Analysis of USDT Asset Reserve Stability

The asset reserves of stablecoin issuers are typically similar to those of money market funds, mainly consisting of cash and high-quality short-term bonds and notes.

Looking back at the 2008 financial crisis, the largest money market fund at the time, Reserve Primary, held approximately $78 million in short-term bonds from Lehman Brothers, accounting for only 1.2% of its total assets of $63 billion. However, this small exposure triggered market panic. Due to the sudden news of Lehman's bankruptcy, Reserve Primary was unable to timely manage its Lehman bonds, leading to its inability to guarantee investors 100 cents for every dollar. On September 16, 2008, Reserve Primary announced that the net asset value per share had dropped to 97 cents, breaking the public's perception that money market funds would always equal $1.

This event triggered the most severe investor panic in modern financial history. In the following two weeks, investors withdrew as much as $123 billion from money market funds. Due to the commitment to a 1:1 exchange, even a slight blemish on the balance sheet could trigger a run-on effect, making money market funds highly similar to stablecoins.

To analyze whether USDT may face a crisis, two questions need to be answered:

1. How is the liquidity of USDT asset reserves?

2. Is it possible for USDT to face a massive redemption like the money market funds in 2008?

Regarding the first question, the asset reserve quality of USDT has been improving. The proportion of commercial paper (CP) is continuously decreasing, while the proportion of U.S. short-term government bonds (T-Bill) is continuously increasing:

Q2 2021: CP 49%, T-Bill 24% Q3 2021: CP 44%, T-Bill 28% Q4 2021: CP 31%, T-Bill 44% Q1 2022: CP 24%, T-Bill 48%

According to a senior executive, $8.4 billion CP was redeemed before March 2022, and it is expected that the CP proportion will further decrease to around 13% in Q2 2022.

The quality of CP held in USDT is also improving, with the proportion of CP rated above AAA rising from 93% in Q2 2021 to 99% in Q1 2022.

Recently, the market has conducted liquidity stress tests on USDT. Over the past month, USDT has redeemed 17 billion USD, with a circulation decrease of 20% from 83 billion to 66 billion (. Among this, 10 billion USD in redemptions occurred during the market panic triggered by the UST collapse from May 12 to 15 ). This indicates that USDT has the ability to handle large-scale redemptions in the short term, with liquidity even better than certain types of banking institutions.

Regarding the second question, if there is a massive redemption of (, such as redeeming over 80% of ) within a week, USDT may indeed decouple. A rapid redemption requires a large amount of asset selling in a short period, which is likely to cause slippage and lead to decoupling. In fact, all stablecoins find it difficult to cope with such extreme situations.

However, the likelihood of such a large redemption for USDT is very low. As an established stablecoin, USDT's uses have far exceeded that of a stablecoin itself. Market makers must hold a large amount of USDT to operate, and many over-the-counter and gray market transactions also rely on USDT. This portion of demand is estimated to account for at least 20% of USDT's issuance, and these holders are unlikely to flee.

In addition, USDT redemptions require whitelist verification, and only certified institutions can directly trade with the issuer to exchange for USD. This also makes it unlikely for USDT to be massively redeemed in the short term.

85% of USDT reserves are in cash and cash equivalents, which can be quickly converted into cash in the short term. More than half of this is in highly liquid U.S. short-term Treasury bonds. Even under the pressure of 80% redemption of circulating supply, due to the intervention of arbitrageurs and the presence of speculative buying, USDT is unlikely to experience a long-term severe decoupling.

In summary, the possibility of a USDT collapse is very low. Hedge funds that short USDT are likely to incur losses. However, if they can create slight fluctuations, such as a drop to 0.95 USD, and close their positions in time, there is still an opportunity for profit. This also explains why there have been constant negative news related to USDT in the market recently.