If you’ve been following the cryptocurrency scene, you’ve now heard of Tether’s settlement with the New York Attorney General’s Office.
The settlement marks a big victory for stablecoin users. Over the next two years, Tether will need to meet some of the same regulatory standards as its stable, licensed competitors. That means attached Stable coins (USDT) will be safer for the public.
JP Koning, a CoinDesk columnist, worked as an equity researcher at a Canadian brokerage firm and financial writer at a major Canadian bank. He runs the famous Moneyness blog.
It might even be good for Tether too. The company’s rapid growth has slowed down lately – the market just doesn’t seem to trust it. Some oversights could change its trajectory.
For those unaware of Tether or its settlement with the New York Attorney General, here’s a brief introduction. Tether’s stablecoin is the largest in the cryptocurrency universe, with some $ 35 billion in tethers in circulation.
The New York attorney general’s office opened an investigation into Tether in 2019 for fraud. After months of sorting through Tether documents, it was finally settled with Tether last month.
In the settlement agreement, the attorney general accuses Tether of being dishonest with customers by describing the stablecoins as being fully dollar-backed. Rather than keeping client funds invested securely in dollars “deposited securely in our bank accounts,” Tether has routinely diverted client funds to an assortment of risky assets. These included a potentially uncollectible claim on Crypto Capital Corp, a fraudulent third-party payment processor, and a risky loan to an affiliate, Bitfinex. Tether even deposited millions of dollars of client money into a Bank of Montreal account held in his attorney’s name.
These misrepresentations would be less of a concern if Tether were just an ordinary small payments company. This is not the case. Consider this. The fintech giant PayPal had around $ 35 billion in customer balances at the end of 2020. Tether said he hit the $ 35 billion mark this month. This means he accomplished in just seven years what took PayPal 23 years.
So Tether, a company that appears to be tied with the pin and the duct tape, has suddenly grown into one of the largest US dollar payment platforms in the world, ranked by customer balances.
No one ever worries about PayPal dollars dropping below $ 1. But speculation that Tether could break its foothold is common in the crypto community. People have good reason to trust the stability of PayPal dollars. PayPal is regulated state by state as a money transmitter. The tether is not regulated. That is, it is not subject to any financial regulatory framework.
Tether says it hit the $ 35 billion mark this month. This means he accomplished in just seven years what took PayPal 23 years.
For example, PayPal could never have loaned its customers’ funds to a dubious third-party payment processor. If it did, it would have broken the law. As part of its licensing requirements, PayPal refrains from investing customer funds in risky assets. If he made an illegal investment, PayPal couldn’t hide it. It is required to submit regularly audited financial statements to the state financial control authorities.
For its part, Tether is incorporated in the British Virgin Islands, which does not have a financial regulatory framework to protect the clients of fund issuers. And so Tether can do things PayPal can’t.
But the regulations change that. It demands that Tether provide clients with a lot of useful information on how it invests their money. Specifically, on a quarterly basis, Tether will need to inform the public of the percentage of reserves held in the form of cash, loans, securities, and amounts owed by affiliates. So for the first time, Tether customers can finally have enough information to verify whether their choice to keep Tether is commensurate with the underlying risk.
There are a few other steps Tether will need to take. This will include providing proof to the Attorney General’s office that it is segregating client funds from corporate and affiliate accounts. Mixing funds is just one of the many practices that make fasteners unsafe. And Tether will also need to regularly provide the Attorney General with a list of its payment processors, along with their location and contact details.
The regulations will expire after two years. But until then, unregulated Tether will be regulated. And so, thanks to the New York Attorney General, Tether users are all a little bit safer.
Regulate for good
I would say a little regulation and the extra confidence it could engender is exactly what Tether needs.
Stablecoins regulated like the USD coin (USDC) and paxos standard (PAX) were first launched in 2018. Like PayPal, issuers of these stable coins are licensed and must adhere to the rules set out in state financial regulatory frameworks.
But despite new competition, unregulated tether remained the most popular stablecoin. Its four-year lead had allowed it to become the standard dollar brand for Asian cryptocurrency exchanges and for inter-exchange arbitrageurs. Tether’s new stable competitors may be more secure, but they couldn’t replicate Tether’s liquidity. The use of Tether was locked, much like how QWERTY remains the world’s standard keyboard layout.
But network effects don’t last forever.
Over the past six months, Tether’s dominance has waned. While there were 10 ties in circulation against its biggest competitor, the USDC, there are now only four ties for each USDC.
Much of the erosion of the tether can be attributed to the enormous growth of decentralized finance, or DeFi, the set of financial tools created on the Ethereum network that make it possible to borrow, lend and trade. . DeFi tools require secure and stable guarantees like grain. When DeFi started taking off in 2020, these tools started ingesting significant amounts of stablecoins.
DeFi consciously tried to shut down Tether.
For example, the largest DeFi protocol – MakerDAO – allows people to take out loans with stablecoins as collateral. People who submit supervised stablecoins under a financial regulatory framework (i.e. USDC, True USD, Gemini, and PAX) currently pay an annual borrowing rate of only 0%. But users who submit USDT as collateral are loaded an 8% usurious.
There is another way to stack the deck against the tether. The manufacturer submits all tether loans to a big 150% guarantee ratio. That is, a $ 100 loan from MakerDAO requires a tie-down guarantee worth $ 150. But regulated stablecoins like USDC enjoy low guarantee ratios of just 101%.
MakerDAO admins say they treat the tether this way because of its “history of opacity and fractional reserve.” The result is that there are nearly $ 700 million in USDC collateral stuck in MakerDAO, almost 10% of all USDC in existence. But there is just a miserable 709 fasteners in MakerDAO.
MakerDAO is also not the only DeFi protocol to discriminate against Tether. Compound and Aave, the two largest pure lending protocols, do not allow USDT to act as collateral for loans. The compound’s decision is based on reports that the tether is “under-guaranteed” and has the “potential to collapse at any time”. The compound has over $ 2 billion in USDC. But he only has $ 320 million in USDT.
Against its will, Tether is now a regulated finance company in New York. He will reluctantly have to make his financial statements public. Assuming they like what they see at the time of reporting, Tether skeptics may begin to rethink their distaste. DeFi protocols like Maker and Compound can even ease their tether penalties, thus gobbling up more tether.
And who knows, maybe Tether, after a taste of oblivion, will try to come back from the cold and apply for a Money Transmitter license like everyone else. Whether he qualifies is another matter. But stranger things have happened.