A few days ago, the President’s Working Group on Financial Markets held a meeting where Secretary Janet Yellen likened Tether to money market funds. I am typically skeptical when I hear regulators opining on the subject of cryptocurrency for fear that they may promote overburdening regulations. In this case, I think it’s time for regulators to go a step further and finally acknowledge that Tether is, in fact, a security.
Tether, the cryptocurrency with the third-largest market value, was first issued in 2014 and originally claimed to be pegged to the U.S. Dollar at a 1:1 basis. Tether held itself out to serve as both a stable store of value in the ever-volatile crypto market and an intermediary that traders can use to move funds between different cryptocurrencies. Today, Tether accounts for over 60 percent of the total stablecoin market and usually over 80% of the daily stablecoin market volume. In short, Tether is currently the glue that keeps the crypto market together.
Tether’s characteristics make it uniquely positioned not only to be a powerful market influencer, but also a potential vulnerability. There’s no shortage of Tether-skeptics who present viable arguments that question the stablecoin’s integrity. Specifically, these criticisms call out the potential fraud committed by Tether Limited, the entity that oversees Tether, and the unknown quality of Tether’s underlying reserves.
In May, Tether revealed the composition of its underlying reserves for the first time as part of a settlement agreement with the New York Attorney General. According to the breakdown, Tether’s reserves as of March 31, 2021 were comprised of 75.85% cash and equivalents, 12.55% secured loans, 9.96% in corporate bonds and precious metals and 1.64% in other investments, including digital currencies. Most notably (or perhaps most troubling), Tether disclosed that 65% of its cash and cash reserves, or approximately 49% of the total reserves, was held in commercial paper of unspecified quality.
This revelation should trouble anyone who recalls the 2008 Financial Crisis when the Reserve Primary Fund, the original money market fund, had to write down its Lehman Brothers Holdings Inc. debt after Lehman had to file bankruptcy. The Primary Reserve Fund subsequently saw its per-share price drop from $1.00 to $0.97, thus it “broke the buck.” This, of course, significantly fueled the economic catastrophe that followed.
With a market capitalization eerily similar to what the Primary Reserve Fund’s was, Tether now finds itself serving a very similar purpose as a money market fund. It provides crypto investors with a liquid instrument (i.e. tokens) that serve as an intermediary as they move cash from one investment to another while maintaining the same value and avoiding market volatility.
We should understand that Tether doesn’t just “resemble” a money market fund. Tether is effectively a tokenized money market fund – a security.
Money market funds are regulated under Rule 2a-7 under the Investment Company Act of 1940. This rule provides a disclosure-based regulatory regime to ensure the public receives adequate information about the funds underlying asset reserves. Despite the relatively stable regulatory regime, recent years have continued to see conversations on how to improve money market fund regulations. Policy debates on capital buffers, asset eligibility, or floating versus fixed NAV share price, for instance, continue to trouble regulators in the wake of the COVID-19 economic chaos.
Nevertheless, one debate that doesn’t need to continue is whether Tether should be subject to the same diversification and disclosure measures that are imposed on other money market funds. Tether clearly has a similar structure, similar function, and similar value to any other money market fund. It is imperative that the Securities and Exchange Commission use its current authority to impose this Rule 2a-7 on Tether because doing so will undoubtably improve confidence in the cryptocurrency market. The questions surrounding Tether’s asset reserves are far too concerning given its importance to the market.
Should we discover that some or all of the commercial paper held in Tether’s reserves are of junk quality, the progress for stablecoins and blockchain technology would suffer a major setback. A sudden liquidation or transfer out of Tether could mirror what we saw with the Primary Reserve Fund during the Great Recession where everyone began to question the quality of assets on their books.
Regulatory clarity is desperately needed for cryptocurrencies. Consequently, I have introduced the Token Taxonomy Act for the past three Congresses in order to provide such clarity that would allow the industry to flourish in America. In the absence of our law, regulators could (and should) be clear that Tether is a security not because it is a stablecoin, but only because it is backed by actively managed securities. Nevertheless, we should all acknowledge Tether’s importance for the market and welcome detailed disclosures that give everyone more confidence that its Net Asset Value as already required by US securities laws.
