October 16, 2018 . 12 min read
Crypto Chat #60
The precarious state of Tether (USDT), the ever-present 1,000 tonne elephant in the crypto asset-themed room, can no longer be ignored.
At the time of writing USDT is trading for $0.93 vs. USD and $0.90 vs. TrueUSD, a regulated fiat-collateralized stable coin. Spreads across USD and USDT exchanges now exceed $500, having peaked at $1,500 this morning.
On Thursday October 11th I wrote the following in preparation for this week’s newsletter. I remain slightly confounded as to why it took another 5 days for the wider market to react.
USDT: The Reddest of Flags
All signs point towards the imminent collapse of Tether
Rumours of Tether’s (USDT) insolvency are a staple of the crypto asset industry.
Initially I considered myself part of the skeptics camp: the persistent refusal to release full audits did not instill confidence that USDT was fully collateralized, and it seemed largely apparent that there was no easy way for the average investor to redeem USDT for USD.
Around January/February 2018 I reevaluated my position: how could Tether possibly be insolvent when crypto asset exchange BitFinex, which shares the same operators, was generating multi billion dollar profits?
The markets seemed to have shared my shift in sentiment, with USDT maintaining a near-perfect peg to USD since Februrary 2018 following a period of marked turbulence in the final months of 2017.
And now, roughly 8 months later, I’m back in the skeptics camp!
The End is Nigh
For the first time in 8 months USDT has broken its peg from USD and it has done so in dramatic fashion.
To many, this peg-breaking does not seem particularly significant — indeed, the peg broke numerous times throughout 2017. I have since spoken to several active industry participants, none of whom have so much as batted an eyelid at this instance of peg-breaking.
However, within the current market context, this situation seems more alarming, and thus deserving of attention, than usual.
Banking Relationships Sour
Tether, which commands a $2.68bn market cap and over $3bn in daily volume, recently ended its relationship with Noble Bank.
Since then it has opened a private account with HSBC under the name ‘Global Trading Solutions’.
The Block’s Larry Cermak notes, “it was not clear whether HSBC is aware that Bitfinex was banking with the firm. Now it appears that the private account is no longer functional. Bitfinex currently has no active method of deposits as all USD, EUR, JPY and GBP deposits are paused.”
Cermak’s report does not explicitly comment on withdrawals and to my knowledge withdrawals have not officially been halted (although there are numerous complaints surrounding the withdrawal process).
Nevertheless, that customers are no longer able to deposit into Tether’s bank account raises serious questions as to the state of their accounting, and consequently the ability for USDT holders to seamlessly redeem their holdings for USD.
This Time IS Different
On the evening of the 10th October, USDT fell as low as $0.9710 vs. USD.
Why is this especially significant? Because BTC/USD fell by ~$300, or ~4.5%, in the same two-hour time period.
As BTC falls versus USD, we would naturally expect demand for USD and USDT to increase: investors are moving out of BTC and into a stable alternative, i.e. cash. Indeed, this has historically been the case, as the chart below indicates.
USDT rose to $1.03 after BTC fell from $20,000 to $15,000 and peaked again following a BTC move from $15,000 to $11,000.
USDT saw lows of $0.98 just as the BTC market accelerated to $20,000 in the November-December 2017 period, and similarly dropped to $0.98 as the market saw a brief reversal in February 2018.
All this is to say that we should expect an inverse correlation between demand for USDT and BTC/USD.
And yet, on the evening of the 10th October we saw USDT fall 3% as BTC fell 4.5%, indicating that even falling BTC prices is not enough to sustain demand for USDT.
Meanwhile, spreads across BTC/USD and BTC/USDT exchanges are currently over $100.
Why are spreads at the highest in 9 months?
Those holding USDT are losing confidence in the peg and exiting at pace into what they consider a relatively safer store of value, BTC. Despite BTC’s volatility, investor’s know that they will eventually be able to convert it into real, hard USD via a fiat-based exchange like Coinbase Pro or Gemini.
Meanwhile, sellers of BTC on USDT exchanges are demanding higher prices over USD exchanges because of the risk involved in holding USDT.
These spreads would not exist if USDT were risk-free: arbitrageurs would simply buy as much BTC as they can on USD exchanges and then sell all their BTC for USDT for X% risk-free gain, with additional sell pressure returning markets closer to their true-fiat counterparts.
