1, the company announced that it had dramatically reduced the amount of commercial paper in its reserves, which has been a sore point with critics for some time.
Embracing U.S. Treasury reserves?
Tether’s commercial paper reserves are expected to reach a new low of $3.5 billion by the end of July, down from $24.2 billion at the end of 2021. The company added that its “goal remains to bring the figure down to zero.”
Many stablecoins like Tether are stand-ins for the U.S. dollar, and they are supposed to be backed 1:1 by liquid assets like cash and U.S. Treasury bills. But, historically, as much as half of USDT’s reserves were in commercial paper, which is generally seen as less secure and more illiquid than Treasuries. Hence, the potential significance of the commercial paper statement.
It raises questions too. On the positive side, does it signal a new maturity on the part of Tether, embracing more of a leadership position in favor of “increased transparency for the stablecoin industry,” as the company declared in its announcement? Or is this rather just more distraction and obfuscation, as some believe, given that Tether continues to avoid a more intensive, intrusive and comprehensive audit, in favor of a more limited “attestation” with regard to the firm’s reserves?
Is it telling, too, that Tether’s “independent accountant reports” are issued by a small Cayman Islands-based accounting firm rather than a Big Four audit group?
Finally, what if the short sellers are right and there is less to Tether’s collateral than meets the eye? What would happen to the crypto and blockchain sector if USDT, like TerraUSD Classic (USTC) two months earlier, were to lose its peg to the United States dollar and collapse?
Why commercial paper matters
Historically, “The market’s concern about Tether’s commercial paper is that Tether would not disclose what paper they were holding,” Bruce Mizrach, professor of economics at Rutgers University, told Cryptox.
There can be large variations in the creditworthiness of commercial paper. This may be more of an issue now because “some short sellers say they believe that most of Tether’s commercial-paper holdings are backed by debt-ridden Chinese property developers,” the Wall Street Journal reported, a charge that Tether has strenuously denied.
For that reason, this latest announcement in which the company declared that “U.S. treasuries will now make up an even larger percentage of Tether’s reserves” than commercial paper and certificates of deposit share “could be reassuring to investors,” Mizrach said. In its accountant’s March 31 report “To the Board of Directors and Management of Tether Holdings Limited,” U.S. Treasury bill reserves were $39.2 billion, almost double the $20.1 billion from “commercial paper and certificates of deposit.”
On the other hand, Tether’s stablecoin circulation could be trending downward as a result of the crypto sector’s continued slump. If that is the case, “there will be fewer Tether in circulation and therefore less reserves needed as a result of the decline in value and volume of Bitcoin and other crypto transactions,” Francine McKenna, faculty lecturer at the Wharton School and publisher of The Dig newsletter, told Cryptox.
Is Tether really turning over a new leaf then? “Changes in the composition of reserves does nothing to change the modus operandi of Tether,” Martin Walker, director of banking and finance at the Center for Evidence-Based Management, told Cryptox. It remains an unregulated entity that is economically equivalent to a money market fund or a bank. “Regulators really should look to regulate economically equivalent activities on the same basis, whether crypto related or not.”
Martin wasn’t particularly impressed by the Tether’s May 18 attestation, either, i.e., its Independent Accountant’s Report signed by MHA Cayman, a small firm based in the Cayman Islands, which noted:
“We considered and obtained an understanding of internal controls relevant to the preparation of the CRR [Consolidated Reserves Report] in order to design procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of such internal controls. Accordingly, no such opinion is expressed.”
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Attestations of this sort, Martin said, are limited to checking the composition of reserves at a given moment in time — in the case, cataloging USDT’s reserves on March 31, 2022 — but “to get real assurance” an audit firm must be allowed to go deeper, examining the process by which reports are generated, said Martin. “The March statement from MHA Cayman explicitly said they had no opinion on the controls in place on generating reports,” a significant omission, he told Cryptox.
Meanwhile, investors have been placing bets against Tether for the past year, and the pace has quickened since the May collapse of TerraUSD, the algorithmic stablecoin, with more hedge funds joining the shorts, according to the Wall Street Journal. USDT briefly lost its peg to USD during the Terra fiasco, falling to $0.95 before fully recovering.
Big Four Audit: An effective solution?
Recently, John Reed Stark, an SEC lawyer for 18 years, suggested on Twitter that a “fast/effective/guaranteed way” way for Tether to quell short sellers would be to “Engage a Big 4 accounting firm to conduct an audit which finds a rock-solid balance sheet.”
