The Tether Put: Crypto Equivalent of Credit Default Swap?

Tether, the largest dollar-backed stablecoin that pervades almost every corner of the crypto market, is back in the news for unfortunate reasons.

Perma-bears, fearful that fears of the lingering tether (USDT) could eventually culminate in a break in the dollar, may now be looking for the crypto-market equivalent of a credit default swap – a derivative instrument that allows buyers to access the one other trading counterparties to bet creditworthiness.

The answer to that could be a put option on Tether, essentially a bet that the stablecoin’s price will fall below its supposed redemption value of $ 1. Some traders have actively sought such a trade, according to some players in the digital asset markets.

“We have constant inquiries about tether puts,” said Rich Rosenblum, co-founder and president of institutional market maker GSR Markets.

The question of how to bet against Tether was once an academic question, and is given new impetus by a report on Monday that the US Department of Justice is investigating the stablecoin issuer for possible bank fraud. So far, the token, which has been instrumental in unlocking the $ 1.6 trillion crypto market, has kept its peg to the dollar. Tether described the latest report as “wrapping obsolete claims as news.”

A put option gives the buyer the right, but not the obligation, to sell the underlying asset at a specified price on or before a specified date. A put buyer is implicitly bearish and pays the seller a premium or compensation for offering insurance against a fall in prices.

Traders asking for tether puts are essentially looking for a hedge against tether, which is losing its 1: 1 peg to the US dollar. Tether maintains a dollar peg and helps buyers bypass volatility risks associated with other cryptocurrencies such as Bitcoin. USDT has been used extensively to fund crypto purchases over the past 12 months, as evidenced by the six-fold increase in its market cap to over $ 60 billion.

What makes Tether controversial is the persistent lack of transparency about the reserves it backs and the growing regulatory unease around stablecoins in general.

“Since the beginning of the Tether Foundation, market participants have questioned the reliability of stablecoins,” said Chris Dick, a quant trader at B2C2, in a Telegram chat.

Some fear that the stablecoin is not fully backed by liquid reserves and will break the dollar peg on mass redemptions, resulting in a crypto-equivalent of a bank run. This is a situation where customers instantly withdraw money from a bank, resulting in the bankruptcy of that institution.

The market could face a severe liquidity shock if traders lose confidence in Tether, analysts at JPMorgan said earlier this year. It is therefore not surprising that there is some demand for put options on Tether. However, meeting those needs is easier said than done.

Costly business

There is currently no active market for put options on Tether. Exchanges do not find a business case there, since technically there is no offset risk. Traders don’t make bullish or bearish bets on tether as they do on other assets. It is a stablecoin that was bought with confidence that any redemptions would bring in an equivalent amount of dollars, and it is used to fund crypto purchases.

Participants who fear a collapse of the tether must find a put seller in OTC markets or contact market makers. It’s an expensive business.

“Because there is no active market for USDT options or even Bitcoin options with Tether as the counter currency [BTC/USDT], a trader selling a USDT put cannot hedge volatility risk, ”said Chris Dick of B2C2. “This risk is of course reflected in the premium that is paid for a USDT put.”

Market makers and traders are on the opposite side of traders and investors and usually run a direction-neutral portfolio. For example, a market maker who sells a bitcoin put option is exposed to a potential fall in prices and could hedge himself by selling bitcoin on the spot or futures market.

If this option is not available, the market maker could charge the buyer a higher compensation or premium to justify the completion of the trade.

According to Rosenblum from GSR, the high costs have so far been spoilsport. “The price is too expensive for most buyers,” he said.

The solution could be to trade a tethered put at a much lower or out of the money strike under $ 1.00. That would cost relatively less than buying a $ 1.00 put.

For example, if a fund wanted to hedge against a complete collapse of the Tether Foundation, it would likely pull a strike deep out of the money – perhaps a price of $ 0.50 for USDT. This would help keep the fund’s premium low but pay off well if the prospect is realized.

As a liquidity provider, B2C2 has no view of Tether, but is ready to provide a price and other hedging solutions.

“Any fund manager looking to take this position should consider borrowing USDT from B2C2, backed by any currency of their choice,” said Dick. “This would allow them to sell their borrowed USDT, which would give them a short position that would benefit from a decline in USDT / USD.”

Tether Put, a bearish bet on the entire market?

According to Kaiko Research, the Bitcoin tether trading volume is orders of magnitude larger than the Bitcoin dollar volume. So there are fears that the instability with the tether peg could trigger a market-wide panic.

Despite recent regulatory action, Binance remains the world’s largest crypto exchange by trading volume. The stablecoin is also widely used for harvesting income in decentralized financial logs.

So buying a put option on a tether option would essentially mean making a bearish bet on the entire crypto market. That is a factor that the buyer should consider.

“If the USDT were to drop significantly, it would likely be a time when the crypto market in general is suffering significant losses,” said Rosenblum of GSR. “USDT put buyers should be wary of what the credit environment would be if the puts pay off.”

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