Short sellers bet tether, crypto’s central bank, is vulnerable to a run

A few investment firms, including Fir Tree Partners and Viceroy Research LLC, have placed substantial bets in recent months that the price of tether will fall, according to people familiar with the matter. Tether is the most popular currency for trading bitcoin and is supposed to have a fixed value pegged to the U.S. dollar.

Some hedge funds arranged short sales of tether with Genesis Global Trading Inc., one of the larger crypto brokerages for professional investors, said Matt Ballensweig, Genesis’s co-head of trading and lending. About a dozen funds discussed doing the same with Genesis, but many didn’t move forward, Mr. Ballensweig said.

With about $82 billion tether in circulation, tether is the largest so-called stablecoin, a digital asset linked to the dollar and backed by reserves of cash or other financial instruments.

The short sellers follow a pack of regulators, lawmakers, prosecutors, plaintiffs attorneys and amateur sleuths who have spent months, or years, in some cases, attempting to unearth details about a cryptocurrency whose usage has far outpaced its transparency.

Tether isn’t a household name, but it is a cornerstone to the crypto ecosystem. Traders on big exchanges often use tether as an easier way to buy crypto than through bank accounts or wire transfers.

A Tether spokesperson said that the short sellers seem to be involved in a “clever scheme to raise capital from those less knowledgeable, by leveraging on disinformation with the end goal of collecting a management fee."

“Tether has been stress tested time and time again and passed with flying colors. During such events, its peg remained solid, all redemptions were honored and even the price on exchanges remained stable," the spokesperson added.

That price stability—tether hasn’t traded lower than 0.999 cents against the U.S. dollar in the past year—means that short sellers’ bets have yet to pay off. And most of Genesis’s initial clients have since exited the initial trade, Genesis said, though some investors have wanted to discuss ways to short tether in recent weeks. Fir Tree’s shorting of tether was earlier reported by Bloomberg News.

Short sellers are betting that the $82 billion portfolio that underpins tether’s value, now the size of a big money-market fund, is at risk of losses that the parent company hasn’t disclosed, according to some of the people familiar with the short positions.

The Tether spokesperson said that the company takes transparency seriously.

“Tether manages a portfolio of conservative, diversified, liquid assets," Tether said. It said that its reserve-fund assets exceeded their liabilities.

Regulators, lawmakers and other critics have accused tether of being too opaque. Tether Holdings Ltd., its parent company, has promised a full audit of its reserves for years but never produced one. It took a yearslong investigation by New York’s attorney general, and an eventual $18.5 million settlement of accusations that Tether misled clients, for Tether to reveal what it holds in only broad terms each quarter through its accounting firm. To prevent more disclosure, even of mundane matters like the name of its chief investment officer, Tether has gone to court to block public-records requests about its business.

Tether said that delivering a full audit remains a priority. It admitted no wrongdoing as part of its settlement with New York’s attorney general. Tether’s attorneys argued in court filings that additional disclosure of its reserve investments would harm its competitive position in the market and that revealing its chief investment officer’s name would “constitute an unwarranted invasion of privacy."

If the tether token is “backed one-to-one, go and disclose it," said Fraser Perring, founding partner at Viceroy who previously spotted accounting problems at German fintech company Wirecard AG before it collapsed. “We know every single really good short of ours, they’ve obfuscated something."

“Surely the management, to dispel this fear, could publish exactly each line item," said Mr. Perring.

Tether releases new tether tokens when it receives a corresponding amount of dollars from customers. It then invests those proceeds into reserves that back the tokens, a portfolio that includes both safe investments, such as cash and short-term U.S. government securities, and riskier ones, including short-term IOUs known as commercial paper, secured loans to companies and other cryptocurrencies.

Some short sellers believe that a chunk of Tether’s commercial-paper holdings, which totaled $24 billion at the end of 2021 and made up a little less than one-third of Tether’s reserves, came from shaky Chinese property developers. A faltering Chinese real-estate market and concerns about developers’ excessive debt levels have led to selloffs and ratings downgrades in their bonds.