“It’s such an easy thing to solve,” Stark, president at John Reed Stark Consulting LLC and former chief of the SEC’s Office of Internet Enforcement, later explained to Cryptox. Moreover, it’s “laughable” that a company with Tether’s market capitalization — $66 billion on July 10, according to CoinMarketCap — is using a small audit firm in the Cayman Islands for its “attestation(s),” which by the way, are no substitute for an audit, in his view.
A Big Four audit carries some weight with the SEC, and many larger companies “want to be audited by a Big Four firm,” because it makes their enterprise more attractive to investors and others. In the case of Tether’s reserves, “we don’t know what the assets are,” added Stark.
One source suggested that a Big Four firm may not want to take on Tether as a client given its controversy and opaqueness, but “I think they would take the engagement,” commented Stark. But, if they did refuse, that in itself would be a red flag, a sign that “the company was really in trouble,” he said.
McKenna doesn’t believe that a giant accounting group would make a meaningful difference now, however. “It really does not matter which firm signs the opinion since it is not an audit but a validation of information that is based on management representations.” The accounting firm is limited to the information that Tether is sharing with it, in other words — and it doesn’t really matter under such circumstances whether the accounting firm is small or large.
Along these lines, a smaller accounting firm “could do a great job on a fuller scope audit if its partner had integrity and insists that no value is delivered by just checking a discrete balance against management’s reports on one day at the end of each quarter and then delivering that report 90 days later.”
Kudos for surviving the drawdown?
In its May 19 statement, Tether noted that it had “maintained its stability through multiple black swan events and highly volatile market conditions” and has “never once failed to honor a redemption request from any of its verified customers.” Shouldn’t the firm be praised for the resilience shown during the recent crypto market plunge and others before?
“Tether has responded to the digital asset crisis by shrinking supply by over $15 billion,” said Mizrach. “They appear to be trying to make their collateral more liquid. Both are reasonable steps to take in a crisis.”
McKenna, by contrast, can’t quite see lauding a firm for simply honoring its withdrawal requests. This is just “the minimum expected by customers who trust a broker to execute its trades, custody its assets on account and honor its requests to transfer funds on a timely basis,” she said. “You shouldn’t expect applause for not being exploitative, fraudulent, or not yet bankrupt.”
Elsewhere, Tether has been losing ground to its closest competitor, USD Coin (USDC), and it was recently reported that USDC may be “on track to topple Tether USDT as the top stablecoin in 2022.” USDC’s market capitalization has increased by 8.27% since May, while USDT’s has plummeted more than 19%.
It sometimes seems that all the powers that be are arrayed against Tether, yet the stablecoin remains popular in many parts of the world, including Asia, especially among those without bank accounts or access to USD. “I wonder what the average Lebanese or Nigerian who relies on Tether as a dollar instrument would think of these super-rich short sellers who are trying to destroy it for their own financial gain,” tweeted Alex Gladstein, chief strategy officer at the Human Rights Foundation.
The company, for its part, appears to view itself as a responsible leader of the stablecoin movement. Its July 1 announcement carried the assertion that the company’s recent move “Solidifies Its Position As The Most Transparent Stablecoin” — though perhaps the firm is over-reaching here? Mizrach told Cryptox:
“When Tether — or any other stablecoin — provides a CUSIP level detail of their collateral and domiciles the assets in an FDIC insured institution, they might be able to make this claim.”
A Committee on Uniform Securities Identification Procedures (CUSIP) number is a unique identification number assigned to stocks and registered bonds, and CUSIPs would provide granular detail about the reserves backing the USDT’s stablecoin.
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Asked if Tether has reformed itself, former SEC lawyer Stark said it is generally not good practice to take a company’s word alone on anything: “Trust but verify is the operative phrase here.” Or, as he put it on June 28, “Without a proper audit, everything else Tether’s CFO says is just noise.”
“It always comes back to life”
In the unfortunate event that Tether does implode — as some critics anticipate, but which is mere speculation at this point — what would that mean for the larger crypto and blockchain industry? According to Martin:
“The collapse of Tether would have a pretty devastating effect, but the crypto industry is a bit like the villain in slasher movies. It always comes back to life in the sequel no matter how it gets destroyed.”
“Tether is critical for maintaining any confidence in the cryptocurrency and blockchain sector,” said McKenna. “If Tether collapses, I would venture that it’s all over but the whining and lots of futile appeals to regulators and courts.”
