If the Tether stablecoin has taken on an animal character, it would have to be a cat, as it apparently has nine lives. On Friday, Celsius, the bankrupt crypto lender, sued Tether for alleged preferential treatment during its bankruptcy. Celsius had borrowed $812 million from Tether, but the stablecoin company held collateral. Therefore, Tether liquidated collateral shortly before bankruptcy to pay off the debt. Had Celsius filed the lawsuit two years ago, it could have potentially been far more serious for Tether.

Celsius claims it transferred 17,886 bitcoin as collateral in the 90 days before its bankruptcy. Legally, such transactions are often set aside because they give the recipient priority over other general creditors. Celsius’ retail clients received about 18% of the cryptocurrency the company owed them. (If you take into account the dollar value of the cryptocurrency at the time of bankruptcy, the repayment percentage was far higher.)

The lawsuit contains other allegations, including the claim that Tether liquidated Bitcoin collateral without waiting as contractually required. Celsius claims that if Tether had waited to liquidate the collateral, Celsius’s Bitcoin would be worth over $2 billion at the current price.

“The plaintiff’s documents contain numerous deficiencies and we are very confident in the soundness of our contract and our actions,” Tether’s CEO Paolo Ardoino wrote on X.

“More than two years later, this baseless lawsuit attempts to claim that we should return the bitcoins that were sold to cover Celsius’ position.” He stressed that Tether has nearly $12 billion in equity. In other words, it has a comfortable buffer against potential losses, although he is confident there will be none.

A two-year delay helped Tether

Two years ago, Tether had no such buffer. If the lawyers had sued around September 2022 (as some expected), that could hypothetically have triggered an unpeg. At that time, Tether’s equity was about $250 million.

Without the additional bitcoins as collateral, Tether would have had a deficit of $365 million, according to the lawsuit. That’s $115 million more than its equity. For a stablecoin worth $66 billion (in 2022), that’s only a small hole, but it’s a hole. Tether would have gotten something back from the bankruptcy, but how much was unclear for a while.

Alternatively, the lawsuit aims to get the court to overturn the collateral liquidation, which would mean a greater loss for Tether.

Tether’s risky bets

But it’s not as if Tether didn’t have a hole in its balance sheet before.

In 2019, Tether claimed: “Each Tether is always backed 1:1 by the traditional currency held in our reserves, so 1 USDT is always equal to 1 USD.”

Despite this claim, it loaned $625 million of its reserves to the Bitfinex exchange under common ownership to cover a massive exchange loss. In other words, it loaned $625 million of money it owed to stablecoin holders to an INSOLVENT affiliated exchange. The exchange did not become insolvent after the loan. It was already insolvent when Tether made the loan.

Tether then quietly changed the description of reserves to include loans made by Tether, “which may include affiliates.” Tether and Bitfinex admitted these and other misrepresentations in a settlement with the New York Attorney General.

With not one but two near-misses, one might think a change in risk appetite would be in order. The danger is that a $12 billion capital buffer could encourage Tether’s management to take greater risks.

Someone recently commented to Ledger Insights that Tether behaves like a hedge fund that does not pay returns to its limited partners.

According to Tether’s latest reserve certification, at least $18.7 billion worth of assets would be considered relatively risky for a stablecoin. This includes corporate bonds, bitcoin, precious metals, loans and other investments. And that doesn’t even include over $12 billion worth of reverse repo agreements.

Reverse repo transactions

Reverse repurchase agreements involve lending cash to banks, usually overnight. In return, the banks provide collateral, which is usually US Treasury bonds. Compared to Celsius loans, the risk here is significantly lower, but it depends on the bank counterparty and the collateral.

If a company in the U.S. goes bankrupt, someone holding collateral for a loan generally cannot liquidate that collateral. However, repo transactions are exempt from this rule. Therefore, the collateral holder (in this case, the stablecoin company) can legally sell the Treasury bonds if the bank borrower goes bankrupt.

Circle is also involved in reverse repo transactions, and on a much larger scale. Reverse repo transactions often account for over 50% of USDC stablecoin reserves, sometimes as much as two-thirds.

However, there are two key differences between Tether and USDC’s reverse repo. First, Circle (via BlackRock) discloses the bank counterparties and detailed collateral on a daily basis. The banks are systemically important banks and the collateral is of the highest quality.

Tether does not disclose the counterparties or the detailed collateral, so for all we know, the lender could be a state bank or money market fund rather than a systemically important bank. Tether also mentions in the notes that the collateral for the repo is “US Treasury securities where the ultimate issuer or guarantor is rated A-2.” Since the US federal government is rated A-1+, unless we’re missing something, the collateral is not German government bonds.

Is this important?

Most of the time, these are just details that don’t matter, but the short window of time in which they matter is likely to impact all riskier assets at the same time.

In a recent interview with Wired, Ardoino said he is not happy with Europe’s MiCA regulations because they require 60% of reserves to be held in banks. He is not the only one who has raised eyebrows at this policy, but he claims his concern is that it is unsafe.

Given Tether’s risk-taking nature when rewarded accordingly, the poor interest rates on bank deposits may have something to do with it.