Short sellers may struggle to bet against Tether.

The U.S. Securities and Exchange Commission (SEC) is taking a tough stance on the cryptocurrency industry, which could be putting pressure on the stablecoin tether (USDT). Concerns about tether’s health have arisen due to worries of a direct regulatory attack by U.S. authorities or stress on related entities. Last week, tether experienced a minor depegging, dropping from its U.S. dollar face value to $0.0996. Tether claims that its dollar-denominated tokens are fully backed by assets, including U.S. Treasury bonds, held by its parent company. However, a pattern of questionable attestations and activity over the years has built up skepticism towards tether. The worst-case scenario would be if Tether’s assets on hand don’t match the face value of outstanding tether tokens, meaning some tether holders couldn’t redeem their tokens for real dollars. As a result, large tether holders may want to insulate themselves from that risk by taking a “short” position in the token that would pay out if tether lost its one-dollar peg. While it’s not difficult to short tether, the process is technically complex and financially risky. The overall level of short interest is also hard to gauge considering how widely integrated USDT is in the crypto economy and in crypto trading pairs. Nevertheless, Tether seems to be thriving operationally, reporting $1.48 billion in profits in the first quarter of 2023 and investing some of those profits in assets such as bitcoin.

This is an excerpt from The Node newsletter, a daily roundup of the most pivotal crypto news on blockchain and beyond. You can subscribe to get the full newsletter here.

Tether is crucially distinct from the so-called stablecoin TerraUSD, which imploded spectacularly a little over a year ago along with the underlying Terra blockchain. TerraUSD was proudly unbacked, relying instead on a fatally flawed “algorithmic” system. Some metrics indicate increasing interest in shorting tether in recent days, but tether’s challenge and opacity may make the stablecoin more robust against big-money skeptics.

One of the challenges for U.S. firms in trading tether is the lack of available trading venues outside of decentralized finance (DeFi) that make shorting tether straightforward. According to Campbell, many of the firms that want to short tether are not crypto natives, but traditional finance firms. They end up going through broker-dealers, which can be more expensive. This increases the cost of the underlying trade and the carrying cost must be borne until the short pays off, which can nibble away at potential profits with each passing day tether doesn’t depeg.

Even if a firm is skeptical of tether’s value, going through broker-dealers increases the cost of the underlying trade. As a result, some firms may not have the technical expertise to short tether profitably via direct on-chain methods. Furthermore, the profits themselves might not be that great, since even a tether depeg would likely be confined to a tight band. Tether skeptics would accept that the token is substantially backed by real assets.

There are also significant risks in a tether short position. It’s uncertain when or if an SEC action against the Tether corporation might happen – if at all. Jurisdiction is one factor. While the SEC was able to go after Binance because of the exchange’s U.S. subsidiary, Tether has a less obvious operational footprint in the U.S. This is an additional source of uncertainty for anyone considering a big short.

The level of short interest in tether is also difficult, if not impossible, to accurately measure. Much of the secondary market activity in the token takes place over-the-counter in private trades. And because one leg of the tether short involves simply borrowing the token, it can be difficult to distinguish even publicly visible shorts from other kinds of on-chain leverage. This matters because shorting is often a collective activity – that is, traders may be more likely to short when they see others doing the same thing.

Finally, one of the biggest forces protecting tether is ironically the SEC. By making it so hard for U.S. firms to interact with crypto at all, they have prevented price discovery, and prevented the largest players from coming in and doing these trades.