Crypto Analyst Describes USDT as “Fragile” After Tether Changes “100% Backed” Claim


XDEX Chief Analyst Fernando Ulrich took to Twitter today to explain how fractional reserves, maturity mismatching, and liquidity have all led to a fragile environment for Tether (USDT), the world’s most popular stablecoin.

“Fractional reserves, maturity mismatching, liquidity,” wrote Ulrich on Twitter earlier today, introducing his 46-part thread. “A long needed and essential thread on #Bitcoin and banking (and the fragility of USD Tether).”

Tether has been in headlines all week after the company adjusted its description of liquidity. Originally, Tether claimed that all Tethers (USDT) were backed 1:1 with US Dollars stored in a bank account. Customers could swap their USDT for USD at any time, theoretically giving USDT a value identical to the US Dollar.

This week, Tether changed its language to say something totally different:

“Tethers remain complete stable and 100%, so Tether’s reserves always equal or exceed the number of issued Tethers. The only change is that the composition of the assets that provide that backing includes a combination of cash, cash equivalents, and may also include other assets or receivables from loans issued by Tether.”

Ulrich was motivated to write his thread after Tether announced the new changes. In a 46-tweet thread on Twitter, CDEX Chief Analyst Fernando Ulrich explained why Tether’s change is a problem, and what it means for the future of the world’s most popular stablecoin.

This thread is a must-read. By the end of it, Ulrich explains that Tether could be providing free liquidity to Bitfinex, helping to pump markets while setting up Tether and Bitfinex for an epic collapse.

The Difference Between a Regular Deposit and a Loan

First, to setup the pending Tether catastrophe situation, Ulrich describes the difference between an irregular deposit and a loan.

“What we now call ‘bank deposits’ are loans, not ‘irregular deposits’ in a kind of bailment contract,” writes Ulrich. “Deposits are promises to pay on demand in specie (cash, that is ‘paper-currency’…)”

In other words, if you deposit $1,000 into your bank account, you bank needs to pay that money back on demand whenever you ask for it. This, however, is where the confusion starts for most customers:

“Yes, I grant that there is confusion and/or omission on the part of banks nowadays, since most people think money deposited in a bank is theirs and that banks actually hold the physical pieces of paper at all times. Contracts SHOULD be clear on this crucial fact, I agree. Despite this lack of clarity, though, courts in many jurisdictions have acknowledged depositors are in fact creditors to banks.”

The fact that depositors are creditors to banks is a crucial point. To reinforce that point further, Ulrich mentions that banks list deposits as liabilities on balance sheets:

“Besides, if deposits weren't loans, banks wouldn't have to book these as liabilities on its balance sheets. If it’s mere bailment (no transfer of ownership), there's no need to record it as a liability. Thus, in case of bailment (in modern banking this is a “safe deposit box”, there goes the word “deposit” again to complicate things).”

When you give money to the bank, you no longer own the money. The bank isn’t just storing your money temporarily. It’s taking your money with a promise to pay it back:

“Modern bank deposits are no bailment contracts. They are loans, IOUs, obligations, promises to pay the depositor in specie. But when is the obligation due? Whenever the customer asks for repayment (that's why it's called demand or sight deposits).”

What Happens When a Bank Doesn’t Have the Funds to Allow Customers to Withdraw?

So we’ve established that customer deposits are like liabilities to banks. So what happens if a bank cannot cover that liability? What happens when a customer goes to withdraw $1,000 and the bank doesn’t pay it?

“What if all depositors show up at the same time to ask for repayment?” writes Ulrich. “Well, a bank might need more time to repay everyone. But remember, the contract is always between bank and customer, and not between bank and a collective of customers.”

This is where a term called ‘maturity mismatching’ comes into play. Maturity mismatching ensures that customers never arrive to withdraw their deposits at the exact same time: liability is mismatched throughout the year to ensure banks can always cover withdrawals:

“Maturity mismatching (or transformation). Banks receive deposits (effectively borrow from depositors) and lend them in full or in part. And depending on the use of borrowed funds, they may put themselves under an illiquid situation. There's a liability maturing at any time (bank deposits, zero maturity) and possibly a loan maturing in months or years. How will it be able to repay depositors? Either by constantly asking its creditors to roll over outstanding debt (depositors refraining from withdrawal) or by selling assets in the market for more liquid assets (like cash) to repay depositors. The higher the degree of maturity mismatching, the more illiquid a bank becomes and more susceptible to bankruptcy.”

