If Tether’s stablecoin features an animal character, it must be a cat since it appears to have 9 lives. On Friday, bankrupt cryptocurrency finance company Celsius sued Tether for alleged preferential treatment during bankruptcy. Celsius borrowed $812 million from Tether, but the stablecoin company held the collateral. Therefore, just before bankruptcy, Tether liquidated its collateral to resolve its debt. If Celsius had filed suit two years ago, things could have been even more dire for Tether.
Celsius claims to have transferred 17,886 Bitcoins as collateral in the 90 days before the bankruptcy. Legally, this type of transaction prioritizes the beneficiary over other general creditors, so it is often set aside. Celsius’ retail customers received about 18% of the cryptocurrency owed to the company. (The recovery rate was much higher considering the dollar value of cryptocurrencies at the time of bankruptcy.)
The lawsuit also includes additional allegations, including allegations that Tether liquidated Bitcoin collateral without waiting for contractual obligations. Celsius claims that if Tether had postponed the liquidation of its collateral, it would have held Bitcoin worth more than $2 billion at current prices.
Tether CEO Paolo Ardoino said of said.
“More than two years later, this baseless lawsuit seeks to claim that the Bitcoin sold to cover Celsius’s position should be returned.” I emphasized one thing. In other words, there is ample cushion against potential losses, but he is confident there will be none.
Two year delay helped Tether
Two years ago, Tether did not have such a buffer. If the lawyers had filed the lawsuit around September 2022 (as some expected), it could hypothetically have triggered the lifting of the peg. At the time, Tether’s capital was approximately $250 million.
Without the additional Bitcoin collateral, Tether would have been left with a $365 million shortfall, the lawsuit alleges. This is $115 million more than its equity. This is just a small hole for a $66 billion stablecoin (in 2022), but it is a hole. Tether will likely get some money back in bankruptcy, but it was unclear for some time how much that amount would be.
The lawsuit instead seeks to ask the court to put the collateral liquidation on hold, which would cause Tether to lose even more.
Tether’s risky bet
But that doesn’t mean Tether hasn’t had holes in its balance sheet.
In 2019, Tether claimed: “All Tethers are always backed 1:1 by traditional currencies held in our reserves. Therefore, 1 USDT is always equal to 1 USD.”
Despite this claim, the company lent $625 million of its reserves to the Bitfinex exchange under shared ownership to cover large exchange losses. In other words, the company lent $625 million in funds owed to stablecoin holders to an insolvent related party exchange. The exchange did not go bankrupt after the loan. Tether was already in bankruptcy when it granted the loan.
Tether has since quietly amended its description of its reserves to include loans made by Tether that “may include affiliates.” Tether and Bitfinex acknowledged these and additional misstatements in their settlement with the New York State Attorney General.
If you had two close calls instead of one, you would think that a change in risk appetite might be warranted. The danger is that the $12 billion equity buffer could encourage Tether management to take even bigger risks.
Someone recently commented on Ledger Insights that Tether is behaving like a hedge fund paying zero returns to its limited partners.
Based on Tether’s latest proof of reserves, its assets of at least $18.7 billion are considered relatively risky for a stablecoin. This includes corporate bonds, Bitcoin, precious metals, loans, and other investments. Additionally, this does not include reverse repurchase agreements in excess of $12 billion.
reverse repo
A reverse repurchase agreement involves lending cash to a bank, usually overnight. In return, banks provide collateral, usually U.S. Treasury securities. This is significantly lower risk compared to Celsius loans. However, it depends on the bank counterparty and the collateral.
Generally, when a company goes bankrupt in the United States, those holding loan collateral cannot liquidate that collateral. However, repositories are exempt from that rule. Therefore, if the bank debtor goes bankrupt, the collateral holder (in this case, the stablecoin company) can legally sell the US debt.
Circle is also involved in reverse repo to a much greater extent. Reverse repos often account for more than 50% of USDC stablecoin reserves, and in some cases can reach two-thirds.
However, there are two major differences between Tether and USDC reverse repo. First, Circle (via BlackRock) discloses bank intermediaries and detailed collateral on a daily basis. These banks are systemically important banks and their collateral is of the highest quality. (However, the bank is an intermediary, so it does not know the identity of the counterparty).
Tether does not disclose counterparties or collateral details. Therefore, as far as we know, the loans may be made to state-owned banks or money market funds rather than to systemically important banks. Tether also said in the note that the collateral for the repo is “a U.S. government bond whose ultimate issuer or guarantor is rated A-2.” Given that the U.S. federal government is rated A-1+, the collateral is not federal debt unless something is missing.
Does it matter?
In most cases, these issues are just details and are not important. But that small window of time in which an issue becomes important can affect all high-risk assets simultaneously.
In a recent interview with Wired, Ardoino said he was unhappy with Europe’s MiCA regulations, which require banks to hold 60% of reserves. He was not the only one to raise eyebrows at this policy. However, he claims he is concerned that this is not safe.
Perhaps the low interest rates on bank deposits have something to do with it, given Tether’s tendency to be risk-averse when it comes with decent rewards.
Update: Added a warning that you don’t know who you’re dealing with because BlackRock is disclosing three-party banking intermediaries.
