While individual coins and tokens in the cryptocurrency sector have grabbed much of the headlines, the backroom reality is that stablecoins or cryptos pegged on a 1:1 ratio with the U.S. dollar help keep the broader sector moving.
Unfortunately, the erosion of sentiment imposes major question marks on Tether (USDT), currently the biggest stablecoin by market capitalization. I am bearish on USDT (although I maintain a very small holding).
As inherently decentralized assets, the beauty of most publicly-traded cryptos is that they exchange hands 24/7/365, irrespective of holidays, religious ceremonies, and other significant social downtimes.
However, such an always-on profile clashes with the cadence of human civilizations. From off-business hours to weekends to other demarcation points, “analog” commerce bakes in certain limitations.
Therefore, even if you wanted to desperately Buy a particular cryptocurrency, your fiat currencies might be tied up with a financial institution, an institution that doesn’t work on weekends and occasionally requires the odd restroom break. To remedy this friction or pain point, stablecoins like Tether fill the opportunity gap.
In some ways, Tether is the hybrid dollar. A cryptocurrency itself (though centrally administered), Tether can be easily converted to other virtual currencies. At the same time, because USDT maintains a one-to-one peg with the dollar, the valuation of the greenback is baked into each unit.
Thanks to this remarkable convenience, many crypto investors hold their funds in stablecoins, allowing them to respond immediately to market rumblings. However, this mass exposure to assets like Tether means a digital bank run could spell doom for the entire crypto complex.
Tether and the Minimum Velocity Concept
Formula 1 represents the pinnacle of motorsport, with teams competing aggressively to manufacture the fastest racing machines possible within the defined regulations (or formula, hence the name). While they are not the fastest vehicles in a straight line, what makes F1 cars so special is their cornering speeds.
Modern F1 cars can generate a lateral cornering force that is equivalent to three-and-a-half times their own weight. Theoretically, then, at a minimum speed of approximately 120 miles per hour, these incredible machines can drive upside down. The concept is similar to how aerodynamics work in airplanes, except, in this case, reversed.
Of course, an F1 car can only drive upside down while maintaining a minimum velocity. Should the vehicle slow down below the threshold, the aerodynamic forces will no longer be enough to overcome gravitational pull. The outcome, then, would be obvious.
In corollary fashion, the biggest fear that skeptical investors have about Tether is the minimum velocity threshold. So far, the assumption is that Tether, the company that administrates USDT, has enough cash reserves and other traditional assets to back up USDT so that, in theory, all stakeholders who wish to convert their stablecoins to dollars can do so without a problem.
Unfortunately, growing evidence suggests that this may not be the case. Up to this point, no one has tested the 1:1 ratio theory, so no one’s the wiser. However, should a digital bank run materialize, the emperor could be found with no clothes.
Caught in the Wake
Casual observers of cryptos might reason that a disruption or even implosion of the Tether stablecoin would be limited to just USDT. However, that’s not the case, at least according to Hilary Allen, a finance expert at American University.
In an interview with The New York Times, Allen stated, “Tether is really the lifeblood of the crypto ecosystem.” Further, the analyst remarked, “If it imploded, then the entire facade falls down.”
Indeed, investors already witnessed the devastation wreaked upon the crypto sector when the recently rebranded Terra Classic (LUNC) failed when its sister stablecoin project collapsed. Because this particular system used other cryptos to hold up the assets’ valuations, the subsequent sell-off of virtual currencies caused many investors to panic out of their positions.
A similar scenario could play out but on an even wider scale if USDT was disrupted or lost the confidence of its investors. For instance, if it were discovered that Tether has reserves supporting a ratio far less than 1:1, stakeholders would likely rush to convert their USDTs to dollars.
Nonetheless, as valuations rapidly decline, many might choose to Sell their core crypto holdings to beat others to the punch.
Conclusion – Up in the Air
To be completely upfront, the above scenario is speculation. Investors simply have no way of knowing how humans will react. However, that’s also the reason why Tether stakeholders need to be careful. Generally speaking, the mob is extremely unpredictable, making the sector dangerous.
Further, the Terra Classic fiasco has already provided a clear warning, contributing to a wider valuation erosion of the crypto sector. To completely dismiss this threat would be unwise, to say the least. Therefore, investors must be extremely vigilant, perhaps considering trimming exposure to USDT and other stablecoins.