Pressure rises on stablecoin to deliver on original promise

When stablecoins emerged in the crypto world, they were touted as answer to the inherent volatility of many digital assets. Most stablecoins would be backed by hard assets such as a currency, anchoring its value.

For some stablecoins, it has clearly not quite worked out like that, with one very prominent token named TerraUSD imploding in spectacular fashion and another, Tether, facing continued questions over its asset backing.

Confidence in the sector is not high, it is fair to say, with some critics even questioning whether stablecoins should exist.

The crypto industry is now under pressure from the courts, regulators and lawmakers to show more transparently that it is delivering on the original promise of stablecoins of firm asset backing.

Gary Gensler, the Securities and Exchange Commission chair, reiterated a call this month that stablecoins need more regulation, saying he would work with Congress to develop it. And in a more immediate move, a New York court this week has struck a blow to crypto industry giant Tether over the disclosure of information on the reserves backing its own eponymous stablecoin.

Tether’s USDT token is widely used in cryptocurrency markets for trading bitcoin and other major digital assets. It is the largest stablecoin in circulation with market value of around $70bn. But there have been long-running questions over the quality of its asset backing. Rather than publish a formal audit of its assets, Tether provides attestations of their value.

In 2021, both Tether and sister crypto exchange Bitfinex paid an $18.5mn penalty after New York’s attorney-general accused them of covering up “massive” financial losses. “Tether’s claims that its virtual currency was fully backed by US dollars at all times was a lie,” Letitia James said at the time. Tether and Bitfinex admitted “no wrongdoing”.

The New York court ruling turns up the heat on the company once again. A lawsuit, filed in the US District Court for the Southern District of New York in June 2019, alleges Tether and Bitfinex shared false information about the tether stablecoin and engaged in market manipulation. Tether has called the case meritless.

This week Judge Katherine Polk Failla ordered Tether and Bitfinex to produce information in line with plaintiff requests, describing said documents as “undoubtedly important, as they relate to the backing of tether and cryptocommodities transactions”.

“A court of law has now weighed in and said you have to turn over these documents to prove you were backed the way you said you were. It’s no longer a please, it’s a you have no choice,” said blockchain firm R3 chief executive Charley Cooper.

Bitfinex declined to provide comment on the court ruling. Tether has said the court ruling was a “routine discovery order and does not in any way substantiate plaintiffs’ meritless claims”. The company added it has already agreed to produce documents “sufficient to establish the reserves backing USDT, and this dispute merely concerned the scope of documents to be produced”.

In August, Tether said it would focus on moving to releasing attestations from a quarterly to a monthly basis, working with accounting firm BDO Italia. The firm also said this represented the “next step in the company’s path toward a complete audit”. 

Meanwhile, the court’s decision also comes at a time of when a draft stablecoin bill is being negotiated by Congressman Patrick McHenry (R-N.C.) and Congresswoman Maxine Waters (D-CA) who serves as chairwoman of the House Committee on Financial Services.

According to a copy of the draft bill seen by the Financial Times, regulators would consider the ability of an issuer to maintain reserves for tokens on “at least a one to one basis” in any application to operate in the US. And reserves would have to comprise assets such as US currency, treasury bills, repurchase agreements and central bank reserve deposits. Stablecoins backed by code and algorithms — similar to the now infamous Terra stablecoin that imploded — would be out in the cold.

“It reflects the widely held view among regulators and lawmakers that there is too much risk in the sector, and the sector should not be relied on to self-regulate”, said Charlie Steele, a former US government lawyer and now partner at Forensic Risk Alliance, a regulation consultancy.

Individuals familiar with the draft say it is unlikely the bill becomes law this year, with one person suggesting that would take “an act of God”. However, the draft stands to inform how the 118th Congress — to be elected in November — approaches stablecoin regulation.

“Rather than start fresh after the mid-terms, we’re already somewhere in the game. It is serious to the extent that it will serve as the framework around stablecoins next year,” says Cooper.

scott.chipolina@ft.com