For last several months and even years USDT or Tether has been a source of consternation for me.
For the uninitiated USDT is an ERC20 stable coin pegged to the US Dollar. It is supposedly backed 1:1 by actual dollars in a bank account. No one apart from the guys who run it know which bank it is or whether there is any money in it, or it is all made up.
They do not publish any audited financials or have not displayed any transparency about their dealings.
A simple google search about USDT scam can bring any reader upto speed on all the shenanigans that have been happening in this space.
And yet the token peg remains generally unimpacted!
It traces the price of USD quite consistently, it is #4 among all crypto with over $4.2 Billion under circulation. It remains extremely liquid and remains the token of choice among various OTC players.
From an uninitiated non-biased observers perspective this whole thing makes no sense. Well established banks have faced runs for even whispers of wrong doing. And in case of Tether almost everyone who is involved in dealing with it is reasonably well aware that the whole thing does not stack up.
Tomes and tomes of investigative pieces have conclusively proven that USDT is not above board, it faces regulatory action from US bodies among its long list of issues.
Then why does USDT continue to survive? how does it manage to stay liquid and maintain its value within a very small tolerance.
For a long period of time, this has thrown me off kilter.
My first reaction has been always that this is unsustainable and things will come crashing down at some point.
But as anyone who has been involved in a Ponzi scheme, it is almost impossible to predict when it will all go bust. Bernie Madoff ran a Ponzi scheme for 20 long years before things went pear shaped.
The real question one should be asking is why is there no bank run happening on Tether and why do sane people, a large number of whom are well aware of the issues with Tether still continue to deal in it.
Every second Tether continues to exist, is a poke in the eye of those who deem themselves logical.
But you cannot just attribute its existence to a mass suspension of reasoning faculties. There is something more at play here and things might be logical after all.
The answers we find may have significant ramifications and might just open up new doors to a range of opportunities.
The question we are trying to answer is why does Tether continue to command value, despite most people being aware that it is definetely not backed by dollars in the bank.
Why does anything have value?
Some noted economists like Paul Krugman claim that it is because men with guns say that it is so.
We accept the currency of the nation state we live in as legal tender because we are under duress.
While that is largely true, it does not stay true beyond a certain point. If that was so Zimbabwe would not have faced Hyperinflation.
Consider another perspective, most of the money under circulation is actually created by banks. They lend out money against some real world collateral, and that loan becomes a new asset which they can again use to lend more money. All of that money is created out of thin air. This is known as the fractional reserve system.
While this may seem like magic money, the reason it works is because banks are part of a wider network. Money lent out by one bank using this fractional reserve mechanism is accepted as perfectly legal tender in another bank within the same country. Banks are nodes on a federated ledger of money which syncs up with each other via the Reserve bank.
Something new has value because it can be exchanged readily against something old that is already accepted as having value.
Money created by a bank with a newly licensed bank has the same credibility because it can be accepted in all other banks (or in the wider economy).
If A = B and B = C, then A = C
That is the simple law of transposition.
Which effectively means network effects play a massive role.
Once something has a certain volume of distribution it acquires a momentum and life of its own and it becomes very hard to displace it.
The US Dollar itself has this phenomenon playing in its favour.
It has other reasons such as being backed by the largest economy in the world, that is based on the rule of law, and being the monetary tender of choice across the global financial markets.
It is the unit of exchange, account and value in the biggest platform in the world.
Tether was floated by the guys at Bitfinex and they accept Tether as an exchange for Bitcoin. Given that Bitcoin is already widely accepted to have value, this becomes the mechanism by which Tether derives value.
As long as Bitfinex continues to exist, Tether is likely to have value.
Yes, tether does trade on other exchanges as well, but they will all cut it out if Bitfinex chooses not to deal with it. The value flows from the liquidity that Bitfinex is willing to provide and it then permeates outwards.
As a proponent of decentralization and transparency, all this boggles my mind.
But from a lay persons perspective, all they really want is a mechanism to hold USD in an anonymous manner and an ability to offload that to something else that has value on demand.
Tether satisfies these two criteria. It is anonymous (as much as any ERC20 can be) and can be readily swapped for something else that has value.
The man on the street does not care if it is decentralized or not, whether there is anything backing it or not.
All they want to know is can it be exchanged for something of value, and if the answer to that is a yes then Tether has value.
This liquidity has to be instantaneous, it cannot be hours, days, weeks, months. It has to be instant. And if your token can meet that criteria of instant liquidity then it has value.
It's not as if it cannot be immediately swapped then it does not have value. For instance, houses are not liquid but by all means they do have value. But they are not used as currency and their value would be much higher if they were instantly liquid.
A company listed on an exchange typically enjoys roughly a 30% premium in its valuation to another company that is similar but not listed. This is known as the liquidity premium or conversely the illiquidity discount.
