Shorting Tether For Fun and Profit
The trials and tribulations of betting against crypto's biggest stablecoin.
Let’s talk about shorting Tether.
Act I: The Why
Tether is the largest of the crypto stablecoins, a crypto asset pegged to the US dollar or some other fiat currency. Described that way, it sounds harmless enough. So why might someone want to short Tether?
Here are some facts that might begin to answer that question. Tether has promised a public audit since 2017, which it has failed to deliver. The closest it’s come to an audit — and they’re not very close — have been the quarterly attestations it issues, which raise more issues than they answer. Jay Pinho’s excellent Tether Insolvency Calculator makes the case that, based on those attestations, Tether is regularly insolvent, even today.
Tether’s CFO is a former plastic surgeon who once paid 100m lira to Microsoft to settle a counterfeiting dispute. As of June 2022, Tether allegedly had over $60 billion in assets but employed just 50 people. That’s probably not surprising when you consider that this is a company which sent hundreds of millions of dollars to a sketchy Panamanian payment processor called Crypto Capital without a signed contract. That money is yet to be recovered.
In 2021, a Bloomberg reporter named Zeke Faux went looking for Tether’s assets. At the time Tether claimed to hold $30 billion of commercial paper, which would make it a top 10 holder of that asset. Yet when Faux spoke with commercial paper traders on Wall Street, none of them had heard of Tether. Faux was able to confirm, however, that Tether had made loans backed by cryptocurrencies, including to now-bankrupt Celsius Network.
Two months ago, Bloomberg reported that the DOJ was taking a “fresh look” at a criminal investigation of Tether executives, led by US Attorney Damian Williams, who’s also in charge of the FTX case. Tether’s most public executive, CTO Paolo Ardoino, uses a Twitter avatar that seems to be a pear with the face of the Joker. His wife, Claudia Lagorio, began working at Bitfinex as a Mobile Application/Frontend Developer in 2016. Three years later, she was appointed Chief Operating Officer of both Bitfinex and Tether.
Now you might understand why some individuals might want to make a bet that Tether will decline in value. This is a bet that, despite claiming tens of billions of inflows over the past few years, the money’s just not there, and when people figure that out, Tether’s going to get crushed.
At Fake Money News, though, we Do Our Own Research. So before we rush into any rash trades, let’s take a look at the bull case for Tether.
Act II: The Case Against Shorting
Noted Tether watcher Bennett Tomlin was recently a guest on Bloomberg’s Odd Lots podcast. Odd Lots co-host Tracey Allow asked him why the shadiness we described above doesn’t seem to have impacted Tether. Here’s what he said:
Well, Tether has existed since 2014 and has been mostly worth a dollar since 2014. Like, I can talk and list many very specific lies and things that Tether has done. But the truth is that over most of that time, for most of the people who used Tether, it was worth what they expected it to be worth. It was able to be transferred from exchange to exchange and it broadly represented about a dollar's worth of value.
Or put more succinctly by a 3,000-follower Twitter account retweeted by Tether CTO Paolo:
Tomlin made another point about Tether’s resilience:
Tether has been around and has connections to many of these other entities in the cryptocurrency industry and then a decent portion of people in the industry, especially those who've been around for several years have at least some vested interest in these entities being successful.
Tether’s large enough by now, and significant enough to the crypto ecosystem, that crypto’s major players will likely do just about anything they can to stop it from failing.
Lastly, there are many who believe that while Tether engaged in some shenanigans in its earlier years, the growth in its assets under management, as well as the boom in crypto markets has since more than compensated for whatever money might have been lost/stolen/vaporized. And now they’re just sitting on a huge money machine that’s cranking out cash. 4% of 60 billion is a lot!
We don’t really buy these arguments. So the next natural question — if shorting Tether is such a good idea, why isn’t the Smart Money putting this trade on?
Act III: Hungry Hungry Hedge Funds
Ah, but they are! Or, at least, they’re trying to.
From a recent Bloomberg article:
A handful of hedge funds are now turning their focus back to the $66 billion stablecoin, which they warn could be the next crypto catastrophe — one that would make the implosion of Bankman-Fried’s FTX exchange look small in comparison.
Fir Tree Capital Management and Viceroy Research are among the firms shorting Tether, according to people familiar with their wagers — positions they’ve held for months, waiting to cash in on their bets.
Let’s explain the likely structure of this short Tether trade in plain English. Say you’re a portfolio manager at one of these hedge funds. You’re busy at work one day scrolling Twitter looking for the next juicy short. You come across a link to, I don’t know, an interesting Substack post. It’s implying all sorts of wild things about Tether — wow! This USDT/USD peg is not long for this world.
But this means — you see dollar signs. Holy shit, you say to yourself. I found it. I can short Tether and then, I’m gonna be rich, like actually rich, not worry-about-my-kids-private-school-tuition-do-you-know-how-much-a-decent-nanny-is-in-New-York-these-days rich, like actually rich.
Now you just need to find someone to lend you some Tether. You reach out to Genesis, one of the largest institutional crypto lending desks. They agree to lend you 100 million Tether. They just ask that you put up 1 million USD as collateral and pay them 10% interest on your loan.