That big market makers/arbitrageurs, AKA ‘whales’ AKA 'those in the know', have not closed the spread yet suggests that they too might be questioning the strength of USDT.
A further catalyst for USDT’s demise is the rapid emergence of alternative fiat-collateralized stable coins like GeminiUSD, TrueUSD, and Paxos Standard, all of which are closely regulated by government agencies and provide regular audits of their custody accounts.
Tether, which is waving the proverbial ‘red flag’ with increasing voracity, seems like a bad bet in comparison.
What To Expect Next?
What does this mean for the market as a whole? What should we expect if the Tether peg continues to collapse?
1. We should logically expect spreads across USDT and USD exchanges to continue to rise. Historically, as the chart below indicates, there has been a near-perfect inverse correlation between USDT/USD price and the spread across USD and USDT exchanges: as USDT value plummets, spreads increase.
2. We should expect any exchange that has large reserves of USDT to start panicking, and eventually stop operating. Even if they do manage to move all their USDT into BTC or ETH, they’ll be taking on a significant loss when they sell back for USD at a discount.
3. Once investors have finished moving $2.6bn+ USDT into BTC, we should expect BTC/USD prices to deflate as those same investors once again look to move into cash.
This deflation will be further exacerbated as non-USDT holders simultaneously move out of BTC and into USD, knowing that their USDT-holding counterparts are about to crash the price.
4. We should rightfully expect scrutiny from the press, which will further instill fear within the markets, and presumably have some knock on effect for regulators and the ‘institutional money’ that is ostensibly eyeing up crypto asset exposure. 'Crypto Reserve Currency Collapses' is not a particularly rosy headline and will probably not help alleviate concerns around an impending Bitcoin ETN.
Bitfinex announced that the fiat deposit system will be available in the next 24 hours.
Binance temporarily paused all USDT withdrawals.
KuCoin temporarily pauses USDT deposits and withdrawals.
OkEx announced that they will list all regulated stablecoins today. Deposits open today and trading will open tomorrow.
The inaugural Cryptoeconomics and Security Conference (CESC) took place last week in San Francisco.
MetaStable Capital’s Haseeb Qureshi kindly shared his diligent notes, the most interesting (to me) of which I have featured below.
Discussion of mechanism design as it relates to the crypto asset ecosystem and topics on which panelists have changed their mind over the last 12 months
China is a motivated, capable, and credible threat to Bitcoin
When PoW block rewards approach 0, mining security goes down
Miners will be incentivized to turn off their machines (or point them at different chains) until enough profitable transactions accumulate
This is bad!
Most Read From CC#59:
3. On Consensus
Volatility has returned to the Bitcoin (BTC) markets, with price slipping close to 10% on Wednesday evening before bouncing up 11% as the market reacted to Tether’s imminent collapse.
As described above, I expect BTC to continue appreciating over the course of the week as USDT holders move in, before depreciating as those same holders once again return to cash.
Blockchain analytics service, Chainalysis, published research indicating that, contrary to expectation, BTC’s diverse group of large holders may actually be stabilizing the market: during the major price declines of December 2017 and 2018, ‘whales’ were actually net purchasers of BTC.
Last week I featured the Sia hard fork story, noting that maintaining less-popular forks is difficult, if not impossible, in this nascent market state. As Ashley Lannquist notes, the vast majority of Bitcoin’s forks have failed, while even the ‘sustained Bitcoin forks’ struggle to keep their heads above water.
Ether (ETH) suffered another disappointing week, falling disproportionately versus Bitcoin on Wednesday and then failing to capture gains via the Tether debacle. In many ways this was to be expected as USDT holders will look to exit into the most liquid asset.
The Constantinople hard fork, which was released on various testnets over the weekend, suffered a setback after succumbing to a consensus bug. The bug has since been identified and fixed, although it remains unclear as to whether Constantinople will be integrated into mainnet before the end of the year.
Constantinople has significant implications for the ETH market as it will include a 33% reduction in the rate of inflation via block rewards.
Cointracker has released a ‘ Cryptocurrency Correlations’ visualization, providing insight into the overlap of coin holders across various crypto assets. Of particular note is that 73% of ETH holders also hold BTC, while 68% of BTC holders hold ETH. So much for maximalism!
