If the Tether stablecoin adopted an animal character, it should be a cat since it appears to have nine lives. On Friday Celsius, the bankrupt crypto lender, sued Tether over alleged preferential treatment during its bankruptcy. Celsius had borrowed $812 million from Tether, but the stablecoin firm held collateral. Hence, shortly before the bankruptcy Tether liquidated collateral to settle the debt. If Celsius had brought the lawsuit two years ago, it could have been potentially far more serious for Tether.
Celsius alleges that it transferred 17,886 Bitcoin as collateral during the ninety day period prior to its bankruptcy. Legally, these sorts of transactions are often set aside because they give the recipient preference over other general creditors. Celsius’ retail clients received around 18% of the cryptocurrency that the company owed them. [Taking the dollar value of the crypto at the point of bankruptcy, the recovery percentage was far higher.]
The lawsuit contains additional allegations, including a claim that Tether liquidated Bitcoin collateral without waiting as contractually obliged. Celsius claims that if Tether had held off from liquidating the collateral, Celsius would have Bitcoin worth more than $2 billion at current prices.
“There are plenty of flaws in the claimant’s filing and we’re very confident in the solidity of our contract and our actions,” wrote Tether’s CEO Paolo Ardoino on X.
“More than two years later, this baseless lawsuit is trying to claim that we should give back the bitcoin that were sold to cover Celsius’ position.” He highlighted that Tether has equity of nearly $12 billion. In other words, it has a comfortable buffer against potential losses, although he’s confident there won’t be any.
A two year delay helped Tether
Two years ago, Tether didn’t have a buffer like that. If the lawyers had sued around September 2022 (as some expected), hypothetically it could have triggered a de-peg. At the time, Tether’s equity was around $250 million.
Without the additional Bitcoin in collateral, the lawsuit claims that Tether would have had a $365 million deficiency. That’s $115 million more than its equity. On a $66 billion stablecoin (in 2022) that is only a small hole, but it is a hole. Tether would have recouped something in the bankruptcy, but how much was unclear for a while.
The lawsuit is alternatively trying to get the court to set aside the collateral liquidation, which would mean a higher loss for Tether.
Tether’s risky bets
But it’s not like Tether hasn’t had a balance sheet hole before.
In 2019 Tether claimed that “Every Tether is always backed 1-to-1, by traditional currency held in our reserves. So 1 USDT is always equivalent to 1 USD.”
Despite this claim it lent $625 million of its reserves to the Bitfinex exchange under common ownership to cover a massive exchange loss. In other words, it lent $625 million of money that it owed to stablecoin holders to an INSOLVENT related party exchange. The exchange did not become insolvent after the loan. It was already insolvent when Tether granted the loan.
Tether subsequently quietly amended the reserves description to include loans made by Tether, “which may include affiliated entities.” Tether and Bitfinex acknowledged these and additional misrepresentations in a settlement with the New York Attorney General.
With not one, but two close calls, you’d think a change in risk appetite might be warranted. The danger is that a $12 billion equity buffer could encourage Tether’s management to take bigger risks.
Someone recently commented to Ledger Insights that Tether behaves like a hedge fund that pays its limited partners a zero return.
According to Tether’s latest reserves attestation, at least $18.7 billion of assets would be considered relatively risky for a stablecoin. That includes corporate bonds, Bitcoin, precious metals, loans and other investments. Plus, that’s not counting reverse repo agreements of more than $12 billion.
Reverse repos
Reverse repurchase agreements involve lending cash to banks, usually overnight. In return, banks provide collateral which is usually US Treasuries. This is exponentially lower risk compared with the Celsius loans. However, it depends on the bank counterparty and the collateral.
Generally, when a company goes bust in the U.S., someone that holds collateral against a loan can’t liquidate the collateral. But repo is exempted from that rule. Hence, the collateral owner (in this case the stablecoin company) can legitimately sell the Treasuries if the bank debtor goes bust.
Circle is also involved in reverse repo, and to a far greater degree. Reverse repo frequently makes up over 50% of the USDC stablecoin reserves and sometimes as much as two thirds.
However, there are two significant differences between Tether and USDC’s reverse repo. Firstly, Circle (via BlackRock) discloses the bank intermediaries and the detailed collateral daily. The banks are systemically important banks and the collateral is of the highest quality. [However, the banks are intermediaries so we don’t know the identity of the counterparties].
Tether neither discloses the counterparties nor the detailed collateral. So for all we know, the lending could be to a state bank or a money market fund rather than a systemically important bank. Tether also mentions in the notes that the collateral for repo is “US Treasuries where the ultimate issuer or guarantor has a rating of A-2”. Given that the U.S. federal government is rated A-1+, unless we’re missing something, the collateral is not federal debt.
Does it matter?
Most of the time, these issues are just details that don’t matter. However, that small window of time when they matter is likely to impact all the higher risk assets simultaneously.
During a recent interview with Wired, Ardoino said he’s not happy with Europe’s MiCA regulations because it requires 60% of reserves to be held at banks. He’s not the only one to have raised an eyebrow at this policy. However, he claims his concern is that this is unsafe.
Given Tether’s appetite for risk where there’s a suitable reward, perhaps the lousy interest rate on bank deposits might have something to do with its aversion to bank deposits.
Update: added caveat that BlackRock discloses the triparty bank intermediaries so we don’t know the counterparties.
