Bitcoin’s investment thesis – Volatility and market manipulation

A convenient way for crypto investors to add funds to their crypto holdings (ie to have an ‘on-ramp’ option) and keep a cash-like reserve without moving the funds off-chain are stablecoins (ie cryptocurrencies whose value is pegged to a given fiat currency such as the US dollar). They are issued in exchange for the fiat currency they are pegged to, which is then kept as a reserve by the stablecoins’ issuer. The most important stablecoin (and at the same time the third-largest cryptocurrency overall) has been Tether (USDT) with a current market capitalisation of c US$65.5bn.

Some market participants have been concerned about the US dollar reserves backing USDT – if they cover all the stablecoins in circulation to justify the peg and in what kind of assets are they held. Moreover, in a study published in 2018, authors from the University of Texas claimed that entities associated with the Bitfinex exchange (a sister company to Tether as both are owned by iFinex) used the stablecoin to push up BTC price following downturns between March 2017 and March 2018 (ie during a major crypto boom and bust). The US Department of Justice and the CFTC have been investigating this since 2018, according to Bloomberg, but with no official results yet. Having said that, the approach behind the above-mentioned study faced some criticism (see for instance BloombergQuint or LongHash for reference). Another study from the University of Queensland Business School concluded that no empirical evidence for the USDT impact on BTC prices could be found.

Furthermore, In February 2021, Tether and Bitfinex agreed to pay a US$18.5m fine to settle a legal dispute related to the alleged use of at least US$700m of USDT reserves to help cover a US$850m loss of Bitfinex arising from the Crypto Capital fraud, without disclosing it to investors (as implied by the New York Attorney General). Bitfinex eventually repaid the full amount to Tether.

As part of the efforts to stay compliant with the above-mentioned settlement, Tether has started releasing a breakdown of its reserves. The latest available attestation as at end-June 2021 shows that close to 50% is invested in commercial paper and certificates of deposit, with a further c 8% in corporate bonds, funds and precious metals. According to the document, the commercial paper and certificates of deposit are predominantly rated A-2 (45%) or A-1 (47%) and have an average duration of 150 days.

Still, Fitch recently pointed out that given Tether’s commercial paper holdings may be larger than most prime money market funds in the United States and Europe, Middle East and Africa (EMEA), a sudden mass redemption of USDT could affect the stability of short-term credit markets amid wider selling pressure in the commercial paper market. In this context, we note that Tether’s assets exceeded its liabilities from issued USDT stablecoins by only 0.2%.

Meanwhile, the reserves of USDC, the second largest stablecoin with a market cap of c US$27.0bn, have been released by Circle (its administrator) as well, showing 46% held in cash and cash equivalents (see exhibit below), and the overall portfolio maintaining an average credit rating of A or better on the S&P scale and a weighted average maturity of less than or equal to 1.5 years. Commercial paper made up just 10% of USDC reserves. Cash and cash equivalents include ‘US dollar deposits at banks and short-term, highly liquid investments that are readily convertible to known amounts of cash and have a maturity of less than or equal to 90 days from purchase’. USDC’s assets were presented as being at least equal to the liabilities from the issued stablecoins. We note that in a recent tweet, Emilie Choi (president and COO of Coinbase, which is part of the consortium behind the stablecoin) said that all USDC’s reserves will be held in cash and short-duration US government treasuries starting in September 2021.