Tether losing its dollar peg may be the moment the crypto crash reaches the real world

Recent weeks have not been kind to those involved in cryptocurrencies. A massive exodus from the market has hammered the crypto space’s marquee currencies. Bitcoin, the largest cryptocurrency, is down below $ 27,000 (£ 22,000), erasing 16 months of gains. Ether, the second-largest coin, has fallen below $ 2,000 for the first time since July last year.

But as the onslaught continues, the crypto economy faces even graver dangers. Much of this comes from the plight of stablecoinswhich underpin most of the inner workings of the Crypto market.

A stablecoin is a cryptocurrency which is nominally pegged to underlying assets, the most common being the dollar. This means that, unlike other coins whose values ​​can fluctuate, one Tether will in theory always be worth one dollar. The company behind the coin ensures that this will be the case by having enough assets in reserves to back each and every coin they give out.

Of all these stablecoins, Tether is the largest. Its collapse would have serious implications not just for the crypto economy but also potentially for the traditional economy.

As of writing, the price of Tether had fallen as low as 95 cents and is now oscillating at around 98 cents. It’s not a drop that would be remarkable for Bitcoin or even a traditional stock, but it is not very stable for a stablecoin, whose entire function is based on sticking to the real-world dollar.

What’s behind Tether

Much of the current instability surrounding Tether comes from two places. Firstly, another “algorithmic” stablecoin – algorithmic in that it is backed by nothing more than financial alchemy and the power of belief – recently collapsed. The collapse of this stablecoin, called TerraLunawhich was among the top 10 most popular cryptocurrencies, sent shockwaves throughout the crypto world, which has likely ricocheted onto Tether.

Secondly, no one is exactly sure what Tether is exactly backed by. It wasn’t until February last year when Tether was fined by the New York District Attorney, that Tether was compelled to give quarterly breakdowns of the assets backing its tokens.

Tether also paid a $ 41m (£ 34m) fine to the United States Commodity Futures Trading Commission for allegedly misstating its reserves. At the end of last year, Tether stated that it held $ 35bn (£ 28bn) in short-term Treasuries, or bonds, but these figures haven’t been audited under generally accepted accounting practices.

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In its regular financial stability report this week, the Fed warned that stablecoins backed by reserves “may lose value or become illiquid during stress”, adding that “these vulnerabilities may be exacerbated by a lack of transparency regarding the riskiness and liquidity of assets backing stablecoins “.

There is added worry that the immense size of these stablecoins means that a run on the stablecoin could prompt such a heavy selling of the assets held in reserve as to threaten the wider financial system. Just three coins, Tether, USDC and Binance USD make up 80 per cent of the entire stablecoin market.

In June of last year Eric Rosengrenpresident of the Federal Reserve Bank of Boston, listed tether among the “financial stability challenges” the US central bank is watching.

In an interview with Yahoo Finance, he said: “I do worry that the stablecoin market that is currently pretty much unregulated as it grows and becomes a more important sector of our economy, that we need to take seriously what happens when people run from these type of instruments very quickly. “

Paolo Ardoino, chief technology officer of Tether and the Bitfinex trading platform, stated on Thursday that the company has coped with the volume of redemptions, tweeting: “300M [tether] redeemed in last 24h without a sweat drop “.

The price of Tether has also begun to recover from a low of 95 cents to almost 99 cents, indicating that confidence in the currency may be recovering.

Outside the crypto space

While the likelihood of the current crypto chaos escaping the crypto space seems to still remain a fear only in the abstract, the effects of the crash are certainly being felt in the real world.

A message pinned to the top of one of the largest forums for the now-defunct currency TerraLuna contains a list of suicide hotline numbers while the rest of the forum is flooded with stories of unwitting investors losing houses, inheritances and more in the blink of an eye.

The fall of Bitcoin and other currencies has likewise been felt beyond the digital space. The government of El Salvador has invested heavily in Bitcoin, which the Financial Times estimates has lost the country around $ 28.9m (£ 24m) in the last half of the year.

The IMF warned in February of this year that “The adoption of Bitcoin as legal tender is fully funded by public money, through a trust fund. If the price of Bitcoin was to plummet, the resources in the trust could be rapidly depleted. ” This is in a country where government debts already stand at around 85 per cent of GDP.

The major forum for cryptocurrencies on Reddit is also flooded with posts warning users not to use their emergency funds to recover losses. One user added that his emergency fund is down 97 per cent since Friday. One popular post on an Ethereum message board stated, in jest, “I’m not F * cking selling… because I’m already down 99 per cent”. The top reply stated: “I’m down 30k and that’s ok.”

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