One of the most common forms of maturity mismatching used by banks today, as explained by Ulrich, is borrowing short to lend long.

“That means modern banks borrow short to lend long.”

Borrowing short to lend long, however, can become a problem:

“Using demand deposits to fund 30-year mortgages is beyond risky. Why do this persist in developed regions like the US and Europe? Because of lender of last resort (LOLR) and also limited liability laws (in Brazil for instance, banks are much more capitalized and less illiquid than its american or european counterparts, because local laws will put a banker's personal wealth on the line to cover for losses. Skin in the game squared.) The more skin in the game present in a banking system, the less systemic illiquid it will be. LOLR = skin from others in the game.”

Today’s banks maintain enough assets to cover liabilities. Bank liabilities are 100% reserved by assets. However, the quality of these assets (reserves) and the level of maturity mismatching can vary widely between banks.

What Does this Mean for the ‘Fragility of Tether’?

Ulrich begins a new 22-tweet Twitter thread to explain how these basic concepts of fractional reserve banking impact Tether today.

Ulrich starts by examining Tether’s withdrawal policy:

“In order to cause Tether Tokens to be issued or redeemed directly by Tether, you must be a verified customer of Tether. The right to have Tether Tokens redeemed or issued is a contractual right personal to you. So you must be a customer and this promise of redemption is made to you on a standalone basis (not collectively).”

However, Tether’s withdrawal policy has a big stipulation:

“Tether reserves the right to delay the redemption or withdrawal of Tether Tokens if such delay is necessitated by the illiquidity or unavailability or loss of any reserves held by Tether to back the Tether Tokens, and Tether reserves the right to redeem Tether Tokens by in-kind redemptions of securities and other assets held in the Reserves.”

This policy may sound worrying, but Ulrich claims that Tether is actually being more transparent than an ordinary bank here:

“…the above contract clause is pretty much how a standard bank deposit contract should read. Quite remarkable that Tether is much more transparent than banks in this regard.”

Does Tether Hold Enough Real Assets In Its Reserves?

If Tether has highly liquid reserves to match 1:1 with USDT tokens, then none of this is worrying. However, it’s unlikely that Tether has a pile of cash just sitting in a vault idly to back USDT 1:1.

“Anyone who is familiar with the investment world knows that “cash and cash equivalents” means any highly liquid instrument, usually US Treasury Bills up to three months of maturity.”

That’s not a problem. What is a problem, however, is that Tether could be making liquidity out of thin air:

“Now, the very serious and important part, something that I've been vocal about…Tether may be issuing tokens on credit, that is, creating liquidity that can affect bitcoin (and altcoins) prices.”

Tether has been accused of doing this since launch, fabricating the rise of bitcoin and altcoins to all time highs in 2017 and 2018 after pumping millions of dollars of USDT into markets.

But how exactly is Tether creating liquidity out of thin air? That’s where Bitfinex comes in.

Is Tether Financing Bitfinex by Creating Liquidity Out of Thin Air?

Ulrich concludes with a worrying point: that Tether could be financing controversial crypto exchange Bitfinex by creating liquidity through the issuance of tokens.

How does Tether create value out of thin air?

“Bitfinex (an affiliated party) calls Tether and says “hey, I need $50 million worth of Tether Tokens, but I can't pay you right now, alright?” and Tether replies, “Sure, not a problem, here you go.”… If you looked at Tether's balance sheet, it would read as follows: Assets – Receivables from Bitfinex $50 MM; Liabilities – Tokens in Circulation (Issued) $50 MM.”

There’s nothing stopping Tether from doing this aside from its own moral principles. It’s completely within Tether’s terms of service to act this way.

“Tether never said it would maintain an ‘irregular deposit’…it was never a bailment contract.”

Because those tokens will be paid at a later date, the problem continues to be shoved off for now:

“…if you look at Tether, the contract is crystal clear. There are remaining and troubling questions though: Is Tether financing Bitfinex by creating liquidity through issuance of tokens to be paid at a later date? If yes, how much? I worry. And you should too. {fin}.”

Based on what Ulrich says, Tether could be financing crypto exchange Bitfinex by creating artificial liquidity, providing USDT to Bitfinex without actually accepting a deposit of USD cash from Bitfinex. That’s a big issue – and it’s something for which people have criticized Tether since launch.

You can read Fernando Ulrich’s full thread explaining the fragile situation of Tether here.

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