Tether Financial Analysis: Needs an Additional $4.5 Billion in Reserves to Maintain Stability

Original author: https://substack.com/@dirtroads
Original translation: Deep Tide TechFlow

When I graduated from college and applied for my first management consulting job, I did what many ambitious yet timid male graduates often do: I chose a firm that specialized in serving financial institutions.

In 2006, the banking industry was a symbol of "cool." Banks were typically located in the most magnificent buildings in the prettiest neighborhoods of Western Europe, and I was eager to take the opportunity to travel. However, no one told me that this job came with a more hidden and complex condition: I would be "married" to one of the largest yet most specialized industries in the world—banking—and it would be indefinite. The demand for banking experts has never disappeared. During economic expansions, banks become more creative and need capital; during economic contractions, banks need to restructure, and they still need capital. I tried to escape this vortex, but like any symbiotic relationship, breaking free is much harder than it seems.

The public generally assumes that bankers have a deep understanding of banking. This is a reasonable assumption, but it is incorrect. Bankers often categorize themselves into "silos" of industry and product. A banker in the telecommunications sector may know everything about telecom companies (and their financing characteristics) but know very little about banking itself. Those who dedicate their lives to serving banks (the "bankers' bankers," or the Financial Institutions Group (FIG) crowd) are a peculiar breed and are generally not well-liked. They are the "losers among losers."

Every investment banker dreams of escaping the banking industry in the middle of the night while modifying spreadsheets, turning to private equity or entrepreneurship. But FIG bankers are different. Their fate is already sealed. Trapped in a gilded "slavery," they live in a self-contained industry that is largely ignored by others. Banking for banks is deeply philosophical and occasionally exhibits a certain beauty, but most of the time it is invisible—until the advent of decentralized finance (DeFi).

DeFi has made lending fashionable, and suddenly, every marketing genius in fintech companies feels qualified to comment on topics they barely understand. Thus, the ancient and serious discipline of "banking for banks" has resurfaced. If you arrive in the DeFi or crypto space with a box of brilliant ideas about reshaping finance and understanding balance sheets, know that in a corner of Canary Wharf in London, Wall Street, or Basel, an unnamed FIG analyst may have thought of these ideas twenty years ago.

I was once a tortured "banker's banker." And this article is my revenge.

Tether: Schrödinger's Stablecoin

It has been two and a half years since I last wrote about the most mysterious topic in the crypto space—the balance sheet of Tether.

Few things capture the imagination of industry insiders like the financial reserves of $USDT. However, most discussions still revolve around whether Tether is "solvent" or "insolvent," lacking a framework that could make this debate more meaningful.

In traditional enterprises, the concept of solvency has a clear definition: at least assets need to match liabilities. However, when this concept is applied to financial institutions, its logic begins to become less stable. In financial institutions, the importance of cash flow is downplayed, and solvency should be understood more as the relationship between the amount of risk carried by the balance sheet and the liabilities owed to depositors and other providers of financing. For financial institutions, solvency is more of a statistical concept than a simple arithmetic problem. If this sounds somewhat counterintuitive, don't worry—bank accounting and balance sheet analysis have always been among the most specialized corners of finance. It is both amusing and frustrating to see some people improvising their own solvency assessment frameworks.

In reality, understanding financial institutions requires overturning the logic of traditional enterprises. The starting point for analysis is not the profit and loss statement (P&L) but the balance sheet—and cash flow should be ignored. Here, debt is not a constraint but rather the raw material of business. What truly matters is how assets and liabilities are arranged, whether there is enough capital to address risks, and whether sufficient returns are left for capital providers.

The topic of Tether has sparked renewed interest due to a recent report from S&P. The report itself is simple and mechanical, but the real intrigue lies in the attention it has garnered rather than the content of the report itself. By the end of the first quarter of 2025, Tether had issued approximately $174.5 billion in digital tokens, most of which are stablecoins pegged to the dollar, along with a small amount of digital gold. These tokens provide qualified holders with a 1:1 redemption right. To support these redemption rights, Tether International, S.A. de C.V. holds approximately $181.2 billion in assets, meaning it has excess reserves of about $6.8 billion.

So, is this net asset figure satisfactory? To answer this question (without creating a new customized assessment framework), we need to ask a more fundamental question: what existing assessment framework should apply? To choose the correct framework, we must start from the most fundamental observation: what kind of business is Tether?

A Day in the Life of a Bank

Essentially, Tether's core business is issuing on-demand digital deposit instruments that can circulate freely in the crypto market while investing these liabilities in a diversified asset portfolio. I deliberately chose to use the term "invested liabilities" rather than "held reserves" because Tether does not simply hold these funds in a way that matches risk/term; rather, it actively allocates assets and profits from the spread between its asset yields and liabilities (which are almost zero cost). And all of this is done under some broadly defined asset utilization guidelines.