Even DAI, the so called holy grail is based on Ethereum as its collateral, and the liquidity that ETH enjoys serves as the backstop for DAI value.
Liquidity is king in day to day world.
I was in Singapore a year back and was swapping notes with an OTC market maker about the prospects for a real estate backed stable coin. He bluntly told us that it was infeasible, as all they care about is how quickly they can swap out of any position into cash. With lack of distribution and hence liquidity to more widely accepted value, any stable coin backed by real estate would find it hard to take off.
So are we stuck with USDT? Or would be constrained by the liquidity pool ETH offers which would be the upper bounds of DAI? Or is there any prospect for real world assets to serve as collateral onchain?
I believe real world assets can and should be tokenized, but it has to be done in a manner that the market is willing to accept.
The assets that should be tokenized first should be assets that are extremely liquid and can be tokenized in a relatively censorship resistant manner.
Liquidity can be achieved in two ways,
- Build your own liquidity
- Plug into someone else’s liquidity
Building your own liquidity can be a long drawn out process and is best suited for groups which already have intentions of running mass market platforms. Bitfinex runs an exchange with significant distribution, tapping that was easier for them.
Closer to home groups like Liven and Sosure who are in the loyalty points game are also better positioned to deploy their own stable coins as they have already built out the distribution they need. Same goes for the Unihash team out of South East Asia.
In a way nation states are plugging their stable coins which they create out of thin air into a captive distribution which is their citizenry. And it works… most of the time.
So generally speaking if you have captive distribution you have an easier path.
However if you do not have it then you have to employ the maxim,
“If you cannot beat ’em, join ‘em”.
You have to start with assets that already have liquidity. The most obvious asset that comes to mind is listed shares.
Shares have a massive amount of liquidity and are have far more value locked in them than crypto.
Heck, single companies like Apple, Amazon, Alphabet have more market cap than the entirety of Crypto.
We had previously written about this,
However shares have certain challenges around the regulatory side.
To create, sell, and trade shares you need various kinds of licensing. And such licenses are limited to national borders. There is no global securities regulator which means dealing in shares globally can be a pain.
While eventually shares can be tokenized in a censorship resistant manner using zk-Snarks there is probably a lower hanging fruit.
Commodities also have a wide, global, liquid pool.
Coffee, Oil, various beans, Gold, Silver, etc trade round the clock across global borders. In addition commodities are not securities. Derivatives built on top of them are, but nothing prevents you from buying and selling coffee beans to someone else.
You are typically expected to keep track of AML/CTF depending on what jurisdiction you are incorporated in but there are no restrictions on the buying, selling, and making a market in commodities themselves.
And you do not need to make a market in an ERC20 token representing an ounce of gold, there are plenty of decentralized exchanges where people can find their own buyers and sellers.
There would be a simple platform where people can buy commodities or sell it back to the platform. There would be no market made.
A 3rd party custodian of sorts would hold the assets in trust on behalf of the token holders.
If for some reason someone cannot find a buyer for their tokens on Uniswap they can come back to the platform, which will always serve as the buyer of last resort.
The platform will be plugged into the global commodities market and will sell their commodity there and return the cash to the buyer for a small fee. The tokens representing that commodity get burnt at that point.
Tokenized commodity in the form of ERC20 can serve as a fantastic defi primitive.
Holders can construct options and various other derivative structures around it and trade amongst themselves. They already do that using Synthetic structures, but a custodial structure would not require the extremely high collateralization in a synthetic model.
To provide some context, you can create Synthetic Gold on Synthetix by staking their native token SNX but given the volatility in SNX, it is overcollateralized by 750%.
Great for the guys at Synthetix who make more when you buy more, but very capital inefficient.
However if you tokenized gold or coffee beans and then not only it is a much simpler system but you never need extra collateralization. You can always deliver the underlying asset or encash it at the going rate.
Even better tangible assets can serve as a better collateral to create other synthetic asset.
What would you like as the underlying collateral for your Synthetic Dollar? Real gold, real coffee beans, real oil? or SNX tokens?
I do not mean to rain on Synthetix parade, there are pros and cons associated with each approach. Being custodial has obvious risks of confiscation etc, but they can be limited and with some clever mechanisms involving zk-Snarks they can be almost eliminated.
Tokenized commodities can be used to create various Synthetic currencies, and they can be used as an application for money transfers internationally or as a decentralized representation of your national currency. Any one who accepts such a currency can rest safe in the knowledge that they can offramp to underlying asset or convert to fiat if they do need to.
The system is built on top of existing commodity markets.
Once you have a liquid commodity tokenized system, you can then tap into that distribution and start tokenizing other assets that are a bit less liquid such as invoices, mortgages, real estate etc.