The latest Ethereum Foundation grants have been announced, with over $3m directed towards teams working on scalability, security, usability, and client diversity.
Bonus: Plasma Design Comparison, featuring Plasma MVP, Plasma MoreVP, Plasma Cash, PlasmaXT, and Plasma Debit.
Bonus Pt. 2: Ben Edgington’s ‘Ethereum 2.0’ presentation, which provides clear summaries of Casper FFG, Sharding, 2.0 architecture.
NYU Economics Professor Nouriel Roubini was invited to provide his thoughts on the crypto asset industry in front of the US Senate Committee on Banking, Housing and Community Affairs.
Daniel Goldman, CTO of Abacus, has produced a thorough and honest response, which justifiably credits Dr. Doom with certain insights while simultaneously addressing the serious shortfalls in his understanding of the technology underpinning this digital asset class.
I remain rather confused as to why Roubini was given the opportunity to testify in the first place: there are very few, if any, experts in this industry, and he is certainly not one of them.
Fidelity Investments, the fifth largest asset manager in the world, has launched a stand alone company dedicated exclusively to bringing crypto assets to institutional investors.
Fidelity Digital Assets will provide enterprise-grade custody solutions, a trading execution platform, and institutional advising services.
Forbes reports that the subsidiary will launch with 100 employees.
Plenty of activity from Circle this week.
First, the release of the ‘Collections’ product on their investment platform.
Collections are a more sophisticated version of the Coinbase Bundle product: rather than simply focusing on the top assets measured by network value, Collections provides exposure to specific verticals: Platforms (ETH, EOS, QTUM), Payments (BTC, BCH, LTC), and Privacy (ZEC, XMR).
This is a step in the right direction, although I personally think that certain verticals don’t require the same diversification as others. For example, of the assets listed in the Platform collection, only Ethereum has any significant traction among developers. Likewise, neither Litecoin nor Bitcoin Cash are regularly used as media of exchange.
Conversely, diversification is appropriate for verticals like decentralized exchange protocols, where an established winner has yet to emerge. Tokensets, the first relayer on Set Protocol, provides this exposure via their DEXSet.
Second, Poloniex, a legacy crypto asset exchange acquired by Circle earlier this year, has removed margin trading for US-based customers and delisted three assets from their platform.
Both moves are a step towards regulatory compliance, with margin products requiring CFTC approval and the delisted assets (presumably) likely to be deemed unregistered securities by the SEC.
Binance, which has historically shown willingness to resist regulatory compliance, similarly announced the delisting of four assets, all of which duly crashed on the news.
Third, news from Claire Wells, Head of Legal & Business Affairs at Circle, that their OTC desk is averaging $2bn of volume per month.
Fourth, Circle has released their newly-renovated Research page, which features thorough, objective primers on various crypto assets.
It’s fantastic to see Circle stepping up to the plate, contributing resources to industry research and even warning their customers of the myriad risks involved with specific assets.
Largely a week to forget for Coinbase.
First, America’s leading crypto asset exchange announced they will be shutting down their institutional-facing index fund, choosing instead to shift focus to the recently rolled-out retail-friendly Bundle product.
According to The Block, the index fund failed to attract enough clients and faced strong competition from similar products launched by Bitwise, Abra, and Galaxy Digital.
Is anyone surprised that a passive fund charging a 2% annual management fee didn’t attract institutional clients?
Second, Adam White, Coinbase’s fifth employee, has been poached by Baakt, the exchange venture led by ICE, the parent company of the New York Stock Exchange. Baakt is expected to launch in November and White will serve as Chief Operating Officer.
White, who joined Coinbase in 2013, built out its institutional exchange product, GDAX, and led efforts to attract institutional capital to the crypto asset class.
That White left in the same week as Coinbase shut down its index fund suggests serious issues with the exchange’s institutional-facing efforts.
Third, Coinbase added support for ZRX, the digital asset associated with the 0x decentralized exchange protocol.
This is the first Ethereum-based token (ERC20) to be listed on Coinbase. The addition implies that regulators have deemed ZRX to not qualify as an unregistered security, despite its high profile ICO in the summer of 2017.
