19th June 2024 > > A recipe for disaster?

tl;dr

A gold-backed USD stablecoin with an attempt to algorithmically maintain the dollar peg is fraught with risk, and is a huge worry for me.

Market Snap

Market Wrap

Spot BTC ETF outflows show no sign of slowing down. Until they reverse, one cannot discount the possibility of dropping below $60k.

Curious Cryptos’ Commentary – Gold-backed dollar stablecoin

Tether – the company that is still not entirely transparent about the collateral backing the world’s leading stablecoin USDT – has announced the launch of a RWA (real-world asset) tokenisation platform called Alloy by Tether. The first product is aUSDT (i.e. Alloy USDT - that external creative marketing team might have put a little more work into the name) which will be a USD stablecoin collateralised with gold, or rather a tokenised form of gold known as XAUT (Tether Gold).

All sounds good, right? Well, I am not so sure.

Let us take a short look.

Please note that these are my initial thoughts framed from a sceptical point-of-view that this whole shebang looks like a piece of over-complicated financial engineering, which the markets will hurt, and hurt badly, one day in the future. The one thing the crypto markets do not need is the collapse of another stablecoin – the FTX fiasco shows that to be the case. Tether’s aggressiveness towards the stablecoin world continues to nag at me. If anything keeps me up at night, it is Tether.

I am very happy to be corrected on any misunderstanding or misinterpretation from my side.

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The documentation can be found here, though as always, the CC research team has already read it on your behalf:

https://docs.alloy.tether.to/

First up, in a much wider context, tokenisation is going to be huge.

Tokenisation will bring liquidity and pricing clarity to markets that are currently opaque and illiquid. Opaqueness and illiquidity raise the cost of capital for business, making us all poorer.

Tokenisation however will not solve government induced pricing and productivity problems. A prime example of this in the UK is charging stamp duty on house purchases, and also capital gains tax on the sale of your primary residence from next April onwards, but in many other cases the improvements wrought by tokenisation will be material, very beneficial, and very noticeable.

For these reasons, a launch of a tokenisation platform accessible by all is in principle a wonderful idea.

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XAUT is a digital asset that represents “… ownership of one fine troy ounce of physical gold stored in a Swiss vault on behalf of the Tether Gold token holders. This provides a way for cryptocurrency users to gain exposure to the value of gold without physically owning or storing the precious metal.”

This asset can be easily bought and sold, either on an exchange or directly P2P. In many ways it looks like a digitised version of a gold ETF, an innovative product that sparked the ETF revolution foreseen by Larry Fink, CEO of BlackRock.

Buying a gold ETF, or XAUT, provides investor exposure to the gold price without having to own and store gold. Anyone with a safe at home stacked with gold bars will understand the daily security concerns one has about doing so. This democratisation of investors’ access to gold adds liquidity and pricing clarity.

So far, all good. But what happens next to turn this asset into a USD stablecoin?

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Individual owners of XAUT can deposit XAUT into a vault, and mint aUSDT against that collateral.

It is a requirement, and a necessary one at that, for the minter to over-collateralise the vault, let us say at double the value of aUSDT minted. What this means is that for every $1,000 of aUSDT minted from the vault and deposited into the minter’s wallet, $2,000 of XAUT must be deposited.

The minter can then do as they like with the aUSDT. It can be sold for fiat, or used to purchase real-world assets, or perhaps can be invested in BTC. But, as is surely becoming clearer now, this is yet another form of leveraging up, a dangerous path to take in the crypto world.

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At any point in time, the minter can repay the $1,000 of aUSDT into the vault and receive back the XAUT that was used as collateral. I can already see the dollar signs lighting up in some people’s eyes.

Let us suppose that the CCC is right (and when have we ever been wrong?) and that QE is heading back our way in size. It is not fanciful to imagine a world where the gold price has doubled and the price of BTC has quadrupled, all within say three years or less.

A minter starting out with $2,000 of XAUT who invested the $1,000 of aUSDT taken from the vault into BTC, could unwind the whole package at that time leaving them holding $4,000 of XAUT and $3,000 of BTC. This is of course an entirely hypothetical scenario, but it demonstrates that using XAUT to mint aUSDT is at heart a leveraging process, which always brings liquidation risk, which would certainly keep me up at night, if I ever found myself using leverage.

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The liquidation risk occurs when the XAUT collateral falls to 75% of the value of the aUSDT minted.

In our scenario, this means that if the value of the XAUT deposited as collateral falls to $1,333 the vault is liquidated. The liquidator is rewarded with 105% in XAUT of the aUSDT deposited to unwind the vault. There is no mention in the documentation of what happens to the remainder. What we do know is that the original minter has lost the collateral, and lost it for good.

In practise, this means that whatever the minter bought with aUSDT has cost twice what it would have done otherwise.

Ouch.

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The CCC believes that no-one should ever use leverage in the crypto world. The CCC’s resident techie Larry believes otherwise, and he is a wise man. For him, it works. For most people, it really doesn’t.

On a macro scale, if the liquidation process is smooth, there is no systemic risk to the broader ecosphere, just small pockets of pain for individuals.

But markets don’t work like that over the long-term. A sharp crash in the price of physical gold could lead to a wholesale re-pricing of aUSDT to much less than $1. The algorithmic safeguards will crash and burn (*).

The fallout from such an event will be determined by how important aUSDT is at the time within the crypto world. As for me, it is yet another scary invention that is simply not needed.

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(*) The documents claim that aUSDT is not an algorithmic stablecoin, but that is disingenuous at best. It uses smart contracts on-chain with an algorithmically defined outcome, if liquidators step up to the plate. There is no guarantee they will do so, for their number is small, and they may already have too great an exposure to the Alloy ecosphere, in a stress scenario. Yet another reason to distrust the executives at Tether.