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The U.S. Securities and Exchanges Commission (SEC) has charged stablecoin issuers TrueCoin LLC and TrustToken with defrauding cryptocurrency investors and making misleading statements regarding the TrueUSD (TUSD) stablecoin reserves.
SEC’s investigation alleged that, by September 2024, 99% of the reserves backing TUSD were invested in an “illiquid” commodity investment fund.
TrueCoin and TrustToken neither admitted nor denied the allegations and agreed to settle the charges.
The revelation served as a stark reminder about the lack of transparency about stablecoin reserves and questioned the effectiveness of stablecoin collateral verification methods such as proof-of-reserve.
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Proof-of-Reserve Reports “Falsely Assured” TUSD users, says SEC
On its official website, TUSD claims to be a “trustworthy” stablecoin that makes daily audit reports available to anyone to monitor its reserves using Chainlink‘s proof-of-reserve technology.
However, according to the SEC, since 2020, TUSD reserves have been invested in an offshore commodity fund with exposure to trade finance, structured trade, export and import finance, supply chain financing, and project financing.
“Potential purchasers were falsely assured by these reports that the TUSD reserves exceeded the TUSD outstanding.
“It was undisclosed in the holdings reports that a significant portion of the TUSD reserves were invested in the risky Commodity Fund, which the attestation reports were valuing at cost without considering any adjustments,” said the SEC in the court filing.
Proof-of-Reserve Technology for Stablecoin Reserves
Techopedia asked Anndy Lian, an intergovernmental blockchain expert and author of Blockchain Revolution 2030, for his views on the matter, to which he said:
“This situation underscores the potential for misrepresentation and the limitations of existing proof of reserve mechanisms.”
The biggest weakness of stablecoin proof-of-reserves seems to lie in the quality of the off-chain data provided by the third party to oracles like Chainlink.
Stablecoin reserves are typically held in cash, and short-term U.S. treasuries cannot be tracked on-chain. Chainlink’s proof-of-reserve technology is completely dependent on the quality of data provided by third parties.
Lian added:
“While on-chain attestations can verify the presence of reserves at a given moment, they may not account for off-chain activities or the quality and liquidity of the assets backing the stablecoin. The TUSD case illustrates how reserves can be mismanaged or misrepresented, even with real-time attestations in place,”
In the case of TUSD, a Hong Kong-based accounting firm named Moore Hong Kong is responsible for providing blockchain oracles with daily attestation services and stablecoin reserve balance data.
Disclaimers on Moore Hong Kong-owned VeriNumus’ website do not alleviate doubts on whether proof-of-reserves technology can be trusted to verify stablecoin reserves.
“The Balance Data is sourced entirely from third parties, and neither Moore Hong Kong nor any Chainlink service provider has knowledge of its accuracy,” stated the disclaimer.
Techopedia reached out to Chainlink Labs for a comment. At the time of writing, there had been no response.
Do All Stablecoins Use Chainlink’s Proof-of-Reserve Technology?
Not all stablecoins use Chainlink’s proof-of-reserve technology to showcase their reserve balances.
Tether (USDT), the largest stablecoin by market cap, publishes quarterly reserve reports audited by BDO Italia, a third-party accounting firm.
USDT has courted its fair share of controversy and legal action over the years. In October 2021, the Commodity Futures Trading Commission (CFTC) fined Tether $41 million for misleading customers that it had sufficient U.S. dollar reserves to back every circulating USDT stablecoin.
Rival USDC – which brands itself as a regulatory-first and compliant stablecoin – provides monthly stablecoin reserve reports. USDC reserve reports are audited by Deloitte & Touche LLP.
At the time of writing, over 87% of USDC reserves were held in an SEC-registered government money market fund called the Circle Reserve Fund, managed by BlackRock. The rest was held in cash in banks.
Rating agency S&P Global rated USDC’s ability to maintain its peg to the U.S. dollar as “strong.” The agency rated USDT as “constrained” and TUSD as “weak.”
“We have no information on the nature of the assets in the reserve or the creditworthiness of institutions holding these assets,” said S&P Global on TUSD.
Techopedia’s View: Proof-of-Reserve is Not Foolproof
The lack of trustlessness when sourcing off-chain data is the Achilles heel of proof-of-reserve technology.
Oracles have to rely on the trustworthiness of the third parties providing off-chain data and auditing reserve reports. This need for trust requires the end consumer to review the quality of the data feed.
Proof-of-reserve technology works well when tracking the on-chain reserve balances of centralized crypto exchanges, but depending on it to track off-chain stablecoin reserves seems like a leap of faith.
In the future, stablecoin issuers could include tokenized cash, U.S. treasury bills, and notes issued by regulated issuers in their reserves. Such on-chain assets can be accurately tracked by proof-of-reserve solutions.
The Bottom Line: Stablecoin Regulation is Inevitable
On September 24, 2024, the SEC took the chance to advocate for crypto regulations following the charge on TUSD issuer TrueCoin LLC.
“This case is a prime example of why registration matters, as investors in these products continue to be deprived of the key information needed to make fully informed decisions,” said Jorge G. Tenreiro, acting chief of SEC’s Crypto Assets & Cyber Unit.
In June 2023, the European Union passed a comprehensive crypto regulatory framework called the Markets in Crypto Assets Regulation (MiCA).
The U.S. looks to follow suit, having introduced crypto bills such as the Lummis-Gillibrand Payment Stablecoin Act and Financial Innovation and Technology for the 21st Century Act (FIT21) in 2024.