While I am a strong supporter of the 0x ecosystem (and own ZRX myself) I am slightly confused as to how ZRX would fail the Howey Test at this point in time: Amberdata indicates that over 52% of ZRX supply is held by just 4 accounts and infrastructure for ZRX’s utility-via-governance has yet to emerge.
Crypto Asset Funds:
Three items on the crypto asset fund agenda this week.
First, news that Alexander Pack, formerly of Bain Capital Ventures, and Bo Feng, reportedly one of China’s most experienced investors, have launched a new $100m fund, named Dragonfly Capital Partners.
According to Forbes, the fund has already deployed $20m into more than 20 projects and counts Chris Dixon, Marc Andreesen, and Olaf Carlson-Wee as LPs. That Dixon, Andreesen, and Carlson-Wee have all come on as LPs surprises me as they will likely partake in the same deals anyway.
Second, Pantera Capital announced in a letter to its clients that their fund is down nearly 73% over the last year and down 22% in August alone. As the attached article notes, the size of Pantera's positions makes it difficult to exit via today's fragmented and illiquid markets.
Third, news that endowments from Harvard, Stanford, and MIT have followed in Yale’s footsteps , gainng indirect exposure to the crypto asset class.
Another week, another major Ethereum hackathon. Multicoin’s Kyle Samani has listed his favourite projects here.
Confer - Obfuscate token balances within a zkSNARK smart contract.
Meta-Connect - An end-to-end Ethereum gasless onboarding experience powered by meta-transactions.
dArbitrage – An arbitrage bot between Kyber and Bancor
ENS721 - Wrapped ENS contract for transferring domains through 0x
Synful Futures - Allows users to invest in capital markets of any country from anywhere in the world using ETH.
Bonus: Mapping out Ethereum’s ‘Open Finance’ landscape.
SpankChain, an Ethereum-based adult cam streaming service, suffered a breach that saw almost $40,000 in ETH and $4,000 in BOOTY stolen.
In a remarkable turn of events, the hacker then proceeded to return the stolen funds and even took the time to review SpankChain’s SpankBank contract, finding no further vulnerabilities.
You can find a curated list of known vulnerabilities and exploits in smart contracts here.
Verifiable Delay Functions:
An introduction to VDFs, time delays imposed on the output of pseudorandom generators.
This delay prevents malicious actors from influencing the output of the pseudorandom generator, since all inputs will be finalized before anyone can finish computing the VDF.
VDFs play an important role in the selection of validator sets in Proof of Stake-based consensus protocols like Ethereum’s Casper.
Airswap has released a new decentralized OTC product, Spaces, aimed at simplifying the process of large crypto asset trades and mitigating counter-party risk.
Civil, an Ethereum-based ‘marketplace for journalism’, is struggling to reach its $8m ICO soft cap, having raised just $1.3m since September 18th. Of the $1.3m raised, $1.1m came from ConsenSys, of which Civil is a spoke project.
Plenty to be said here.
I first came across Civil at the Ethereal conference in October 2017 and was initially supportive of the project, which sought to leverage token-based network effects in order to revitalize the flailing investigative journalism industry.
However, as more details emerged, it became clear that their execution strategy and token economics were both severely lacking in substance. Indeed, regarding token economics, the project has publicly stated that it is ‘considering additional uses for the token’, which should be interpreted as recognition that the token has not been designed in a way that meaningfully captures value.
It will be interesting to see how things proceeds post-sale. The idea of a 'soft cap' is that the project does not go ahead if that threshold is not breached. This would be the most high profile ‘failed raise’ I can remember coming across in the past 18 months – it should be noted that if the sale had taken place during the ICO boom it would have likely been heavily over-subscribed.
I have seen Civil team member suggest that they plan to refund investors but the WSJ coverage indicates otherwise: 'Civil could offer existing buyers the option of keeping their money in the sale under new terms.' This is rather worrying: if they don't need $8m to proceed then why did they set that as the cap to begin with?
Ultimately, beyond micropayments as an alternative to the subscription model, the direct applications for this technology to the media industry are very limited in scope.
It’s a genuine shame to see this happen to Civil – they're good people and I admire their transparency throughout this pretty awkward phase — but on the bright side, their disappointing fundraising process is a clear sign that the market has matured.
Speaking of redundant tokens — a thorough post-mortem of several projects’ utility tokens, their type of exit, reason for exit, and alternative futures.