Does Tether Cause Systemic Risk for the DeFi Ecosystem?

Luca Prosperi from the M^0 Foundation and Sonya Kim from Steakhouse Financial recently tackled the question of whether Tether poses systemic risk to the DeFi ecosystem, during a panel at ETHDenver on February 28, 2025, titled “Does Tether Cause Systemic Risk for the DeFi Ecosystem?” alongside Phil Liu from Cork Protocol. Their discussion centered on Tether (USDT), the largest stablecoin by market cap, and its outsized role in decentralized finance (DeFi), where it’s a key liquidity provider and trading pair.

Tether Limited, the company behind USDT, asserts that every token is fully backed by a mix of assets in its reserves. Historically, they promised this was all cash—literal dollars in bank accounts. But after scrutiny and legal challenges, they’ve clarified that “reserves” include a broader basket: cash, cash equivalents, U.S. Treasury bills, secured loans, commercial paper, and even some cryptocurrencies like Bitcoin. The idea is that these assets can be liquidated or redeemed to honor USDT withdrawals, maintaining the peg at $1.

Prosperi, with his background in traditional finance and DeFi (notably MakerDAO and now M^0, which focuses on decentralized stablecoin infrastructure), likely approached this from a structural and risk-management perspective. Tether’s opacity—its reserves are a murky mix of cash, equivalents, and commercial paper, with only periodic attestations rather than full audits—could’ve been a focal point. He might’ve argued that this lack of transparency undermines trust, a critical pillar in DeFi, where users rely on code and verifiable systems over centralized promises.

Sonya Kim, tied to Steakhouse Financial (a firm focused on DeFi analytics and risk), likely brought a data-driven angle. She might’ve emphasized Tether’s integration into DeFi—think automated market makers like Uniswap or lending platforms like Aave—where it’s often the stablecoin of choice.

I think Tether has had an interesting journey, if we’re talking about Tether in 2025, it paints a very different picture, if you look at the composition of reserves it’s about 80% cash. I think the credit profile or some of the risks that we were wary of have diminished and they are one of the most profitable institutions in the world. So from a capitalization perspective, Tether looks quite good today. Tether to my mind has been stress tested and has the focus on many people’s nervousness so perhaps there’s less risk now.

Tether falters, the cascading effects could freeze markets, as collateral values drop and margin calls spike. Kim pointed to metrics showing Tether’s usage (e.g., over 50% of stablecoin volume in DeFi) to underline its systemic heft, questioning whether the ecosystem’s reliance on a single, centralized peg creates a single point of failure.

Tether’s reserve mechanics are the backbone of its claim to stability—each USDT token is supposed to be pegged 1:1 to the U.S. dollar, backed by reserves that match or exceed the total supply in circulation. With over $100 billion USDT issued as of March 1, 2025, understanding how these reserves work (or don’t) is key to assessing its systemic risk in DeFi

Together, they’d likely debate whether Tether’s risks—reserve uncertainty, regulatory pressure (like past fines from the CFTC), and concentration—outweigh its utility. Prosperi might lean toward solutions like diversified stablecoin adoption or decentralized alternatives (e.g., M^0’s multi-issuer model), while Kim could stress stress-testing DeFi protocols against a Tether depeg scenario, as seen with Terra’s UST collapse in 2022. The core tension: Tether’s efficiency fuels DeFi’s growth, but its flaws threaten its foundation.

Tether doesn’t release real-time, granular data. Instead, quarterly attestations—snapshots from accountants—confirm assets exceed liabilities but lack detail on liquidity or quality. A 2021 settlement with the New York Attorney General revealed Tether wasn’t fully backed by cash for periods in 2017-2018, paying a $41 million fine for misrepresentation. This history fuels skepticism.

Imagine $100 billion USDT in circulation; Reserves should hold $100 billion in assets. If 10% ($10 billion) is cash, 40% ($40 billion) is Treasuries, 30% ($30 billion) is commercial paper, and 20% ($20 billion) is loans/Bitcoin, the mix looks stable—until stress hits. A sudden redemption wave (say, $20 billion) could force Tether to sell illiquid assets like commercial paper or loans at a discount, risking the peg. In DeFi, where USDT is locked in pools and smart contracts, users don’t redeem directly—they sell on markets. If confidence slips (e.g., a rumor of insolvency), panic selling could drop USDT below $1, disrupting protocols reliant on its stability.