Thread by @patio11

Tether, the cryptocurrency which is theoretically backed 1:1 by USD held in a bank account and available on demand, is currently in the early stages of a bank run.

The early stages of a bank run reach the late stages of a bank run very, very quickly.

Tether/Bitfinex’ explanation for this is banking troubles; their most recent bank found their most recent shell corporation and terminated the relationship.

This has happened 4 times. Each time it happens, their depositors play roulette.

Historically tether appears to have had a few live accounts. When one gets killed, the financial institution controlling it investigates (takes a few month), historically finds hijinx but not a sufficiently high level of hijinx to not return the money, and returns it.

During that period, the tokens which participants treat as fully backed are fully backed*. It’s the classic liquidity risk problem that banks are familiar with: the balance sheet is good for the money but we can’t lay hands on more than X0% of it within a short period.

(Assuming arguendo that Tether is not a straight up fraud and that its balance sheet is USD equivalents. I have maybe 60% confidence that both of those are true.)

Anyhow, what the community under appreciates at the moment is that illiquidity is not the only consequence of losing a banking relationship. Banks do talk to each other (quite a bit) and it is difficult to keep billions of dollars under the radar indefinitely.

Eventually, a bank or, more likely, a regulator is going to say “Actually this doesn’t look like a legit deposit that we’re uncomfortable with supporting due to AML/regulatory reasons. It looks an awful lot like proceeds of crime intermingled with grey money.”

And the terrifying outcome, from the cryptocurrency economy perspective, is the regulator doing what the USFH did with respect to Mutum Sigillum (Mt Gox’s US front): “OK, we’re going to give you two choices.”

Door #1: Prove that it’s legal money. This should be trivial for you because KYC is the law and your compliance should be automatic. So have your lawyer suit up. BTW we expect this to take 3+ years.

Door #2: We propose a 50% haircut.

Gox’s bankruptcy administrator took the haircut. That was an eminently sensible call.

I think there is a material risk that Tether absorbs a billion dollar hair cut.

A historical precedent for this is the Reserve Fund meltdown in 2008. The Reserve Fund was a money market fund; those are not fully reserved but are expected to invariably be a) liquid as cash and b) maintain $1 par value.

If it had a token and didn’t pay interest, that’s Tether

The Reserve Fund “broke the buck” due to the poor decision to have several percentage points of their assets in commercial paper of an American financial institution with zero counterparts risk, Lehman Brothers.

This caused such a large loss of confidence in money market funds as a class that the immediate capital outflow threatened to destabilize the global financial system.

The cryptocurrency economy relies on Tether, specifically, far more than the global financial system relies on money market funds. It has convinced itself that they’re equivalent.

That is wrong. It has always been wrong. It may soon be experimentally disproven catastrophically.

Tether doesn’t have single digit percentage point exposure to a US financial institution who couldn’t pay them 100% and wouldn’t be able to settle for months. They probably have close to total exposure to a financial institution which will be offering much worse.

(If you believe I am wrong you can call up your OTC desk of choice and offer to buy N million dollars of tether at a 3% discount to par. Hoover up that free money.)

(You know why you can’t call up an OTC desk and offer to buy a deposit held in a US bank for a 3% discount to par, at a trade size of millions? And indeed financial professionals would laugh you out of the room for suggesting it? Yeah.)