Stablecoin panic spread Thursday (May 12), with No. 1 stablecoin tether (USDT) breaking the buck in the wake of TerraUSD’s spiraling plunge below $1 over the course of this week.
Tether lost its dollar peg Thursday morning, with the price of USDT dropping below $0.95 briefly around 3:30 a.m. before popping back up to $0.99.
Read more: TerraUSD’s Price Collapse Shows Vulnerability of Dollar-Pegged Cryptos
Tether’s drop was largely because of two factors, the most import being the lingering questions over the existence and quality of the assets backing it one-to-one with the U.S. dollar.
Those concerns had been repeated by both United States and European Union officials, with U.S. Treasury Department Under Secretary for Domestic Finance Nellie Liang telling the House Financial Services Committee Feb. 8 that based on the “public documents that they post,” her understanding is “that their reserve assets include assets that are not credit risk free.”
See more: House Committee Voices Concerns Over Stablecoin’s Effect on Dollar
Beyond that, tether’s chief technology officer and unofficial spokesman, Paolo Ardoino, revealed that USDT’s peg broke lower on some exchanges like Kraken than it did on tether’s sister exchange, Bitfinex, creating an arbitrage opportunity.
Around 2 a.m., he tweeted that more than $300 million had been redeemed for the guaranteed $1 “without a sweat drop.”
GM
Reminder that tether is honouring USDt redemptions at 1$ via https://t.co/fB12xESSvB .
>300M redeemed in last 24h without a sweat drop.— Paolo Ardoino (@paoloardoino) May 12, 2022
Interestingly, the No. 2 and No. 3 stablecoins, USD Coin (USDC) and Binance USD (BUSD) both also lost their pegs, but in the opposite direction, with the former breaking $1.01 for several hours and the latter going past $1.02.
Read also: Stablecoins Are Better, Safer, More Innovative Payments Solution Than Bitcoin
However, the panic spread to the rest of the cryptocurrency market, with bitcoin falling to $26,350, down almost 17%, before rising to $28,000. Altcoins have fared far worse, with most of the top 100 cryptocurrencies down 20% to 35%.
This is likely to redouble already significant pressure to strictly regulate stablecoins, possibly requiring fiat backing.
There were signs the EU might go further, with documents revealing Thursday that the European Commission has considered what amounts to a ban, requiring an issuance halt if transactions surpass 1 million per day, CoinDesk reported. Tether’s 24-hour volume was $171 billion Thursday.
Terra Unfirma
Tether’s problems are directly linked to the ongoing collapse of TerraUSD, which goes by UST on exchanges. Over the weekend, the stablecoin lost its peg, dropping about 5% until Monday (May 9), when it crashed hard, dropping as low as 30% before popping back up and down between $0.30 and $0.82. As of Thursday morning, it is $0.61.
UST is a so-called algorithmic stablecoin, meaning its peg — in theory — is maintained by an automated arbitrage mechanism linked to a sister token, the free-floating Terra coin, known as LUNA on exchanges. UST can always be exchanged for $1 worth of LUNA by burning the stablecoin and minting LUNA.
See more: What Is an Algorithmic Stablecoin? DAI and the Fiat-Free Dollar Peg
When UST lost its peg, arbitrageurs pounced, driving the price of LUNA into the floor. Two weeks ago, it was a top-10 cryptocurrency, worth more than $95 and with a market capitalization of more than $30 billion. It’s currently worth little more than $0.03, with a market cap under $120,000.
Ardoino tried to deflect some of the blame for tether’s plunge below $1 by blaming confusion between its exchange symbol, USDT, and TerraUSD’s, which is UST.
“What a difference a ‘D’ makes,” he tweeted.
He also retweeted a 5:30 a.m. comment by FTX exchange CEO Sam Bankman-Fried that tether only fluctuated a few percentage points and redeemed more than $1 billion.
Tethered to the Dollar
It’s Tether’s ability to redeem its tokens at the full $1 in fiat on demand in the case of a panic that most concerns regulators.
This is for two reasons. First, if the company can’t redeem all its tokens quickly enough — meaning if it does not have enough cash on hand — USDT holders could panic and start a run, causing the price to spiral down like TerraUSD’s did.
Second, selling those non-fiat assets in hurry could lead to fire-sale prices, driving down assets in the broader markets and spreading the financial contagion beyond crypto.
Those concerns came to light in a lawsuit from New York’s Attorney General in 2019 and were exacerbated when it was revealed in May 2021 that only 2.9% of its backing assets were cash, with the rest in “cash equivalents,” including more than 50% in short-term corporate paper — corporate debt — whose liquidity came into question. That was down to 30% by the fourth quarter of 2021, Ardoino told CNBC.
Read more: What Senate Banking Committee Chair Sherrod Brown Should Be Asking Tether
Tether settled charges — without admitting guilt — for $18.5 million, which had quietly dropped its one-to-one dollar peg after loaning its sister company, the crypto exchange Bitfinex, hundreds of millions of dollars after it was swindled by the shadow bank it used to sneak cash past a bank ban to U.S. clients in 2017 and 2018.
See more: Crypto’s Furtive Past on Display With Guilty Plea in $750M Shadow Banking Case
Regulators Worry
Speaking at the House Financial Services Committee’s February hearing about the President’s Working Group on Financial Markets’ Stablecoin Report — which controversially recommended that only federally-insured banks be allowed to issue stablecoins — Liang said corporate paper came with some credit risks.
Asked specifically if she believed any uncollateralized tether had been issued, Liang said, “I expect that is the case. They are not regulated … based on what I understand, they may not be able to deliver a dollar.”
Tether has vigorously denied issuing unbacked USDT.
Speaking more generally, Liang said that she had “concerns about the opacity of the reserve assets of stablecoin issuers,” adding that in the report, the “first risk that we identified was the run risk and the potential that could have for other short-term funding markets if investors were to become concerned about the quality of the assets, underlying a stablecoin.”
The European Central Bank’s crypto point man, Executive Committee Member Fabio Panetta, gave a speech in late April that compared crypto to the Wild West — a favorite comment of Securities and Exchange Commissioner Gary Gensler.
Read more: ECB Executive Says Cryptocurrency Is the New Wild West
“Tether, one of the most popular stablecoins, promises ‘stability’ by investing in low-risk assets, such as commercial paper, and holds a large proportion of the stock of these instruments in circulation,” Panetta said. “Large-scale sales of these assets in response to a sudden increase in redemptions could generate instability throughout the commercial paper market … eventually finding its way to the banks that hold the stablecoins’ liquidity.”
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