Can a cryptocurrency really break the buck?

On September 16, 2008, the day after Lehman Brothers filed for bankruptcy, the Reserve Primary Fund “broke the buck”: Its net asset value fell below $1 per share. The fund — often called the first money-market fund — held $785 million of Lehman commercial paper that was suddenly worthless. Although the paper represented only 1.2% of the fund’s total assets of $64.8 billion, demands for withdrawals escalated, and the fund lost two-thirds of its assets within 24 hours. This triggered a general run on money-market funds that stopped only when the US Treasury issued an extraordinary guarantee of essentially all money-market fund liabilities. The episode underscored how important that $1 net asset value is to investors.
Certain cryptocurrencies known as stablecoins are today’s economic equivalent of money-market funds, and in some cases their practices should have us worried that they could break the buck, creating significant damage in the broader crypto market.
One such stablecoin is Tether. With a market capitalisation close to $60 billion, it is almost as big as the Reserve Fund was in 2008. Each Tether token is pegged to be equivalent to $1. But, as with the Reserve Primary Fund, the true value of those tokens depends on the market value of Tether’s reserves — the portfolio of investments made with the fiat currency it receives.
Tether recently disclosed that as of March 31, only 8% of its assets were in cash, Treasury bills and “reverse repo notes.” Almost 50% was in commercial paper, but no detail was provided about its quality. “Fiduciary deposits” represented 18%. Even more troubling: 10% of total assets were in “corporate bonds, funds & precious metals,” almost 13% were in “secured loans (none to affiliated entities),” and the remainder in “other,” which includes digital tokens.
Tether separately provided a report from the accounting firm Moore Cayman stating that Tether’s assets exceed “the amount required to redeem” outstanding tokens. But that report provided no description of assets. It appeared to be based solely on management’s accounting, noting that Tether’s policy is to use “historic cost,” and that “the realisable value of these assets … could be materially different.”
These facts should put holders of Tether — and other stablecoins — on notice that they may have trouble getting back $1 for each token. Tether doesn’t claim that its tokens are backed by fiat currency. It simply says its tokens “are 100% backed by Tether’s reserves,” which are defined so broadly that any asset could qualify. Tether also says it “reserves the right to delay any redemption or withdrawal if such delay is necessitated by the illiquidity or unavailability or loss of any Reserves” and that it “reserves the right to redeem Tether Tokens by in-kind redemptions of securities and other assets held in the Reserves.”
A money-market fund would never be allowed to follow such policies. The Securities and Exchange Commission permits money-market funds to use a $1 NAV under stable pricing conventions — valuing assets at amortized cost rather than at market price, and using “penny rounding” pricing — only on the condition that they limit their risk.
Their investments must have minimal credit risk and short maturities, such as with short-term government securities and high-quality commercial paper, and they must limit the amount invested in any one issuer.

—Bloomberg