[USDT / PAX] Collateral Onboarding Risk Evaluation

Legal Disclaimer: This communication is provided for information purposes only. The views expressed here are those of the individual Maker Foundation (“Maker”) personnel quoted or who present said materials and are not the views of Maker or its affiliates. This communication has been prepared based upon information, including market prices, data and other information, from sources believed to be reliable, but Maker has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any digital assets and the use of finance-related terminology are for illustrative purposes only, and do not constitute any recommendation for any action or an offer to provide investment advisory services. This content is not directed at nor intended for use by the MakerDAO community (“MakerDAO”), and may not under any circumstances be relied upon when making a decision to purchase any other digital asset referenced herein. The digital assets referenced herein currently face an uncertain regulatory landscape in not only the United States but also in many foreign jurisdictions, including but not limited to the UK, European Union, Singapore, Korea, Japan and China. The legal and regulatory risks inherent in referenced digital assets are not the subject of this content. For guidance regarding the possibility of said risks, one should consult with his or her own appropriate legal and/or regulatory counsel. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any decision. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

  1. Summary Proposed Risk Parameters
  2. Overview
  3. Metrics and Analysis
  4. Risk Parameters

Summary Proposed Risk Parameters

PAX
Risk Premium: 4%
Liquidation Ratio: 120%
Debt Ceiling: 5 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 100 Dai

USDT
Risk Premium: 8%
Liquidation Ratio: 150%
Debt Ceiling: 10 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 100 Dai

Overview

Metrics and Analysis

DeFi Presence

USDT is the second most popular centralized stablecoin in DeFi, behind USDC. USDT is also directly related to the Dai price, as it is present in both the Y and sUSDv2 pools on Curve, which is currently an important Dai trading venue. PAX has an extremely low presence in most popular financial applications on Ethereum, suggesting that DeFi is foreign to PAX users. Consequently, we expect very low Dai generation and low impact from PAX. USDT on the other hand is a systemically important asset in the general crypto market and is likely to see some utility within Maker. Compound and Aave, the two largest lending markets do not allow USDT to be used as a collateral type, which currently have 24.4m and 54.26m deposited respectively. In the following table we see a striking difference between the two stablecoins in terms of DeFi presence.

Volatility

USDT has shown much higher price volatility over time when compared to PAX. In late 2018 USDT traded briefly under $0.96. In recent months however USDT has been significantly more stable. PAX has exhibited very little price volatility since inception. Since the start of 2019, USDT and PAX daily price volatility was 0.26% and 0.08% respectively.

Daily Volume Traded

The below chart illustrates the volume traded for major stablecoins in 2020. USDT volume traded is several orders of magnitude higher than other stablecoins. PAX, on the other hand, is one of the lowest traded centralized stablecoins in the space.

Supply Growth

USDT is present on multiple blockchains, but the overwhelming majority is issued on Ethereum, Tron and the Bitcoin Omni layer. Tether increased supply by 5.89b units or 143.38% YTD with 12.77% average monthly growth rate. Paxos increased supply by 20.6m units or 9.2% in the same time period.

On-chain Transactions

USDT onchain transactions have been steadily increasing over time, while PAX transactions have been declining since May 2020. In 2020, the USDT ERC-20 and PAX average daily transaction count was 147k and 9k, respectively.

Median transaction value

In 2020 the average daily median transaction value was 455 and 90, respectively.

Source: Bloxy.info

Regulatory & Counterparty Risk

PAX

  • Operated by Paxos Trust Company, LLC, formally ItBit Trust Company, LLC (Jurisdiction - US-NY).
  • From PAX website: “Customer funds are held in segregated accounts at FDIC-insured, U.S.-domiciled banks.”
  • Approximately 50% of existing supply is held in addresses controlled by Paxos.
  • Paxos is the main asset used in “MMM BSC Global”, a suspected ponzi scheme.
  • From PAX Terms and Services: “As part of the ERC20 smart contract and as part of the Services, the Company has the ability and the right to freeze and upgrade all USD Stablecoins tokens (on an aggregate basis), regardless of where the USD Stablecoins are being held. The Company will make commercially reasonable efforts to provide prior notice of any material freeze or upgrade and inform holders of USD Stablecoins of the reasons and consequences of such freeze and/or upgrade. The Company will make commercially reasonable efforts to use the freeze and/or upgrade feature only under limited circumstances.”
  • On-chain blacklists: 1 address frozen as of this writing.