From this perspective, Tether resembles a bank rather than merely a funds transfer institution—more precisely, an unregulated bank. In the simplest framework, banks are required to hold a certain amount of economic capital (here I treat "capital" and "net assets" as synonyms; my FIG friends, please forgive me) to absorb the impacts of expected and unexpected fluctuations in their asset portfolios, along with some other risks. This requirement exists for a reason: banks enjoy a monopoly granted by the state to safeguard the funds of households and businesses, and this privilege also requires banks to provide a corresponding buffer for the potential risks on their balance sheets.

Regulators pay particular attention to three aspects for banks:

• Types of risks that banks need to consider
• The nature of the definition of capital
• The amount of capital that banks must hold

Types of Risks → Regulators have standardized various risks that could erode the redeemable value of bank assets, which become apparent when the assets are ultimately used to repay their liabilities:

Credit Risk → Refers to the possibility that a borrower fails to fulfill their obligations when required. This type of risk accounts for as much as 80%-90% of risk-weighted assets in most global systemically important banks (G-SIBs).

Market Risk → Refers to the risk of adverse fluctuations in the value of assets relative to the currency in which liabilities are denominated, even in the absence of credit or counterparty deterioration. This situation may occur when depositors expect to redeem in dollars (USD), but the institution chooses to hold gold or Bitcoin ($BTC). Additionally, interest rate risk falls into this category. This type of risk typically accounts for 2%-5% of risk-weighted assets.

Operational Risk → Refers to various potential risks faced during the operation of a business: for example, fraud, system failures, legal losses, and various internal errors that could harm the balance sheet. This type of risk usually has a low share in risk-weighted assets (RWAs), representing residual risk.

These requirements form the first pillar of the Basel Capital Framework, which remains the dominant system defining the prudent capital of regulated institutions. Capital is the fundamental raw material to ensure that the balance sheet has sufficient value to meet the redemption of liability holders (under typical redemption speeds, i.e., liquidity risk).

The Nature of Capital

Equity is costly—being the most subordinate form of capital, equity is indeed the most expensive way to finance a business. Over the years, banks have become extremely adept at reducing the quantity and cost of required equity through various innovative means. This has given rise to a series of so-called hybrid instruments, which behave like debt in economic terms but are designed to meet regulatory requirements and thus are considered equity capital. For example, perpetual subordinated notes, which have no maturity date and can absorb losses; or contingent convertible bonds (CoCos), which automatically convert into equity when capital falls below a trigger point; and additional tier 1 instruments, which may be fully written down in stressed scenarios. We witnessed the role of these instruments during the restructuring of Credit Suisse. Due to the widespread use of these instruments, regulators have differentiated the quality of capital. Common equity tier 1 (CET1) sits at the top, being the purest and most loss-absorbing form of economic capital. Below it are other capital instruments with gradually decreasing purity.

However, for our discussion, we can temporarily overlook these internal classifications and focus directly on the concept of Total Capital—the overall buffer available to absorb losses before liability holders face risks.

The Amount of Capital

Once a bank has risk-weighted its assets (and classified them according to regulatory definitions of capital), regulators will require banks to maintain a minimum capital ratio against these risk-weighted assets (RWAs). Under the first pillar of the Basel Capital Framework, the classic minimum ratio requirements are as follows:

• Common Equity Tier 1 (CET1): 4.5% of risk-weighted assets (RWAs)
• Tier 1 Capital: 6.0% of RWAs (including CET1 capital)
• Total Capital: 8.0% of RWAs (including CET1 and Tier 1 capital)

On this basis, Basel III also layers additional context-specific buffers:

• Capital Conservation Buffer (CCB): Adds 2.5% to CET1
• Countercyclical Capital Buffer (CCyB): Adds 0-2.5% depending on macroeconomic conditions
• Global Systemically Important Bank Surcharge (G-SIB Surcharge): Adds 1-3.5% for systemically important banks

In practice, this means that under normal first pillar conditions, large banks must maintain CET1 ratios of 7-12%+ and total capital ratios of 10-15%+. However, regulators do not stop at the first pillar. They also implement stress testing regimes and increase capital requirements as necessary (i.e., the second pillar). Therefore, actual capital requirements can easily exceed 15%.

If you want to delve into a bank's balance sheet composition, risk management practices, and the amount of capital held, you can look at its third pillar (Pillar III) disclosures—this is no joke.

For reference, data from 2024 shows that the average CET1 ratio for global systemically important banks (G-SIBs) is about 14.5%, with total capital ratios around 17.5% to 18.5% of risk-weighted assets.

Tether: An Unregulated Bank

Now we can understand that the debates about whether Tether is "good" or "bad," "solvent" or "insolvent," "fear, uncertainty, and doubt" (FUD) or "fraud," have not really grasped the essence. The real question is simpler and more structural: Does Tether hold enough Total Capital to absorb the volatility of its asset portfolio?

Tether has not released disclosures similar to third pillar (Pillar III) reports (for reference, here is UniCredit's report); instead, it only provides a brief reserve report—this is its latest version. Although this information is extremely limited by Basel standards, it is still sufficient to attempt a rough estimate of Tether's risk-weighted assets.

