Analysis of USDT's Asset Reserves and Stability

Recently, there have been some concerns in the market regarding the stability of USDT. This article will analyze whether there is a risk of a collapse of USDT from the perspectives of asset reserves and redemption pressure.

First, let's take a look at the asset reserve composition of USDT. Similar to most stablecoin issuers, the asset reserves of USDT are primarily composed of cash and high-quality short-term bonds, which is similar to the asset allocation of money market funds.

Looking back at the 2008 financial crisis, the largest money market fund at the time, Reserve Primary, held about $78 million in short-term bonds from Lehman Brothers, which accounted for only 1.2% of its total assets of $63 billion. However, this small exposure triggered market panic. The news of Lehman's bankruptcy came suddenly, and Reserve Primary was unable to process the Lehman bonds in a timely manner, leading to an inability to assure investors that its assets were pegged to the dollar at a 1:1 ratio.

On September 16, 2008, Reserve Primary announced that each share of the fund was worth only 97 cents, breaking the public's perception that money market funds would always equal 1 USD. This triggered the most severe investor panic in modern financial history, with withdrawals of up to 123 billion USD from money market funds within two weeks.

From this perspective, there is indeed a similarity between stablecoins and money market funds. Therefore, to determine whether USDT will encounter issues, we need to answer two key questions:

1. How is the liquidity of USDT asset reserves?
2. Is it possible for USDT to face a massive redemption wave similar to that of the money market funds in 2008?

Regarding the first question, the data shows that the asset reserve quality of USDT has been improving. The proportion of commercial papers (CP) has gradually decreased, while the proportion of US short-term government bonds (T-Bill) has been continuously increasing. In the second quarter of 2021, the proportions of CP and T-Bill were 49% and 24% respectively; by the first quarter of 2022, this ratio had adjusted to 24% and 48%.

According to an executive from a trading platform, $8.4 billion of CP was redeemed before March 2022, suggesting that the proportion of CP may further decline to around 13%. In addition, the quality of CP held in USDT is also improving, with the proportion of CP rated above AAA rising from 93% in the second quarter of 2021 to 99% in the first quarter of 2022.

The recent large-scale redemptions of USDT also prove its liquidity. Over the past month, USDT has redeemed 17 billion USD, with the circulating supply decreasing by 20% (from 83 billion to 66 billion). Among them, 10 billion USD of redemptions occurred during the period from May 12 to 15, when the algorithmic stablecoin collapsed and market panic was at its worst.

These data indicate that the asset reserve quality of USDT is continuously improving, with T-Bill possibly accounting for more than 60%. At the same time, USDT has also demonstrated the ability to handle a large number of redemptions in the short term.

As for the second question, in extreme cases, such as if more than 80% of the issuance is redeemed within a week, USDT may indeed decouple. However, in such scenarios, no stablecoin would be spared.

However, the likelihood of such an extreme redemption wave occurring with USDT is very low. Unlike a purely investment tool, USDT plays an important role in the cryptocurrency ecosystem. Many market makers for trading pairs must hold USDT to operate, and this part of the demand is estimated to account for at least 20% of the total issuance. In addition, some over-the-counter trading and other transactions also rely on USDT.

The redemption mechanism of USDT also provides a certain level of protection. Only institutions that have passed whitelist verification can directly exchange USDT for USD with the issuer, which somewhat limits the possibility of large-scale redemptions in the short term.

Approximately 85% of USDT reserves are in cash and cash equivalents, with more than half being highly liquid T-Bills. Assuming that 20% of USDT holders cannot or are unwilling to redeem for various reasons, even if the remaining 80% of holders want to withdraw, the following process is required:

1. USDT briefly decoupled due to selling pressure.
2. Arbitrageurs intervene to purchase USDT and exchange it for USD.

Only when the arbitrage buy orders are insufficient to offset the sell orders can it lead to a panic spread causing a larger scale decoupling. However, historical data shows that the redemption process for USDT has consistently operated well, and even in moments of extreme panic, decoupling tends to be temporary.

In summary, the possibility of USDT collapsing is very low. Although there may be some hedge funds in the market trying to profit by spreading FUD (fear, uncertainty, and doubt), the quality of USDT's asset reserves and its liquidity management capabilities are continuously improving, enabling it to cope with market fluctuations.