Tether said that it has consciously reduced its commercial-paper holdings since its settlement with New York’s attorney general, including a 21% drop in the last three months of 2021. In response to questions about credit exposure to Chinese property developers, Tether referred to a January report from crypto exchange Coinbase that looked at what Tether has disclosed about its commercial paper. That report said that even if Tether “had owned any short-term liabilities associated with weak sectors, such as Chinese real estate, it would no longer be in its portfolio, as rating agencies have downgraded much of that debt to sub-investment grade over the past year."

One short seller also sees trouble in Tether’s holdings of money-market funds and Treasury bills. That firm learned that an affiliate of Deltec Bank & Trust Ltd., a Bahamian bank where Tether does business, sought to invest billions of dollars in outside hedge funds that invest in highly liquid securities, people familiar with the matter said. That money, much of which the short seller believed came from Tether, could be locked up in those funds for months or years, meaning Tether would have a hard time getting it back in a timely manner to meet a wave of redemption requests, the people said.

Tether declined to comment on Deltec’s dealings with hedge funds. Deltec didn’t respond to requests for comment.

Tether also reported owning about $5 billion, or roughly 6% of its reserves at the end of 2021, worth of what it called “other investments." Those investments included digital tokens.

In comparison, the assets backing USD Coin, the second-largest stablecoin after tether, consist only of cash and short-term U.S. government securities, according to its issuer.

Some short sellers believe that tether’s “other" bucket includes equity stakes in or digital tokens issued by unproven crypto startups, people familiar with their trades said. These types of investments are riskier than ultrasafe Treasury bonds.

Tether didn’t respond to questions about those investments.

Companies including crypto lender Celsius Network LLC and Exordium Ltd., the maker of a to-be-released science-fiction videogame, have said that companies affiliated with Tether or its executives made stock or token investments.

Short sellers also liked the asymmetry of the trade: Borrowing tether to sell it short costs between 6% and 8% a year, according to Genesis. That is more expensive than many stocks but would still yield considerable profit if tether drops precipitously. Meanwhile, there was a very low probability that tether would trade above $1 for an extended period since then holders of it would pocket a premium by selling it, according to Genesis. That meant a short squeeze in tether would be unlikely.

Tether’s opacity, combined with its rapid growth, also has made it a frequent topic of conversation in Washington. The Commodity Futures Trading Commission found last year that Tether only held equivalent dollar reserves in its accounts on a little more than a quarter of the days during a roughly two-year period, leading Tether to reach a $41 million settlement with the regulatory agency. Tether neither admitted nor denied wrongdoing as part of its settlement with the CFTC.

The stablecoin giant said at the time that the investigation focused on its past operations and that it had corrected the issues involved when it updated its terms of service in 2019.

At a February congressional hearing, a senior Treasury Department official, Nellie Liang, said she expected that tether wasn’t fully collateralized, citing her understanding of tether’s disclosures and its unregulated status.

She also echoed concerns about stablecoins more generally that a Treasury-led panel raised in a November report. “If investors were to lose confidence in the quality of the assets backing the stablecoin, there could be a run, which has potential systemic risk consequences," said Ms. Liang.

Tether said when the November report was published it had been waiting for clarity about stablecoin regulation and that it looked “forward to working alongside global governments and regulators to ensure proper compliance and issuance of stable assets like Tether tokens."

In the past, Tether executives have taunted short sellers. After Hindenburg Research offered a $1 million reward for previously undisclosed information about the assets backing tether, its parent put out a statement calling Hindenburg’s announcement a “pathetic bid for attention" that was “attempting to discredit not just Tether, but an entire movement."

Paolo Ardoino, Tether’s technology chief, then posted a cartoon on Twitter mocking Hindenburg as a tin-foil-hat-wearing conspiracy theorist. “Woah A miLon daollar bounty," the cartoon read in part.