Weekly Comic: Terra Infirma and Untethered Tethers

By Geoffrey Smith

Investing.com — The crypto world has survived a scary week, but the danger is not over.

The seemingly unstoppable momentum of the past two years has reversed, shuddering, as the outgoing tide of cash shows who – in Warren Buffett’s phrase – has been swimming naked.

The “algorithmic stablecoin” TerraUSD and its ecosystem, which has attracted $80 billion in outside money with promises of token-based returns of 20% per year, crashed last week as early adopters rush to exits and letting latecomers hold the bag. , leaving behind the usual trail of destruction and misery of a Ponzi scheme.

Do Kwon, the Korean-born Stanford prodigy who had pioneered the TerraUSD concept, appealed unsuccessfully for more support from his “community” on Tuesday, proposing to insert a “fork” into the blockchain subreddit. underlying to effectively restructure the claims of all who still hold their worthless – sorry, “classic” – .

The answers (with a few honorable exceptions) boiled down to a direct message: go for it yourself.

Kwon’s mathematical ability cannot be doubted. But the lack of common sense behind the Terra system defies belief.

At its heart was a promise to redeem various forms of on-demand digital currency for real US dollars. Yet the assets backing the system were not dollars, but – for the most part – an asset whose near-perfect correlation to high-beta profitless tech stocks has been clear for years. Any situation stressed enough to trigger a surge in demand for redemptions must – almost by definition – have also killed the value of its reserves.

It is, as one prankster put it, as if Argentina’s central bank in 2002 took dollars from the IMF to create a peg to the peso, then leveraged them on Brazilian junk debt for carry.

Of the more than 80,000 bitcoins held by the Luna Foundation Guard — a group of investors around Do Kwon — while Terra’s peg was still in place, only 313 remained as of Tuesday. The rest was wasted trying to defend the peg, much like the Bank of England in its failed efforts to defend the pound 30 years ago (or any of the many Asian central banks during the 1997 crisis) .

The irony of what happens to a community that can’t speak without laughing at mainstream finance (Kwon himself had smirked at an interviewer just two weeks ago that “there’s entertainment watching corporations die”) could hardly be more perfect.

It is unknown who succeeded and who failed to withdraw their money from Terra in time. Unconfirmed reports have suggested foul play, highlighting a number of large bulk transfers from LFG-controlled accounts, but the claims have been dismissed, cannot be verified, and self-reinforcing momentum d ‘a bank run would in any case suffice by way of explanation.

And a bank run, in slightly modified form, is the most likely risk currently facing an asset whose importance to global financial markets is far more important to global markets – .

For most of recent history, Tether was the world’s most important stablecoin – a digital asset whose value was pegged to the dollar. Its main purpose has been to act as a storage place for digital money between speculations on cryptocurrencies or other digital assets such as non-fungible tokens.

Tether’s market cap peaked at over $83 billion just 10 days ago. However, it has steadily decreased since Terra’s demise. By Tuesday night in New York, its market value had fallen to $75.6 billion.

Much of this is a natural contraction in the overall Tether supply as speculators redeem their crypto assets for cash.

However, it was clear from Tether’s wobble in the middle of last week that it was about more than that. Some did not believe in the ability of Bitfinex, owner of Tether, to pay.

Tellingly, while the market capitalization of Tether has shrunk, that of and Binance USD, which play similar roles in their respective ecosystems, have increased by a total of around $5 billion. Crypto speculators show a clear preference for them over Tether.

This is hardly surprising, given that Bitfinex, the owner of Tether, was fined $43 million last year by US regulators for lying for three years through 2019 about what supports actually his stablecoin. The last attestation from an accountant of Tether’s reserve is five months old and was given by MacIntyre Hudsonan accounting firm based in the Cayman Islands.

By comparison, Circle, which manages USD Coin, has its reserves audited monthly by Grant Thornton in the United States and holds them entirely in cash and Treasury bills. It also uses Bank of New York Mellon (NYSE:) and Blackrock (NYSE:) as custodians, according to a blog post by Circle’s Chief Financial Officer, Jeremy Fox-Green.

Tether bottomed last week at 93.35c, before returning to parity with the dollar this week. Its chief technology officer, Paolo Ardoino, argues that it has never been necessary for holders to accept less than the whole dollar because of what he called Tether’s “secret sauce” – referring to his reservations. But there is no better sauce than transparency, and secrecy adds nothing good to the taste.

Tether’s reserves are undeniably of better quality than Terra’s. More than 43% of them are in US Treasury bonds or cash and equivalents. More is held in money market funds which should bear little risk.

However, more than a third is held in the form of commercial paper – short-term corporate debt – and Tether gives no more detailed breakdown of the promise of payment that ultimately lies hidden. Ardoino did not respond to multiple inquiries from Investing.com for clarification.

Anyone who was there in 2008 will remember how commercial paper as an asset class exploded dramatically as the quality of the underlying assets – subprime loans – were brutally exposed by rising rates. of interest.

Interest rates are doing the same now. If there are any credit risks in Tether’s wallet, they will soon reveal themselves.

Tie holders have been notified.

Daniel K. Denny