USDT

  • Tether has a complex ownership structure and is closely related to Bitfinex. There are several companies and individuals involved, Tether International Limited, Tether Limited, Tether Operations Limited, Tether Holdings Limited and others. The Bitfinex officials are also responsible for setting up the Tether company structure, which is the link between the companies. Due to lack of relevant expertise, we choose to omit any legal risk analysis surrounding the company structure.
    • From The Rise of Stablecoins: “Around the same time, some concerns began to emerge about Tether. The Paradise Papers, released in November 2017, revealed that Bitfinex officials were responsible for setting up Tether Holdings Limited, which owns Tether Limited.”
    • In 2019 the New York Attorney General’s (“NYAG”) office filed a suit alleging that Bitfinex used Tether reserves to cover $850 million in lost customer funds. Bitfinex claimed that Crypto Capital, a financial services firm offering shadow banking services for several cryptocurrency businesses, defrauded Bitfinex out of the $850 million. Court filings revealed that, consequently, Tether only held $2.1 billion in cash and cash equivalent securities. This figure implied that each USDT was backed by only $0.74 instead of a full $1.
    • In the weeks following the NYAG’s filing, Bitfinex conducted a $1 billion token sale for LEO, the proceeds of which, we presume, went to pay back the Tether reserves.
  • On-chain blacklists: 43 addresses frozen as of this writing.

Oracles and Liquidations

  • Given USDT’s historical price volatility and opaqueness, the USDT price will use live oracles as opposed to a fixed price of $1. Consequently, liquidations will be enabled for USDT.
  • PAX, however, is significantly more transparent and we recommend using a fixed oracle price of $1. Liquidations will also be disabled.

Risk Parameters

PAX
Risk Premium: 4%
Liquidation Ratio: 120%
Debt Ceiling: 5 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 100 Dai

USDT
Risk Premium: 8%
Liquidation Ratio: 150%
Debt Ceiling: 10 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 100 Dai

Due to USDT’s noted history of opaqueness and fractional reserve, we recommend an initial LR of 150%. This is the only parameter that can protect Maker in the instance where these risks materialize again. Additionally, since currently no other large lending protocol allows USDT as a collateral asset, there is potentially large demand waiting to flow into Maker from other protocols (~78.5m). Generating Dai against USDT could be an attractive avenue towards yield farming. Additionally, a future change to a lower LR is always possible and can be done smoothly. The opposite, however, is not true. Given that Maker would be the first significant DeFi application offering collateralization against USDT, a conservative risk premium to start should also be considered. We suggest 8%.

Lead Researcher: Marko Stemberger

Sources:
The Rise of Stablecoins,
CoinMetrics,
Bloxy.info,
Official Tether Transparency Dashboard
https: //cointelegraph.com/news/new-york-court-rejects-bitfinex-appeal-over-850m-in-lost-funds
https://cointelegraph.com/news/bitfinex-cries-fraud-as-crypto-capital-executive-indicted-by-us

8 Likes

I think you might need to update the titles on the most recent few of these. They all list -SP2 in the title, which I don’t think is accurate (should be incrementing.)

Nice to see a report thanks @cyrus

While I would like to see USDT be represented on Maker my concern here is this if the USDT grows to any reasonable size those at the head of USDT could use a freeze to manipulate markets to profit.

I don’t like hearing

Both of these have real issues so I don’t expect we should allow them to grow very much DC wise. RP/SF’s seem ‘reasonable’ as a start.