16 May 2022

Tether’s peg got challenged last week – Peak irrational markets

During Thursday’s sell-off, Tether traded at lows of $0.945 on FTX – a clear signal of peak irrationality and chaos in the market.
Source: Tradingview (FTX, Coinbase)
The UST de-pegging last week had second-order effects on the market. Suddenly, Tether began trading at substantial discounts to the $1 peg as the fear reached peak irrationality.Tether has always been accompanied by wide skepticism by a subset of the crypto community. However, it’s essential to be aware of the difference between UST and USDT. Tether is backed by money market instruments, similarly to USDC, with an active redemption mechanism in stark contrast to USTs algorithmic price peg mechanism. In the chart, we show the average hourly low/high spread by day in Tether. Large deviations in the USDT price from the $1 peg are mostly affiliated with periods of extreme market stress and liquidations – i.e., periods with lots of arbitrage opportunities. The Tether discounts on Thursday created attractive opportunities for funds with access to Tether redemptions, likely leading to Tether’s declining market cap. USDT has since returned to its $1 peg.
Food for thought – Implications of a hypothetical USDT collapse
(Disclaimer: We do not view this as a likely event, be very cautious when it comes to jumping on the USDT FUD bandwagon post the very unrelated UST situation.) Imagine that USDT sees a violent dramatic de-pegging. It could have a bizarre impact on the market in the short term. More than 50% of the OI in the derivatives market is based on USDT collateral. A tether collapse would have odd destabilizing effects on the derivatives market. Relative to BTC's USD price, the BTCUSDT price would soar as the value of the collateral declines. Counterintuitively this could lead to an astronomical short squeeze, and complete and utter chaos in the market. In the aftermath, it would likely be a massive blow to the confidence of the industry. The effects are difficult to assess. Funds, market makers, and possibly even exchanges could go bankrupt. It would be an Mt. Goxian event.
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