Trusting Times
In September 2008, the Great Financial Crisis entered its most acute phase when the Reserve Primary Fund broke the buck after disclosing it had 1.5% of its assets in Lehman Brothers commercial paper.
The prospect of a popular money market fund being worth only 98.5 cents on the dollar was enough to send global markets into a tailspin and force the Federal Reserve to backstop every money market fund in the country.
In 2022, by contrast, the crypto market has been perfectly content to learn that its biggest money market fund, Tether, holds a full 6% of its assets in "other investments including digital tokens."
That was at the end of Q1, since which time bitcoin has fallen over 30%.
The Q1 report indicated Tether had $162 million of equity (the value of its assets above $1 per token, effectively). If the entire "other" category was held in bitcoin, Tether would now have negative equity of about $1.3 billion, nearly 2% of its assets.
I have no insight into what Tether actually holds in "other" — maybe it's all in USDC and everything is fine.
But, recalling TradFi's panicked reaction to learning the Reserve Primary Fund was 1.5% underwater, DeFi's non-reaction to learning Tether could be similarly underwater seems notable.
And that's before taking into account the further 4.5% of assets in "corporate bonds, futures and precious metals," which will not have fared very well of late, either.
TradFi types find it exasperating that, given all of the above, Tether remains stubbornly pegged at $1.
They generally ascribed this to crypto types not understanding how finance works.
But, perhaps it's the opposite?
The market should be well aware that Tether's assets are now short of their liabilities, so maybe the message is not that we are ignorant of how finance works, but that we are trusting Tether to do the right thing.
Doing the right thing, in this case, would be for Tether to divert current earnings into the fund until the losses are made whole.
If so, this would compare DeFi favorably to the TradFi situation in 2008 when everyone panicked out of money market funds not because they were aware of the risks but because they had never contemplated the possibility that there were any risks.
Crypto is less panic prone.
Having just survived UST going to zero, the prospect that USDT is only backed by, say, 97 cents or so of assets may just not bother the type of person who is accepting of the general risk levels in crypto.
On the one hand, I find this admirable: It's nice that crypto trusts Tether to do the right thing.
And, more significantly, it's further evidence that DeFi is antifragile in a way that TradFi is not — our money market funds can trade down to 96 cents and back up to $1 without the world imploding in between.
On the other hand, I think DeFi needs to get a little less trusting.
We've just witnessed a major failure of the market's hive-mind: A lot of us who were otherwise skeptical of UST looked at LUNA's $40 billion market cap and thought, "Well, I guess the market knows something I don't."
We probably shouldn't do the same with Tether: USDT is a centralized money market fund that pays no yield, and is undercollateralized, uninsured and unregulated.
If that's not enough to put you off, Tether's own documentation makes the risks even plainer: "We could abscond with the reserve funds."
Tether has come out of the LUNA/UST crash looking even less risky to crypto natives — they are processing billions of redemptions at peg! — and even more risky to TradFi types — they are getting billions of redemptions!
So the debate doesn't seem to have advanced much.
I personally avoid USDT, although I think it's probably fine — if they were going to abscond with your money, I'm sure it would have long since happened by now.
And they have just passed a major stress-test.
But let's remember that the alarm bells had been sounding for some time before the Reserve Primary Fund finally broke the buck: Lehman itself somehow survived six months after the forced sale of Bear.
I expect Tether will survive more than six months past Terra — probably forever, in fact — but why bother with probably when you also have the certainty of DAI, FRAX and USDC to choose from?
(Not to mention newer, more innovative stables like flexUSD, FPI or USDs.)
I trust Tether. But others make it easier to verify.
I'd go with those, for now.
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