When Tether Blows Up

May 30, 2022

Tether is the biggest openly acknowledged fraud in crypto.1 Over the past several years, Tether has claimed one-to-one USD backing, yet has refused to show any proof of it. When pressed, the company has employed a misdirection strategy by redefining “one-to-one backing”. In short, there is a hell of a lot of smoke – even if Tether were not a fraud, its executives act exactly how you’d expect the perpetrators of a fraud to act.

So what? The current modus operandi of the crypto world is to collectively shrug. They take George Soros’s approach: “When I see a bubble forming, I rush in to buy, adding fuel to the fire.” There is more money to be made on the gravy train of providing liquidity for trades, yield farming, etc. than in trying to short Tether and potentially bleeding out before it goes bust.

Maybe Tether will be able to accomplish its implicit goal: Fake it until it makes it, becoming the fractional reserve banking system for all of crypto.

But let’s assume that eventually Tether’s shenanigans catch up with it. What happens if USDT loses its peg?

Tether

The Worst-Case Scenario

  1. USDT loses its peg.

  2. Anyone holding USDT tries to cash out. Important customers are allowed to redeem USDT for USD at a 1:1 ratio. (This recently happened in the Terra death spiral.)2

  3. Tether sells its crypto and other assets to cover redemptions, driving down the price of those assets.

  4. Eventually, Tether limits withdrawals, as it is running low on funds.

  5. The average USDT holder is stuck with USDT they cannot exchange for fiat. They try to exchange it for Bitcoin or Ethereum (“blue-chip” crypto), which they can then hold or cash out on an exchange that is USD- or USDC-denominated.

  6. Any exchange with USDT-denominated crypto prices will see those prices explode, as there will be few sellers of crypto for a soon-to-be-worthless asset.

  7. The average crypto holder will lose confidence in all crypto assets, and there will be a large market sell-off.

  8. We will see some very strange market dynamics where USDT-denominated Bitcoin on Bitfinex costs $500,000, while USDC-denominated Bitcoin on Coinbase costs $10,000.

  9. Anyone still stuck with USDT will lose all of their money, or things get tied up in court à la Mt. Gox.

  10. Some crypto exchanges with USDT exposure will not allow withdrawals. They may sieze user assets to cover their debts.3

Disclaimer

This is a purely speculative piece that solely represents my personal views. I do not hold any Tether, nor do I have a short position (synthetic or otherwise) in Tether. I do hold various cryptocurrencies and a small amount of USDC. I am long cryptocurrency adoption, mainly through my choice of employer.

This post was heavily inspired by patio11. I’ll shortly drop a hash of it on Twitter.

Notes:

  1. In case you need to get up to speed, here’s the story via Bloomberg, The Wall Street Journal, the prolific Patrick McKenzie (Parts One & Two), and a research paper from Griffin and Shams. ↩

  2. SBF has argued that the likeliest scenario, assuming Tether isn’t fully capitalized, is that nobody notices. If there are no mass redemptions, the capitalization level of Tether doesn’t even matter. The next most likely scenario is a 10-15% haircut taken by Tether holders…and the cryptoverse continues on as usual. The cynical reader will here note that SBF and Alameda are likely to fall into the “important customers” bucket here, and that as Alameda is a major liquidity provider in the crypto industry, SBF has a vested interest in Tether usage. ↩

  3. Trigger the overused (but in this case applicable) phrase: “Not your keys, not your coins.” ↩