We often talk about the creation of fiat money by central banks. Most of the fiat money is not created by central banks but by commercial banks. Moreover, not all banks that make and hold fiat money are regulated banks. Many are what we know as “shadow banks.” There’s a whole shadow banking industry on the cryptocurrency network, creating and holding fiat money or something that looks very much like it.
Shadow banks are financial institutions that do banking-like things but are not subject to banking regulations. These include investment banks, non-bank lenders, money market funds, private equity, hedge funds, and insurance companies. They also have select purpose vehicles (SPVs), which are subsidiary companies created by regulated banks to enable them to do unregulated things. They include banks headquartered outside the United States, in particular those in offshore jurisdictions.
Shadow Dollars, created and held by shadow banks, are known as Eurodollars. ‘Euro’ does not refer to the euro currency and does not have much to do with Europe. Eurodollars tend to live in places like the Cayman Islands and the Bahamas.
Because eurodollars are held outside of the US regulated banking system, they do not have FDIC insurance. The institutions in which they are held have no support from the United States. Uh, the Federal Reserve.
However, for their users, eurodollars are indistinguishable from real dollars created by the Fed and US regulated banks. And when Eurodollars flow from the shadow banking system to the regulated system, they become real dollars. Conversely, the Fed and regulated US banks’ dollars become eurodollars when they are sent to offshore or foreign locations. The system operates as long as the 1:1 implied exchange rate between the eurodollars and the real dollar. But when the peg fails, there’s chaos.
The Tether bank, Deltec, is part of the shadow banking network. It is located in the Bahamas, an offshore jurisdiction beyond US regulation, and holds US dollar deposits. The Federal Reserve does not back Deltec Bank, and the US dollars it contains do not have any FDIC insurance.
As a result, Tether’s deposits in Deltec Bank, including cash reserves that Tether claims back to USDT tokens, are eurodollar deposits.
Deltec Bank may hold cash reserves in one or more US-regulated banks. However, these reserves may not be sufficient to support all of its eurodollar deposits. And even if they are, dollars in regulated bank deposit accounts are not “in custody.” They are credited to the bank and only insured up to the FDIC limit of $250,000 per customer per institution. In any case, FDIC insurance applies only to deposits in regulated banks, not to deposits in offshore shadow banks, even if those shadow banks are clients of regulated banks. If Deltec Bank failed, there would be no FDIC insurance for its depositors. Therefore, Tether’s guarantee that 1 USDT = 1 USD depends entirely on the remaining solvent of Deltec Bank.
It’s not just Tether who relies on shadow banks. In a recent interview, Tether’s Chief Technical Officer, Paolo Ardoino, said that Tether himself and the cryptocurrency exchanges are the main customers of Deltec Bank’s US dollar accounts.
Some of these exchanges could be used by Deltec Bank as their settlement bank. But others might have Deltec accounts to make paying for Tethers more convenient. Instead of wiring US dollars to Deltec Bank every time they need to repay their tethers, they can fund their Deltec account whenever it suits them and use the balance to pay for more tethers. But whatever approach they use, the money they keep deposited at Deltec Bank is not insured by FDIC and is not…
Read More:How safe is your stablecoin? Take a look at Tether and Moneta | TechBullion
