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Key highlights:

  • Tether, the issuer of USDT stablecoin, is known for having transparency issues
  • Tether reportedly switched to fractional reserve banking in 2019
  • Should a significant liquidity drain occur, Tether will likely be unable to maintain its peg to the USD

Charlie Morris, the Chief Investment Officer and co-founder ByteTree Asset Management, wrote in one of his recent newsletters that there are important risks revolving around the USDT stablecoin issued by Tether. Tether currently claims the title of the largest stablecoin as well as the third largest digital asset with its over $22 billion market cap. However, Morris thinks that there are certain risks associated with holding USDT that most investors are not aware of. In addition, Morris claims that Tether’s new reserve policy could cause the largest stablecoin to tumble and lose its USD peg.

Tether has had issues with transparency since the very beginning

Tether is a stablecoin project that initially promised 100% currency reserves, meaning that it would guarantee that each USDT token is backed by 1 USD. Bitfinex, a cryptocurrency exchange closely associated with Tether, provides a fee-less 1USDT:1USD pairing to further ensure that the USDT price is equal to 1 USD.

This allows bots to easily arbitrage between exchanges and keeps the value of the stablecoin as close to 1 USD as possible. According to the ByteTree CIO, however, Tether has been the centre of transparency issues for a while. Tether’s opaqueness has led many to believe that the company is participating in foul play regarding its reserves.

Tether changed its reserve policy in May 2019

As noted by many crypto market observers, Tether quietly changed its Terms and Conditions in May 2019. Since then, the Tether’s Customer Agreement states that each USDT is backed by cash, cash equivalents, and loans. This essentially allows Tether to only hold fractional reserves, which exposes the firm and USDT holders to absolute counterparty risk, in case an increased outflow of liquidity from Tether appears. In this case, USDT would likely lose its dollar peg and plunge well under $1, as the company would be unable to pay out USD to all the holders. ByteTree co-founder wrote in the newsletter:

“Tether changed to fractional reserve banking in 2019, which creates an absolute counterparty risk should liquidity drain out of Tether, due to loss in confidence. Investors must bear this in mind. Should a run on Tether occur, and it cannot meet redemptions, then there is a significant risk to digital assets, just as there was to stockmarkets during the banking crisis of 2008.”

In addition, not a single audit has been commissioned to identify the state of Tether’s reserves since 2018. This means that Tether could as well be printing un-backed stablecoins for themselves and use this ‘fake’ liquidity to manipulate the price in USDT trading pairs. Although there is absolutely no evidence that would prove such actions, Morris advises investors to migrate to more transparent and strictly regulated stablecoins until Tether fixes the reserves and transparency issue.

Bitcoin is in the same boat: ByteTree co-founder calls for caution

Tether is by far not the only digital asset subjected to this type of risk. Morris noted that if investors lose hope for further appreciation, they are likely to withdraw and cause additional sell-off. The only difference is that Bitcoin does not promise to maintain a stable value. Anyhow, Morris thinks that Bitcoin’s price is “seemingly ahead of events”, meaning that we could see a major correction in 2021. He wrote:

“There are two ways to cool a market, one is sideways, and the other is down. We vote for sideways. I would think it is certainly a good time to reign in leverage, and possibly take a few Satoshis off the table… I remind you that gold had a 44% correction in 1975/6 before moving 8x higher by 1980. Large corrections are normal, even in great bull markets.”

Nevertheless, the ByteTree co-founder remains bullish and optimistic regarding Bitcoin and the digital space in general in the long-term. “Its success seems inevitable”, he believes.

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