You take the 100M USDT and sell it in the market for 100M USD. Genesis won't let you withdraw this money, unfortunately, so you ask them to plop it in some safe t-bills. And then you wait. If USDT collapses to a price of, say, $0.01 USD / USDT, you can buy up 100M USDT for $1M USD, and hand back that Tether to Genesis to satisfy your loan. They give you your collateral back and you get to keep the money from the sale of the USDT you borrowed. You made $99M — you’re rich!
If USDT doesn’t blow up, you just have to pay $10M USD to Genesis a year to keep the trade on. Seems like a pretty attractive risk/reward.
So what’s the catch?
Even so, the short is hardly straightforward. Valiant, a San Francisco-based hedge fund, made the trade earlier this year, but backed away and made it out unscathed, according to people familiar with the matter. The fund would consider shorting Tether again if it could do so without risking collateral, the people said.
Philippe Laffont’s Coatue Management and other funds looked at the trade and also passed due to counterparty risk, according to people familiar with the matter.
“I’m not short Tether – I haven’t found the vehicle,” said Andrew Left, founder of Citron Research, a short seller. “If someone showed me a way to do it with Goldman Sachs as a counterparty, I’m in.”
Counterparty risk — uh oh. If you put on the trade described above earlier this year, right now you’d be having a bad time. Your lender Genesis suspended withdrawals on November 16 of this year following FTX’s collapse. The issue is less the $1M you put up as collateral, but more so your likelihood of collecting your $100M in profits from a broker who froze withdrawals and is denying “imminent” plans for bankruptcy. As some unlucky hedge funds from the 2008 financial crisis can tell you, there’s no point in hitting it big with a Lehman Brothers short on if the prime broker you bought that CDS from was Lehman.
Incidentally, the good folks over at Tether also read that Bloomberg article. They did not like it. So much so that they wrote a 1,000 word post in response.
We highly recommend that post as a more in-depth explainer of the dangers of counterparty risk when shorting Tether. It also serves as an illuminating glimpse into the psyche of Tether’s management. One might wonder to oneself while reading it, does this read like an official press release of an institution with $65 billion under management with nothing to hide?
Act IV: In Which We Short Tether
So we can’t short Tether in a centralized manner due to counterparty risk. Where we’re going, though, there is no counterparty risk. We speak, of course, of the magical world of decentralized finance, or defi.
In defi, we don’t need to trade with some institutional lending desk that’s gonna go busto the moment Tether starts to collapse. Instead, we can transact with foolproof smart contracts on the blockchain. And code can’t go bankrupt, right?
We actually put this trade on. It looks a lot like the one that everyone flipped out at SBF for putting on. Here are the steps we followed:
First, we deposited about 385 USDC on Aave, a decentralized lending protocol.
Using that USDC as our collateral, we borrowed 250 USDT from Aave.
We headed over to 3pool on Curve and swapped that 250 USDT for 250 USDC.
At the start of all this, we had 385 USDC. Now we have 385 USDC collateral held by Aave, a 250 USDT loan from Aave that needs to be repaid at some point, and 250 USDC. Our loan from Aave is being charged an annual interest rate of 12.36%.
We were having such a good time at this point that we didn’t want the party to end. So we deposited that 250 USDC on Aave as additional collateral, borrowed another 200 USDT, and swapped that for USDC via 3pool. Now we have 635 USDC collateral, a 450 USDT loan, and 200 USDC.
If Tether collapses, we can close out that 450 UDST loan at negligible cost, reclaim our 635 USDC collateral. This will give us a total of 835 USDC, a return of 117%. Ta-da!
So what's the catch? Why aren't hedge funds putting on this magical defi trade themselves?
One answer is the same reason why tradfi hedge funds refrain from directly trading crypto — it's hard to do so in a compliant manner, especially when your auditors need to be comfortable you have custody over your assets. Good luck getting PWC to sign off on your books when you have $100M locked up on Aave.
Luckily for us, Fake Money News is auditor-free. Does that mean we're in the clear?
Act V: Now We Wait (And Worry)
Sadly, no. As magical as defi is, all we've really done here is transform counterparty risk into protocol risk.
What does that mean? Essentially that we’re exposed to the risk of something going wrong with Aave itself and not being able to get our money back. (Aave’s own explanation of its risks is here.) In order to withdraw our money from Aave, Aave actually needs to have the money we want to withdraw. When we deposited USDC collateral on Aave, Aave lends out that USDC to other users who deposit their own collateral on Aave. At the time of this writing, about 53% of Aave’s USDC is lent out.
Let’s assume for the sake of argument Aave isn’t susceptible to getting Ronin’d or Mango’d. Even then, we have exposure to the pool of assets used as collateral on Aave. Notably, USDT (and some other assets like BUSD) can be deposited on Aave to be lent out, but can’t be used as collateral. Still, just over half the collateral on Aave is ETH or stETH, and another 13% is wBTC. Aave’s designed to liquidate positions before the become under-collateralized. Let’s hope that happens fast enough if Tether depegs.
We can sleep soundly at night knowing we only have a couple hundred dollars at risk with this trade. But you can understand why an institutional investor might be a little wary about putting a large amount of capital into a defi protocol like Aave.
So now we wait, paying 12.36% a year for the eventual pleasure of saying “I told you so”. Seems like a pretty good deal to us.
Betting the casino burns down only works if you can bet outside the casino.
Banks can't trade their own CDS's