In the past few months, a growing number of hedge funds from outside the cryptocurrency industry have been shorting Tether’s UDST, the largest stablecoin, to the tune of hundreds of millions of dollars. The result could be chaos in the cryptocurrency industry, potentially sending bitcoin and other cryptocurrencies tumbling.
That isn’t to say this will happen. But the potential is there, and it speaks to a fundamental weakness in crypto.
In a nutshell, stablecoins play a vital role in the cryptocurrency trading industry. While they can, and to an extent are, being used for payment of any kind, the vast majority goes to facilitating crypto trades. If shorting causes a run on the No. 1 stablecoin, with $66.7 billion outstanding, not only would it be a huge blow to confidence in the broader cryptocurrency market, it could freeze up trading.
Such a crisis in confidence was seen, to a far lesser extent, in May’s $48 billion run on and collapse of the terraUSD stablecoin — known as UST — and its partner token, LUNA. Not only is it thought to have had a big part in the downturn that sent the price of bitcoin below $30,000 in May, but the fallout rippled through decentralized finance (DeFi) and sent a major crypto hedge fund and lending platform spiraling toward insolvency. It also sent the price of bitcoin below the psychologically vital $20,000 mark this month.
See also: Is Crypto’s Richest Billionaire Becoming its ‘Lender of Last Resort?’
A run on USDT would be far, far worse. When Bitcoin first broke $20,000 this month, analysts were predicting it could fall as low as $11,000. A market shaking event like Tether’s collapse could make that seem like peanuts.
The Danger of Stablecoins
By and large, stablecoins are used in three ways. First, they are the lubricant of cryptocurrency trading, providing liquidity. Most cryptocurrencies trades are done by selling one coin for stablecoins and then using that to buy a different token.
Second, they are used by large and frequent traders to park funds while waiting for trading opportunities. A collapse would mean that a lot of big investors would suffer heavy losses, likely forcing them to liquidate other investments by selling off other crypto holdings at fire sale prices.
Third, a growing amount is staked in various DeFi projects, which would see a storm of liquidations.
The President’s Working Group’s November report on stablecoins warned that a failure “would harm users and could pose systemic risk.”
One of the biggest threats, it said, would be if the market lost faith in a stablecoin issuer’s ability to redeem them at face value.
That’s one reason opponents of stablecoins have called for them to be strictly regulated or even outright banned — something that has happened in a number of countries, most notably India.
Read here: FSB Tells National Regulators to Move Faster on Stablecoin Regulation
The Nightmare Scenario
It starts like this: Hedge funds that short stocks, commodities or cryptocurrencies have a vested interest in seeing their target fall in value, and often help that along with a number of tactics, publicizing what they see as weaknesses high among them.
The problem is twofold. First, when you short a stablecoin, you are not hoping the price will go down, as with a normal cryptocurrency. You are betting that it will lose its dollar peg, or break the buck. That can, as many regulators around the world have warned for years, lead to a confidence-based run that would be faster and harder to contain than any bank.
That’s what happened terraUSD, which had been the No. 3 stablecoin and took just a week to collapse to become virtually worthless. And it did affect Tether, with USDT breaking the buck and briefly dipping as low as $0.95.
Also read: Global Agencies Call for Stablecoin Regulation as Prices Collapse
The problem with Tether is that there have been long-standing questions about the existence of its reserve funds and, recently, that they are invested in shaky and insufficiently liquid commercial paper rather than cash and treasuries like the No. 2 stablecoin, Circle’s USDC.
These concerns have been raised by the U.S. Treasury Department Under Secretary for Domestic Finance Nellie Liang, among others. At a February hearing, Liang told the House Financial Services Committee that her understanding is Tether’s “reserve assets include assets that are not credit risk free.”
On Monday (June 27), Tether Chief Technology Officer Paolo Ardoino addressed the situation in a Twitter thread, accusing hedge funds of “trying to cause further panic on the market after TERRA/LUNA collapse.”
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I have been open about the attempts from some hedge funds that were trying to cause further panic on the market after TERRA/LUNA collapse.
It really seemed from the beginning a coordinated attack, with a new wave of FUD, troll armies, clowns etc. https://t.co/hhcsgHV1Ow— Paolo Ardoino (@paoloardoino) June 27, 2022
He added that it “really seemed from the beginning a coordinated attack, with a new wave of FUD [fear, uncertainty and doubt], troll armies, clowns etc… [in order to] create enough pressure, in the billions, causing ton of outflows to harm Tether liquidity and eventually buy back tokens at much lower price.”
Ardoino also said the fears were unfounded, saying that during the terraUSD collapse, “in 48 hours Tether processed $7B in redemptions, averaging 10% of our total assets, something almost impossible even for banking institutions.”
Over the month, he added, that number grew to $16 billion with no disruptions, “again proving that our operations, portfolio, banking infrastructure and team are solid and battle tested.”
Ardoino said Tether has reduced its commercial paper holding from $48 billion to $8.4 billion, and will roll the rest into U.S. treasuries in the coming months.
That said, his responses highlight that $16 billion was pulled out of USDT, with $7 billion moved to rival USDC, which has a 100% cash and treasuries reserve fund. So, there are confidence problems.
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