On June 12, 2022, Alex Mashinsky, founder of crypto lender Celsius, made an urgent plea for help. As the price of bitcoin crashed, panicked customers were rushing to withdraw billions of dollars’ worth of crypto from their Celsius accounts. But after a series of bad investments, the company no longer had the funds to pay up and now found itself on the brink of collapse.
For aid, Mashinksy turned to Giancarlo Devasini, CFO at Tether. The stablecoin company had extended loans worth around $800 million to Celsius; Mashinksy was asking for further assistance. The pair agreed to speak at 9 am the following morning. But all the while, Tether was allegedly setting up to sever its longstanding ties with Celsius, to protect against its imminent demise. Celsius filed for bankruptcy a month later.
This is the sequence of events laid out in a lawsuit filed on August 9 against Tether by the administrators of the Celsius estate in the bankruptcy court for the Southern District of New York. As Celsius was “tumbling towards bankruptcy,” the complaint alleges, Tether moved to “extinguish its entire exposure,” by unceremoniously selling off large amounts of bitcoin posted as security by Celsius against its outstanding loans. Doing so was a violation of the terms of an agreement between the pair, the lawsuit claims, but allowed Tether to walk away with its pockets fully replenished instead of having its funds locked in the bankruptcy, as was the case with others owed money by Celsius.
The aim of the lawsuit is to claw back the 39,500 bitcoin—worth $2.3 billion at the current price—that was transferred to Tether by Celsius before its collapse. The suit cites a combination of bankruptcy laws designed to avoid a scenario in which creditors that act most swiftly to retrieve funds from an ailing business make a better recovery than others, and various other legal provisions.
In a scathing riposte posted on its site, Tether cast the lawsuit as a “shakedown” designed to deflect the blame for failures by Celsius, which gave explicit consent for the trove of bitcoin to be liquidated, it claims. “Tether will never fall prey to shameless litigation money grabs. We will defend ourselves vigorously,” the company wrote.
Legal representatives for the administrators of the Celsius bankruptcy estate did not respond immediately to a request for comment.
Regardless of whether the legal arguments set out in the complaint ultimately hold, the lawsuit underlines the narrowness of the margin by which Tether sidestepped the contagion that brought down Celsius and a number of other crypto firms in 2022.
The money for loans doled out by Tether comes from the reserve of assets that pegs the company’s stablecoin, USDT, to a one-dollar valuation. If Tether had failed to liquidate the $800 million in collateral posted by Celsius before its fall into bankruptcy, accounts for June 2022 show, USDT would no longer have been fully backed by readily available assets, potentially undermining the all-important stability of the token’s price.
“If you came [near to] falling afoul of your reserve requirements, that’s a pretty close brush with the ‘stable’ falling out of ‘stablecoin,’” says Charley Cooper, former chief operating officer at the Commodity Futures Trading Commission, a US financial regulator. “The systemic implications of this asset class not being what it proclaims to be”—namely stable—“could be really damaging to the crypto economy.”
Slim Margin for Error
The way USDT holds its value is relatively simple: Tether receives US dollars in exchange for tokens that customers can use to trade freely in the crypto market. It keeps some of those dollars in cash, trades most for low-risk government bonds, and loans some out. The token holds a steady valuation by way of the understanding that, if ever someone wants to exchange a USDT token for the dollar it represents, Tether can draw from the reserve.
Today, on top of the amount that would hypothetically be required for all USDT tokens to be redeemed, Tether holds an additional $5 billion in its USDT reserve, its latest quarterly report shows. However, in June 2022, the size of that buffer was only $190.9 million, leaving little margin for error.
Under bankruptcy rules, had Tether failed to sell off the $800 million in collateral posted by Celsius, the funds would have been effectively frozen, says Alan Rosenberg, a partner at the law firm Markowitz Ringel Trusty and Hartog and a member of the American Bankruptcy Institute. “If Celsius had filed for bankruptcy while that collateral was being held, it would have been subject to an automatic stay,” says Rosenberg. “Tether would have needed to obtain relief from the court to take any action with that collateral—and it may not have been granted.”
