By Geoffrey Smith
Investing.com -- The crypto world has survived a scary week, but the danger isn’t over.
The seemingly unstoppable momentum of the last two years has gone, shudderingly, into reverse, as the outgoing tide of liquidity shows who - in Warren Buffett's phrase - has been swimming naked.
The 'algorithmic stablecoin' TerraUSD and its ecosystem, which lured in $80 billion of outside money with promises of token-based returns of 20% per annum, collapsed last week, with early adopters dashing for the exits and leaving the late arrivals holding the bag, leaving a Ponzi scheme's usual trail of destruction and misery behind.
Do Kwon, the Korean-born Stanford whizzkid who had pioneered the TerraUSD concept, appealed in vain for more backing from his ‘community’ on Tuesday, proposing to insert a ‘fork’ into the underlying blockchain to effectively restructure the claims of all those who still hold their worthless – sorry, ‘classic’ – Terra.
The responses (with a few honorable exceptions), boiled down to a blunt message: Go fork yourself.
Kwon’s mathematical ability can’t be doubted. But the lack of common sense behind the Terra system defies belief.
At its heart was a promise to redeem various forms of digital money on demand for real, hard U.S. dollars. Yet the assets backing the system were not dollars, but – for the most part – Bitcoin, an asset whose near-perfect correlation with high-beta profitless technology stocks has been clear for years. Any situation stressed enough to trigger a sharp increase in demand for redemptions must – almost by definition – have also killed the value of its reserves.
It is, as one wag put it, as if the Argentinian central bank in 2002 had taken dollars from the IMF to create a peso peg and then levered them up on Brazilian junk debt for the carry.
Of over 80,000 Bitcoin held by the Luna Foundation Guard – a group of investors around Do Kwon –while Terra’s peg still stood, only 313 remained as of Tuesday. The rest was frittered away trying to defend the peg, just like the Bank of England in its doomed efforts to defend sterling 30 years ago (or any one of a host of Asian central banks during the 1997 crisis).
The irony of this happening to a community that can’t open its mouth without mocking traditional finance (Kwon himself had smirkingly told an interviewer only two weeks ago that “there is entertainment in watching companies die”) could hardly be more perfect.
It’s not clear who did and didn’t manage to get their money out of Terra in time. Unconfirmed reports have suggested foul play, pointing to a number of large block transfers from accounts controlled by the LFG, but the claims have been denied, cannot be verified and the self-reinforcing momentum of a bank run would in any case by explanation enough.
And a bank run, in slightly modified shape, is the most likely risk now facing an asset whose importance to world financial markets is much more important to global markets - Tether.
For most of recent history, Tether has been the world’s most important stablecoin – a digital asset whose value was fixed to the dollar. Its chief purpose has been as a place to park digital money between speculations on cryptocurrencies or other digital assets such as non-fungible tokens.
Tether’s market capitalization peaked at over $83 billion only 10 days ago. However, it has been shrinking constantly since Terra’s demise. By late Tuesday in New York, its market value had fallen to $75.6 billion.
Much of that is natural contraction of the overall supply of Tether as speculators redeem their crypto assets for cash.
However, it was clear from Tether’s wobble in the middle of last week that it was about more than that. Some didn’t believe in the ability of Bitfinex, Tether’s owner, to pay.
Tellingly, while the market cap of Tether has shrunk, that of USD Coin and Binance USD, which play similar roles in their respective ecosystems, has risen by an aggregate of around $5 billion. Crypto speculators are showing a clear preference for them over Tether.
This is hardly surprising, given that Bitfinex, Tether's owner, was fined $43 million last year by U.S. regulators for having lied for three years through 2019 about what actually backs its stablecoin. The latest attestation by an accountant of Tether’s reserve is five months old, and was given by MacIntyre Hudson, an accountancy firm based in the Cayman Islands.
For comparison, Circle, which runs USD Coin, has its reserves audited monthly by Grant Thornton in the U.S., and holds them entirely in cash and Treasury bills. It also uses Bank of New York Mellon (NYSE:BK) and Blackrock (NYSE:BLK) as custodians, according to a blog post by Circle chief financial officer Jeremy Fox-Green.
Tether bottomed out last week at 93.35c, before returning to parity with the dollar this week. Its chief technology officer, Paolo Ardoino, maintains that there was never any need for holders to accept less than the full dollar because of what he called Tether’s ‘secret sauce’ – referring to its reserves. But there is no better sauce than transparency, and secrecy adds nothing good to the taste.
Tether’s reserves are, undeniably, of higher quality than Terra’s. Over 43% of them are in U.S. Treasury bills or in cash and equivalents. More is held in money-market funds which ought to bear little risk.
However, over one-third is held in the form of commercial paper - short-term corporate debt - and Tether gives no more detailed breakdown of whose promise to pay ultimately lies behind it. Ardoino didn’t respond to multiple requests for detail from Investing.com for clarification.
Anyone who was around in 2008 will remember how commercial paper, as an asset class, blew up spectacularly, as the quality of the underlying assets – subprime loans – was brutally exposed by rising interest rates.
Interest rates are doing the same thing now. If there are any credit risks in Tether’s portfolio, they will not take too long to come to light.
Tether holders have been warned.