Tether: The coin that could unleash havoc on crypto

SAN FRANCISCO • Cryptocurrency prices are plummeting. A so-called stablecoin lost all its value in a matter of days. A newfangled crypto bank halted withdrawals. And investors have been plunged into financial ruin.

Now the crypto industry is grappling with an even grimmer prospect: The worst may be yet to come. Concern is rising over another potential vulnerability in the crypto market - Tether, a firm whose namesake currency is a linchpin of crypto trading.

Long one of the most scrutinised firms in the industry, Tether is facing heightened pressure from regulators, investors, economists and growing legions of sceptics, who argue it could be another domino to fall in an even bigger crash.

"Tether is really the lifeblood of the crypto ecosystem," said finance expert Hilary Allen at American University. "If it imploded, then the entire facade falls down."

Tether is the dominant issuer of stablecoins, a type of cryptocurrency pegged to a stable asset such as the US dollar. Unlike traditional cryptocurrencies such as Bitcoin and Ether, whose monetary value can fluctuate widely, stablecoins are typically designed to maintain a constant peg of US$1 and are backed by huge reserves of funds or other financial engineering. That consistency allows traders to do safe, predictable crypto transactions without relying on banks or other financial gatekeepers.

But many of these coins are stable in name only. Last month, when cryptocurrencies melted, the crash was triggered partly by the failure of TerraUSD, a stablecoin with a US$1 peg that was algorithmically linked to a sister cryptocurrency called Luna. When Luna's price plunged, TerraUSD also fell, creating a "death spiral" that shook the broader market.

By contrast, Tether claims its stablecoins are backed by cash and other traditional assets, making its reserves essential to the health of the crypto market. In theory, anyone who wants to exchange Tethers for US dollars can do so quickly and easily.

But Tether's financial statements show a significant portion of its reserves to be tied up in unsecured corporate debt known as commercial paper. Such financial instruments are riskier and harder to quickly convert into cash, especially during financial turmoil.

Last year, New York's attorney-general fined Tether US$18.5 million (S$25.6 million) and said the company had lied about its reserves, calling it "a stablecoin without stability".

Critics say Tether essentially acts as a loosely regulated bank. Traders hand over millions of dollars and, in return, receive millions of stablecoins, which they use to bet on more volatile cryptocurrencies such as Bitcoin or Dogecoin. Tether currently has 70 billion coins in circulation, making it more than three times the size of TerraUSD before the crash.

In a worst-case scenario, critics say, a downturn could spark the crypto equivalent of a bank run. Traders might all rush to exchange their Tethers for dollars, only to discover that Tether could not fulfil those orders. Investors would lose billions of dollars, forcing them to sell their other crypto holdings, causing a potentially devastating panic that might spill into non-crypto markets.

Tether got a taste of that scenario last month. As cryptocurrencies plummeted, a flood of investors asked to exchange their Tethers for dollars, forcing the company to pay out about an eighth of its reserves, or US$10 billion, over the course of a week and a half. On cryptocurrency exchanges, Tether briefly wavered from its US$1 peg.

Ultimately, the company said, it met the demand. Tether went on a victory lap, proclaiming it had weathered the crisis "flawlessly". The crash was "the best story that could have happened to Tether", Mr Paolo Ardoino, the company's chief technology officer, said in an interview. "We're not fooling around, and we take risk management extremely seriously."

Then last Sunday, the crypto bank Celsius Network announced it was halting withdrawals, causing digital currency prices to crash again.

Tether had invested in Celsius in 2020 and lent it about US$1 billion in Tethers, according to Bloomberg News; the company last week said it had "zero exposure" to Celsius apart from a small investment. Still, as the market reeled, investors pulled out about US$1.6 billion from Tether.

More sceptics are speaking up. Last month, a top US banking official called for new rules governing Tether and its competitors, saying the TerraUSD crash highlighted the risks of loosely regulated stablecoins. Some traders are now putting their funds into alternate stablecoins, amid fears that the next crash could test whether Tether has adequate reserves.

"They had enough collateral to weather this run, but that doesn't mean they have enough to weather the next run," said Rutgers University's economics professor Bruce Mizrachat, who studies cryptocurrencies.

And when Treasury Secretary Janet Yellen testified before Congress last month, she noted Tether's wavering from its US$1 peg and called for greater regulation of stablecoins.

NYTIMES