It was shocking to see the reserve breakdown of Tether – The USD stablecoin (USDT) pegged to USD which was released last week.
At ARYZE we will be doing much better than that with our “digital cash” stablecoins representing almost entirely credit risk-free backing with central bank deposits and short-term central bank issued assets.
If a claim is made directly or indirectly that a stablecoin represents something, it must be exactly that and nothing else (unless explicitly and detailed made public), and that fact must be verified by independent trustworthy 3rd parties.
There are three important elements to take into account :
Firstly – market value risk. The value of a dollar is exactly 1 dollar if held in cash (coin or notes) with a call on demand deposit in the fed. If a Fed issued short term bills is used for backing up a USD stabelcoin in terms of the backing the issuer must compensate for the potential changing market value of the asset. VAR (Value At Risk) models are used for analyzing and determining the extra collateralization required when the asset has a maturity longer than on demand (now).
Secondly, only assets issued by a central bank or guaranteed by a central bank (government) or deposit in a central bank carries zero credit risk in the currency in question. Everything else has a value of less than 1. Even if the asset matures tomorrow. Black Swan events or what we sometime measure as Gamma risk in option theory deals with this form of risk from a model perspective, which is measure of large and unforeseeable events resulting in a big change in the Delta risk component – a massive volcanic explosion in Yellow Stone National Park could be such an event.
Irrelevant in the bigger scheme of things?
LTCM (long Term Capital Management) the largest hedge fund in the world defaulted in the 1990’s when Russia all of sudden decided to change the maturity off short term bills to having 2-3 year or longer maturity dates, which overnight changed the market value of the “risk free” asset negatively by 25% or more.
If credit risk is taken into consideration, and the weighted average market value (the credit derivative markets can be used to analyze these) is 1% less than the face value of the instruments used to back up a USD stablecoin. For example, the current under capitalization from this component alone is USD 580 million based on the USD 58 billion current market cap of Tether.
It could be higher, and it could be lower, but we just do not know because we have no insight into the details of the underlying components used to back up the stablecoin (USDT). However, per definition it is greater than zero and an equal overcollateralization must be in place.
Thirdly, A statement of solvency and backing must be made by a trusted and fully independent 3rd party, just like a company annual report is being audited by a certified accountant, and they must make their findings publicly available without any involvement of the company (stabelcoin issuer) being audited.
Finally, there are other considerations to contemplate such as transfer risk, counterpart risk, security risks etc. But that is another discussion for another day.
Suffice to say that the crypto market deserves something better than USDT/Tether.