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When a Stable Coin Isn’t Truly Stable

March 21, 2019

This month, Tether (USDT) announced that its “dollar backed coin” may not, in fact, be backed by the US dollar. Originally, their website claimed, “every tether is always backed 1-to-1 by traditional currency held in our reserves.” Since its release in 2014 (it initially launched as RealCoin) it has always purported to be 100% backed in cash. But now, the company is singing a different tune.  

In March 2019, the website was changed to claim, “Every tether is always 100% backed by our reserves, which include traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties, which may include affiliated entities (collectively, ‘reserves’)”

That’s quite the jump.

To say dollars and equivalent assets back your coin is one thing, but to include receivables from loans puts Tether in a much riskier category. What happens if one of those affiliated entities defaults on one of those loans made by Tether?  What recourse does a Tether holder have?   What would happen to the overall value of USDT?   If Tether is not backed on a 1 US dollar to 1 USDT basis, then the only thing keeping the price in place is perception.

Now, advocates of Tether can say this is all semantics. Who cares if Tether is backed in cash or equivalent assets? Banks can claim loans as assets, and we’re not making a run on banks. And that’s true - there is the potential that these things don’t matter and Tether could continue to trade at $1 indefinitely. Unfortunately, this hasn’t been the case. Back in October 2018, USDT dropped to $.85. It eventually bounced back to the $1 price.  But why did it trade down to $.85 in the first place? If the US dollar dropped that much overnight, we’d have an economic disaster on our hands.

That severe price drop was bad enough, but what was even more unsettling was the disappearance of the supply of USDT in the market. Before the price drop in October 2018, there were 2.9 billion USDT in circulation. After the decline, that number hit 2.1 billion. Eight hundred million USDT just disappeared overnight.  And that number has stayed consistent, today.  Was this a great $50mm arbitrage trade for an affiliated entity?

After the initial drop, Tether Chief Compliance Officer Leonardo Real tried to reassure investors that USDT was stable, tells CNBC. “We would like to reiterate that although markets have shown temporary fluctuations in price, all USDT in circulation are sufficiently backed by U.S. dollars (USD) and that assets have always exceeded liabilities.”  Why the price drop and why the disappearance of USDT?

Despite all of this, there has been no audit on Tether. Why not?

In a recent article in Forbes, financial commentator Francis Coppola claimed that Tether’s dollar backing claim is “no longer credible.” Many other critics have said more or less the same.  

What Now?

Now we’re faced with the question, “What happens when stable coins aren’t stable?” What protections exist for USDT buyers? What’s to stop USDT from dropping to $0.70, $0.50, or even $0.05 to the dollar? There are no safeguards in place for investors who trust Tether and end up being wrong about the coin’s stability.  

Should stable coins fall under securities laws?

Valerie Szczepanik, the senior advisor for digital assets at the SEC, believes she has the answer. In a recent statement at SXSW, she said that truly stable “dollar backed” coins should be categorized as securities. To classify stable coins as securities would allow them to be fully regulated and approved by the SEC.  Creating stable coin securities would also give investors the protection of an investment agreement and the ability to trade in their assets at any time for the equivalent dollar value.  

At CERES, we believe this is the right course of action. It’s why we’re seeking SEC qualification as a security for our stable coin CERES Coin. We think this is the only way to securely and efficiently manage stable coins. We’re excited that the senior advisor for digital assets for the SEC is ready to pave a broader, more diverse path forward for the securities of the future. 

To learn more about CERES Coin, contact us at info@cerescoin.io.