Tether's balance sheet is relatively simple:

• About 77% invested in money market instruments and other cash equivalents denominated in dollars—according to standardized methods, these assets require almost no risk weighting or have very low risk weights.
• About 13% invested in physical and digital commodities.
• The remaining portion consists of loans and other miscellaneous investments not detailed in the disclosure.

Risk-weighted classification (2) requires careful handling.

According to standard Basel guidelines, Bitcoin ($BTC) is assigned a risk weight of up to 1,250%. Combined with the total capital requirement of 8% against risk-weighted assets (RWAs) (see above), this effectively means that regulators require full reserves for $BTC—i.e., a 1:1 capital deduction, assuming it has no loss-absorbing capacity. We included this in our worst-case assumptions, although this requirement is clearly out of touch—especially for issuers whose liabilities circulate in the crypto market. We believe that $BTC should be more consistently viewed as a digital commodity.

Currently, there is already a clear framework and common practice for handling physical commodities (like gold)—Tether holds a considerable amount of gold: if it is directly custodied (as is likely the case with some of Tether's gold), there is no inherent credit or counterparty risk. Its risk is purely market risk, as liabilities are denominated in dollars rather than commodities. Banks typically hold 8%-20% of capital against gold positions to buffer price fluctuations—this corresponds to 100%-250% risk weight. A similar logic can be applied to $BTC, but adjustments must be made based on its distinctly different volatility characteristics. Since the approval of Bitcoin ETFs, $BTC has had an annualized volatility of 45%-70%, while gold's volatility is 12%-15%. Therefore, a simple benchmark approach is to amplify the risk weight of $BTC relative to gold's risk weight by about three times.

Risk-weighted classification (3), the loan book is completely opaque. For the loan portfolio, transparency is almost zero. Without knowing information about borrowers, maturity dates, or collateral, the only reasonable choice is to apply a 100% risk weight. Even so, this remains a relatively lenient assumption given the complete lack of any credit information.

Based on the above assumptions, for Tether's total assets of approximately $181.2 billion, its risk-weighted assets (RWAs) could range from approximately $62.3 billion to $175.3 billion, depending on how its commodity portfolio is treated.

Tether's Capital Position

Now, we can complete the final piece of the puzzle by examining Tether's equity or excess reserves from the perspective of relative risk-weighted assets (RWAs). In other words, we need to calculate Tether's Total Capital Ratio (TCR) and compare it to regulatory minimum requirements and market norms. This step of analysis inevitably carries a degree of subjectivity. Therefore, my goal is not to provide a final conclusion on whether Tether has enough capital to reassure $USDT holders, but rather to offer a framework that helps readers break this issue down into understandable parts and form their own assessments in the absence of a formal prudential regulatory framework.

Assuming Tether's excess reserves are approximately $6.8 billion, its Total Capital Ratio (TCR) will fluctuate between 10.89% and 3.87%, primarily depending on how we treat its $BTC exposure and the conservativeness regarding price volatility. In my view, while fully reserving $BTC aligns with the strictest interpretations of Basel, it seems overly conservative. A more reasonable benchmark assumption is to hold enough capital buffer to withstand 30%-50% price fluctuations of $BTC, which falls entirely within the historical range of volatility.

Under the above benchmark assumptions, Tether's collateral level is generally sufficient to meet minimum regulatory requirements. However, compared to market benchmarks (such as well-capitalized large banks), its performance is less satisfactory. According to these higher standards, Tether may need an additional approximately $4.5 billion in capital to maintain its current $USDT issuance scale. If a more stringent, fully punitive approach to $BTC is adopted, its capital shortfall could range from $12.5 billion to $25 billion. I believe this requirement is overly harsh and ultimately does not reflect actual needs.

Independent vs. Group: Tether's Rebuttal and Controversy

Tether's standard rebuttal regarding the collateral issue is that, from a group perspective, it has a substantial amount of retained earnings as a buffer. These figures are indeed not to be underestimated: by the end of 2024, Tether reported annual net profits exceeding $13 billion, with group equity exceeding $20 billion. More recent audits for the third quarter of 2025 show that its profits year-to-date have surpassed $10 billion.

However, the counter to this rebuttal is that, strictly speaking, these figures cannot be considered regulatory capital for $USDT holders. These retained earnings (on the liability side) and proprietary investments (on the asset side) belong to the group level and are outside the isolated reserve scope. While Tether has the ability to allocate these funds to the issuing entity in times of trouble, it has no legal obligation to do so. It is precisely this arrangement of liability isolation that gives management the option to inject capital into the token business when necessary, but it does not constitute a hard commitment. Therefore, viewing the group's retained earnings as fully available capital to absorb $USDT losses is an overly optimistic assumption.

To conduct a rigorous assessment, one must examine the group's balance sheet, including its holdings in renewable energy projects, Bitcoin mining, artificial intelligence and data infrastructure, peer-to-peer telecommunications, education, land, and gold mining and franchise companies. The performance and liquidity of these risk assets, as well as whether Tether is willing to sacrifice them in times of crisis to protect the interests of token holders, will determine the fair value of its equity buffer.

If you expect a clear answer, I apologize that you may be disappointed. But this is precisely the style of Dirt Roads: the journey itself is the greatest reward.