In such a scenario, there would have been an effective shortfall in the USDT reserve of around $600 million, which the company would have had to scramble to fill. The combination of a small reserve buffer and a large loan to a single borrower—despite it being secured against plenty of collateral—created a situation in which Tether was risking the prospect of UDST potentially dropping its dollar peg.
Tether declined to comment on its ability in 2022 to cover the potential reserve shortfall associated with its loan to Celsius with corporate funds. In a statement provided to WIRED, Tether CEO Paolo Ardoino says the “safety of Tether’s operations is our top priority.” Tether adheres to “comprehensive risk metrics and processes that guide all financial transactions,” he adds.
It is common for a lender to try to recover money by some means in anticipation of a borrower going bankrupt, even if it entails risking a lawsuit later down the line. “At the end of the day, a lot of people would rather take the money and risk being sued,” Rosenberg says, “because nine times out of 10, these things settle for an amount less than the demand.”
But the opportunity for a stablecoin provider that governs a token with a present combined value of more than $100 billion to find itself in so precarious a position speaks to “the need for clear stablecoin regulation,” says Christian Catalini, founder of the MIT Cryptoeconomics Lab and co-creator of the now-defunct Diem stablecoin, which was incubated by Meta.
“Ensuring that a stablecoin retains its peg even under stressed market conditions is a solvable problem,” Catalini says. In an optimal scenario, he says, reserves would be made up of exclusively “high-quality, liquid assets,” like short-term US government bonds, and providers would maintain an “adequate capital buffer.”
In the two years since Celsius filed for bankruptcy, Tether has voluntarily both increased the size of its USDT reserve buffer and slightly reduced the proportion of the reserve made up of secured loans—from 6.76 to 5.55 percent. But Tether “does not operate under a framework that would limit what the directors of the company can and cannot do,” says Catalini. “This is where regulation is required.”
There have been a handful of attempts to regulate the stablecoin industry in major markets. Earlier this year, rules for stablecoin issuers came into force in the EU under the Markets in Crypto Assets (MiCA) act, including requirements regarding the amount of cash a stablecoin issuer must hold, the types of assets that can comprise a stablecoin reserve, the safe custody of reserve assets, and more.
In April, US senators Cynthia Lummis and Kirsten Gillibrand proposed a bill under which stablecoin issuers would not be permitted to lend out reserve assets. The bill is unlikely to pass through Congress before the upcoming presidential election, says Cooper, but “there is recognition on both sides of the aisle that some level of regulation is necessary.”
By and large, though, stablecoin businesses have been left to figure out how to police themselves. “We’re dealing with a new asset class that, as of right now, is run by a group of people looking around for guidance as to what is and isn’t allowed—and they are not getting it,” says Cooper. “In an industry that thrives on risk-taking—and there is a lot of that in crypto—it’s not surprising that some outfits are pushing the boundaries.”
The difficulty for the first handful of regulators that institute stablecoin regimes will be in limiting the threat of a de-peg without driving issuers away. The appetite for risk among stablecoin providers—whose profitability is tied to some degree to the risks they are permitted to take with reserve assets—could lead them to retreat from jurisdictions that impose the most stringent restrictions. “The problem of regulatory arbitrage is as old as time,” Cooper adds.
Since the introduction of MiCA, Tether reportedly has yet to seek a license to operate in the EU. In an interview with WIRED earlier this month, Tether CEO Ardoino said the company is still “formalizing our strategy for the European market,” but expressed misgivings about some of the reserve requirements imposed under MiCA, which he described as unsafe.
Meanwhile, although Ardoino considers stablecoins a potential threat to traditional banks, he balked in the interview at the prospect of Tether being asked to abide by a similarly stringent set of regulations, citing the freedom for banks to lend out the majority of deposits they receive, unlike a stablecoin company.
But the window for regulatory arbitrage, whatever the motivation, will close, says Catalini, as an international consensus forms around the appropriate controls to be placed on stablecoin issuers. “Regulatory arbitrage is a temporary phenomenon,” he says. “It’s only a matter of time before any stablecoin with significant scale will be required to comply.”
