With the U.S. Securities and Exchange Commission (SEC) committed to burning the earth and salting the fields of the cryptocurrency industry, the stablecoin tether (USDT) could face serious pressure. Whether from a direct regulatory attack by U.S. authorities, or thanks to pressure on related entities, the market is showing signs of concern about tether’s health. Those concerns manifested in a minor depegging last week, with the asset-backed token dropping from its U.S. dollar face value to $0.0996. Tether is crucially distinct from the so-called stablecoin TerraUSD, which imploded spectacularly a little over a year ago along with the underlying Terra blockchain. TerraUSD was proudly unbacked, relying instead on what turned out to be a fatally flawed “algorithmic” system. Tether, by contrast, purports that its dollar-denominated tokens are backed by assets held by Tether’s parent company. But a pattern of questionable attestations and activity over the years has built up a well of skepticism towards Tether, too. Most recently, a CoinDesk investigation showed seemingly misleading claims about the token’s backing assets circa 2021. The worst-case scenario would be that Tether’s assets on hand don’t match the face value of outstanding tether tokens, currently just over $83 billion. That would mean some tether holders couldn’t redeem their tokens for real dollars in the event of a surge of redemptions. As crypto winter grinds on, large tether holders may want to insulate themselves from that risk by taking a “short” position in the token that would pay out if tether lost its one-dollar peg. Some traders might also simply hope to profit from a short position in tether. It wouldn’t be the first time - last March, the hedge fund Fir Tree publicly shorted tether at significant scale, betting that its issuer Tether’s commercial paper holdings were fragile. Some metrics could indicate increasing interest in shorting Tether in recent days. For instance, the tether borrowing interest rate on the Curve decentralized lending platform has spiked as high as 7.4%, after ranging between 4% and 4.4% over preceding weeks. Curve’s 3Pool last week saw a huge spike in borrow interest in tether, largely from a single address that reportedly swapped the borrowed tether to USDC, the second-largest stablecoin by market capitalization. That surge helped nudge tether slightly off its peg in the Curve market, and more broadly. Borrow and lending activity on the Aave V2 platform has also spiked in recent weeks to levels not seen since April, according to data from Parsec (account required). But it turns out tether is a funny beast. While it’s not difficult to short exactly, it is both technically complex and in a moment of great uncertainty. And the overall level of short interest is hard to gauge. A rising annual percentage yield (APY) cost for tether borrowers, for instance, could reflect several other factors, including a desire to go long other assets, such as Bitcoin. There are also conflicting indicators. While Tether may be at regulatory risk, it seems to be thriving operationally. The firm reported $1.48 billion in profits in the first quarter of 2023, and has said it is investing those profits in assets including Bitcoin. That might form an additional layer of stability, and defense against shorts. That challenge and opacity may make the stablecoin more robust against even big-money skeptics. In principle, shorting tether is straightforward. “The easiest way to short tether is to do it on-chain – borrow tether, then sell it,” says Austin Campbell, a stablecoin veteran and founder of Zero Knowledge Consulting. “[Borrow it on] Compound, Aave, whatever, then buy another stablecoin if you don’t want price pressure.” This kind of short would pay off if tether crashed, making it cheaper to repay the initial loan. But there are a variety of obstacles to the trade, some unique to tether. For one thing, there are relatively few trading venues outside of decentralized finance (DeFi) that make shorting tether straightforward. “A lot of the firms that want to short tether are not [crypto] natives, they’re traditional finance,” says Campbell. “They wind up going through broker-dealers, and it’s more expensive.” That is, many of the firms who are skeptical of tether’s value, and with enough capital on hand to make the trade at scale, may not have the technical expertise to do so profitably via direct on-chain methods. Going through a broker-dealer, though, increases the cost of the underlying trade, normally made up largely of the borrowing interest rate. As with all shorts, this carrying cost must be borne until the short pays off, nibbling away at potential profits with each passing day tether doesn’t depeg. And the profits themselves might not be that great, since even a tether depeg would likely be confined to a tight band. Even tether skeptics would accept that the token is substantially backed by real assets. “Even if you short tether, it’s not going to zero, so what’s your risk reward?” asks Campbell. “If you want to make eight cents [on the dollar], is that worth it?” This limited upside only accentuates the significant risks in a tether short position. In particular, it’s uncertain when or if an SEC action against the Tether corporation, which would likely catalyze a significant depegging, might happen – if at all. Jurisdiction is one factor. While the SEC was able to go after Binance because of the exchange’s U.S. subsidiary (among other factors), Tether has a less obvious operational footprint in the U.S. That’s not airtight protection from regulatory action, but it is an additional source of uncertainty for anyone considering a big short. The level of short interest in tether is also difficult, if not impossible, to accurately measure. Much of the secondary market activity in the token takes place over-the-counter in private trades. And because one leg of the tether short involves simply borrowing the token, it can be difficult to distinguish even publicly visible shorts from other kinds of on-chain leverage. This matters because shorting is often a collective activity – that is, traders may be more likely to short when they see others doing the same thing. This seemingly played a role in the TerraUSD depegging, for instance, which was closely observed on-chain. There is a final sardonic twist to Tether’s strange defensive position: while regulatory anxiety may be driving some short interest, regulators are also partly responsible for making shorting tether harder. “Ironically, one of the biggest forces protecting tether is the SEC,” Campbell argues. “By making it so hard for U.S. firms to interact with crypto at all, they have prevented price discovery, and prevented the largest players from coming in and doing these trades.” – David Z. Morris @davidzmorris david.morris@coindesk.com | 