USDT | Tether releases audit report claiming excess reserves, what are the issues?

At the end of last month (3/31), the issuer of the stablecoin USDT, Tether, released a "Reserve Report," proving that the stablecoin issued is "fully backed"; furthermore, this report also included a confirmation signed by the small accounting firm Moore Cayman in the Cayman Islands, verifying the authenticity of Tether's report. But does this dispel all doubts?

The case of cryptocurrency exchange Bitfinex misappropriating $850 million of Tether's reserve funds concluded at the end of February. The New York Attorney General's Office (OAG) announced a settlement with Bitfinex and Tether. Both companies are required to pay $18.5 million as part of the settlement, submit quarterly reports on the reserves of the stablecoin USDT for the next two years, and leave New York.

On the 31st of last month, Tether also released a "Reserve Report". The report indicated that as of February 28, Tether's total assets were $35.272 billion, liabilities were approximately $35.154 billion, and the total circulating value of the digital currency issued by Tether was around $35.111 billion.

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The term "liabilities" indicates that Tether has issued a total of $35.154 billion worth of USDT, but even though USDT is a stablecoin pegged to the US dollar, there can still be a spread, meaning 1 USDT ≠ 1 USD.

Overall, currently Tether does indeed have sufficient backing, even exceeding by over a thousandth, but does this mean everything is completely fine?

Are There Sufficient Reserves Before February 28?

For those who doubt Tether, this report is not enough to silence their concerns. The report is deemed too simplistic as it only discloses the assets on February 28, but what about before that date?

The OAG has previously raised concerns about misleading information in Tether's reserve reports.

In 2017, Tether published a "transparent financial update" on September 30 to prove that they had sufficient reserves, including a bank report stating that Tether had $442 million in reserves.

In theory, the $442 million should have been in the account all along, but according to the OAG's settlement document, Tether's account only had $61 million before September 30, and it was not until that morning that Tether deposited $382 million into the account.

Will it be different this time? Tether has not yet responded to these questions.

What Form Do the Reserve Assets Take?

Aside from the unclear timeline, this report also fails to disclose the form of assets, which is a crucial factor for investors to assess the risk.

The report states:

As of February 28, Tether's total assets amounted to at least $35,276,327,156, exceeding the total amount needed to redeem these digital assets.

Rohen Grey, a law professor at Willamette University, pointed out in a tweet that it is currently unknown what assets Tether holds, which banks hold these assets, and in what form they are held.

Aside from having sufficient collateral, the quality of assets is also vital.

Generally, asset quality refers to liquidity. Assuming Tether has enough reserves (collateral), during peaceful times, there should be no issue for users to redeem USDT for USD. However, in a liquidity crisis, the redemption capability of USDT could be compromised. The best assets would be U.S. Treasury bonds.

In addition to the form of assets, the custodian bank is also crucial, as USD assets involve "custodial bank credit risk."

Due to the complex flow of funds for USDT users, no U.S. bank is willing to accept Tether's USD deposits, leading Tether to hold assets in "offshore banks." If Tether does not hold assets in a bank that is a part of the Federal Reserve System (Fedwire), the bank cannot provide reserve liquidity through the central bank or banks in that system, significantly increasing the difficulty of converting collateral assets into reserves.

As shown in the image below, banks that are not part of the Federal Reserve System (Fedwire) need a Fedwire bank to guarantee user assets, so in the event of a liquidity crisis, the USD redemption rate will significantly increase.

If the Reserve Includes Digital Currency, What Happens if Prices Drop?

What's even worse is that Tether's reserves include Bitcoin, as confirmed by Tether's CTO Paolo Ardoino and Chief Legal Officer Stuart Hoegner in a "What Bitcoin Did" podcast.

At that time, Stuart Hoegner stated that Bitcoin is part of the reserves because some transactions are conducted on Omni, requiring payment in Bitcoin. Following this logic, as Tether issues USDT on more and more blockchains, the position of cryptocurrency assets in hand will also increase, leading to two issues: price volatility and currency inflation.

It is well known that Bitcoin (or cryptocurrencies) is extremely volatile. In the event of a Bitcoin drop, whether Tether can come up with other solutions to supplement reserves becomes a question that investors need to consider.

In addition, Tether's issuance of USDT should involve receiving USD from investors and anchoring the issuance of USDT at a 1:1 ratio. In theory, this reserve should not be touched, but if the reserve includes Bitcoin, it means that Tether has used investors' USD to purchase Bitcoin. Consequently, the same USD (USDT and users' USD) will be double-counted, potentially driving up the price of crypto assets.

For these two issues, Tether has yet to disclose its Bitcoin holdings, which is also why the market is skeptical. A single proof may not resolve market concerns, and Tether may need to put in more effort.