The world’s largest stablecoin issuer, Tether, has released its latest reserve attestation report, showcasing a stronger and more conservative asset allocation. Despite these efforts, analysts at Barclays warn that even fully-backed stablecoins like USDT could face liquidity crises and a potential “death spiral.”
Tether’s Chief Technology Officer, Paolo Ardoino, emphasized the strength and resilience of the company’s reserves, stating that the past week served as clear evidence of Tether’s robustness. The consolidated total assets reached at least $82.4 billion, backed by increased investments in U.S. Treasury Bills and a significant reduction in commercial paper holdings.
Key Changes in Tether’s Reserve Composition
Tether continues to shift its reserves toward lower-risk, higher-liquidity assets. Commercial paper holdings were reduced by approximately 17% compared to the previous quarter, falling from $24.2 billion to $19.9 billion. Since April 2022, Tether has cut its commercial paper exposure by 20%, a move that will be reflected in the Q2 2022 report.
Additionally, the average credit rating of the commercial paper portfolio improved from A-2 to A-1. The company also reduced its secured loans by $1 billion.
On the other hand, Tether increased its investments in U.S. Treasury Bills and money market funds by over 13%, bringing the total from $34.5 billion to $39.2 billion. This reallocation indicates a strategic move toward greater stability and liquidity.
Barclays’ Warning: The Liquidity Risk Behind Fully-Backed Stablecoins
Despite these improvements, Barclays strategist Joe Abate highlights a critical risk: even if a stablecoin is fully collateralized with assets worth at least $1 per token, it can still experience a sudden loss of liquidity and a “death spiral” scenario.
Abate points out that although Tether holds cash reserves and bonds to maintain its 1:1 peg with the U.S. dollar, it also imposes controls on redemptions. These include fees and minimum redemption thresholds in fiat currency.
For example, to redeem USDT for U.S. dollars directly through Tether, an investor must open an account, redeem a minimum of $100,000 worth of tokens, and pay a 0.1% fee on the redeemed amount.
Investors who cannot meet these requirements or wish to exit faster may turn to the secondary market. However, this often means accepting a discounted price, especially during periods of stress.
Recent Market Stress and USDT’s Deviations from Peg
In mid-May, concerns around stablecoin safety led USDT to trade below its $1 peg, at one point falling to just $0.95. Some investors were willing to accept a 5% loss to exit their positions quickly.
This behavior, Abate notes, suggests that even if a stablecoin is fully backed and has ample liquidity buffers, the willingness of investors to take losses for quicker exits can lead to preemptive runs.
Why Stablecoin Liquidity Can Vanish Quickly
In the cryptocurrency secondary market, liquidity is highly dependent on market sentiment. When crypto asset prices are rising, it is easy to sell stablecoins at par because there are many willing buyers. However, during downturns, liquidity can dry up almost instantly.
As buyers disappear, even modest sell orders can cause prices to gap down and trading volumes to shrink. In Tether’s case, the fact that most investors cannot redeem directly with the issuer—coupled with the psychological urge to sell quickly before prices fall further—can intensify selling pressure.
Comparison with ETF Arbitrage Mechanisms
In traditional finance, exchange-traded funds (ETFs) rely on market makers to arbitrage price differences. If an ETF’s market price deviates from the net asset value of its underlying securities, market makers step in to buy or sell shares, thereby narrowing the gap.
A similar mechanism should, in theory, apply to stablecoins like USDT. If USDT trades below $1, arbitrageurs should be incentivized to buy discounted tokens on the secondary market and redeem them with Tether for $1 each.
However, this process assumes that market makers are not under significant balance sheet pressure and are willing to engage in such trades. More importantly, unlike ETFs—which hold securities with intrinsic cash flows—cryptocurrencies are often driven by momentum, making them vulnerable to sharp downdrafts with little fundamental support.
Two Obstacles to Effective Arbitrage
According to Abate, two major factors can prevent arbitrage from restoring a stablecoin’s peg:
- Doubts About Collateral Quality or Liquidity: Investors may begin to question whether the issuer truly holds sufficient liquid assets to back all tokens at par, especially during stress events.
- Practical Costs of Arbitrage: Arbitrageurs must buy tokens at a discount and redeem them at face value, but redemption fees, minimums, and processing delays can eat into profits or even make the trade unfeasible.
These structural barriers mean that even if arbitrage opportunities exist, they may not be sufficient to stabilize the price during a crisis.
Frequently Asked Questions
What is a stablecoin death spiral?
A death spiral occurs when falling prices trigger panic selling, leading to further declines and a loss of liquidity. Even fully collateralized stablecoins can enter this cycle if investors lose confidence and rush to redeem or sell their tokens.
How does Tether control redemptions?
Tether imposes a minimum redemption amount of $100,000 and charges a 0.1% fee. These measures help manage liquidity but can also discourage small investors from redeeming directly, pushing them toward the secondary market where prices may be less favorable.
Can arbitrage help stabilize USDT’s price?
In theory, yes. If USDT trades below $1, traders can buy it at a discount and redeem it with Tether for $1. However, redemption limits, fees, and timing delays can reduce the effectiveness of this mechanism during fast-moving market crises.
What are Tether’s main reserve assets?
As of the latest report, Tether holds a significant portion of its reserves in U.S. Treasury Bills and money market funds. It has also greatly reduced its exposure to commercial paper and secured loans.
Why did USDT lose its peg in May?
Concerns over the stability and transparency of stablecoin issuers during market-wide stress led some investors to sell USDT quickly, even at a discount. This temporarily broke the peg until confidence was restored.
Are all stablecoins equally risky?
No. Different stablecoins use various collateral mechanisms—including fiat currency, cryptocurrencies, and algorithms. Each has its own risk profile regarding liquidity, collateral quality, and regulatory compliance.
Conclusion
Tether’s recent reserve report reflects a conscious effort to improve the quality and liquidity of its assets. However, as Barclays warns, structural and psychological factors can still lead to liquidity crises even in fully collateralized stablecoins.
Understanding redemption mechanisms, arbitrage barriers, and market dynamics is essential for anyone using or investing in stablecoins. For those looking to deepen their knowledge of market mechanisms and liquidity risk, explore more strategies available in today’s digital asset landscape.
As with any financial instrument, it is important to conduct thorough research and understand the risks involved. Market conditions can change rapidly, and maintaining a cautious approach is often the best strategy.