The End of the Tether?

Concept of Tether (or USDT) equals to1 US Dollar, Cryptocurrency

What is Tether?

According to Tether’s website, “Tether converts cash in digital currency, to anchor or tether the value to the price of national currencies like the US dollar…” The primary manifestation of Tether is the “USDT”, the cryptocurrency coin which is pegged to the American dollar. In other words, in theory, for every USDT in circulation there is 1 US dollar held in a reserve deposit which underpins the value of that USDT. This article will deal exclusively with USDT.

The intended purpose of Tether is relatively straightforward. Many exchanges struggle to maintain banking services from mainstream financial institutions. Exchanging cryptocurrencies such as Bitcoin or Ripple for fiat currencies such as the US dollar can be expensive and time consuming as a result. Many cryptocurrency traders simply use USDT as a method of exiting crypto positions without actually having to go through the process of converting cryptocurrencies to US dollars. Traders hold USDTs, each of which is supposedly 100% backed by a real US dollar by the issuer of USDT, Tether Limited, and which can be redeemed for one US dollar when desired.

USDT coins are designed to operate in an almost identical fashion to central banks during the era of the gold standard. In other words, in the days of the gold standard, the value of government currency was dependent on there actually being gold within the vaults of the central bank to an equivalent value of all circulating currency. Likewise, the value of all UDSTs in issue is, or should be, dependent on the existence of fiat currency held in reserve by Tether Limited to an equivalent value of all issued USDT.

Lack of Professional Audit

Clearly, as outlined above, the integrity of USDT is dependent on its users’ belief that Tether Limited has sufficient reserves to redeem their tokens at their face value. If Tether were to be shown to be unable to do this, the value of USDT as being equivalent to one US dollar, and as a result its very utility, would become questioned.

Perhaps it is for this reason that Tether states on its website that:

“Our reserve holdings are published daily and subject to frequent professional audits. All tethers in circulation always match our reserves.”

Yet these audits have failed to materialise. Tether, recognising this, recently announced that:

“…we have engaged Friedman, LLP, in New York, to perform comprehensive balance sheet audits on a quarterly basis going back to Dec 31, 2016. We will share those results with you as they become available in the coming weeks or months.”

However, in January 2018, Tether stated that their relationship with Friedman, LLP, had “dissolved.”

“We confirm that the relationship with Friedman is dissolved. Given the excruciatingly detailed procedures Friedman was undertaking for the relatively simple balance sheet of Tether, it became clear that an audit would be unattainable in a reasonable time frame.”

Therefore, no independent professional audit of Tether and, crucially, its US dollar reserves currently exist. As a result, some commentators have begun to question whether, in fact, all USDTs in issue are really capable of redemption at their purported face value.

Dramatic Increase in the Supply of Tether

The supply of USDT has increased dramatically over the past 6 months.

The above chart demonstrates that the supply of USDT increased at a gradual and steady rate until July 2017. This reflected the increase in demand for USDT corresponding to the increase in interest for cryptocurrencies during this time. This is because, for many, the most convenient method of using crypto exchanges was via USDT.

However, the exponential increase in the total USDT supply between July 2017 and January 2018 is more puzzling. In April 2017 Tether’s banking services in Taiwan were terminated. Following this, Tether temporarily froze all deposits and withdrawals. Later Tether commented that it was unable to process international deposits, stating:

“Since April 18, 2017, all incoming international wires to Tether have been blocked and refused by our Taiwanese banks. As such, we do not expect the supply of tethers to increase substantially until these constraints have been lifted.

For customers with bank accounts in Taiwan, we are currently experiencing no difficulties or delays in funds transfers in USD, with deposits and withdrawals functioning as expected.”

Despite Tether’s claim that “we do not expect the supply of tethers to increase substantially”, total USDT supply in fact increased from just under US$55 million on 1 April 2017 to just under $2.5 billion 28 January 2018.

For Tether’s claims to remain true, that each USDT in issue is backed by one real US dollar , this would have required an additional US$2.19 billion to have been deposited with Tether during this nine month period, despite the absence of banking facilities, or at least any disclosed banking facilities.

No explanation has been given as to how a company that lacks basic banking facilities could process such a vast sum of money in such a short period of time. This lack of disclosure is troubling, to say the least.

The Bitfinex Connection

Bitfinex is the largest cryptocurrency exchange in the world. If traders want to get in via USD, they can only do so by purchasing USDT. Once they have acquired USDT they can proceed to trade cryptocurrencies on Bitfinex.

Bitfinex has always denied that its exchange was associated with Tether. However, the leaked Paradise Papers, which are a set of 13.4 million documents relating to offshore investments that were leaked in 2017, confirms that the law firm Appleby assisted Philip Potter and Giancarlo Devasini in setting up Tether in the British Virgin Islands in 2014. These individuals also happen to be senior employees of Bitfinex.

Furthermore, Bitfinex and Tether joined up to bring a lawsuit against Wells Fargo after the institution refused to continue to offer their services to the pair.

The Inflation of Bitcoin Prices

The exponential increase in the quantity of USDT in issue and the price of BTC has occurred simultaneously. This fact, combined with the suspiciously close relationship between Tether and Bitfinex, has led some experts to suggest that, as reported by the New York Times journalist Nathaniel Popper:

“Bitfinex appears to be creating Tether coins out of thin air and then using them to buy Bitcoin and push the price up.”

The implications of this allegation, if true, are immense. Firstly, it means that cryptocurrency investors who are currently holding assets in USDT may be unable to redeem them for real currency as each USDT is not backed up by adequate reserves. But, more importantly, it calls into question the basis for the rapid rise in the price of BTC over the last year and whether this rise is based on fundamental demand from fiat capital.

If it is in fact the case that:

  • much of the demand for BTC during this period has been driven by USDT investment, AND
  • USDT is not in fact 100% US dollar backed,

the current price of BTC and the basis for its recent increase would have to be questioned.

To put it into context, the BTC price immediately before the rapid increase in USDT supply was US$2,000, against over US$11,000 today.

Events over the last 9 months do appear to raise questions which, in a properly functioning and transparent market, participants like Bitfinex and Tether would be obliged to address.

It is curious indeed that, despite so many experts accusing Tether of issuing unbacked UDST, no credible audit report on Tether’s fiat reserves has been made available to the public. It should be relatively straightforward for Tether to address these rumours and allegations. All that would be required would be the production of evidence that each USDT is backed by one US dollar, as the Tether website suggests. The fact that Tether has not done this after 6 months of very public accusations appears suspicious.

The crypto world is of course no stranger to fraudulent activity. Famously in 2014 the Mt Gox exchange, which at the time was the largest in the world, collapsed after losing more than 850,000 BTC in a hack. The implications for Bitcoin at the time were huge. In the aftermath the BTC price of Bitcoin dropped by almost 50%.

Tether and Bitfinex both trade far higher volumes than that of Mt Gox. There is therefore the risk that a sudden loss of confidence in either Tether or Bitfinex could cause significant volatility to the price of Bitcoin.

The cryptocurrency eco system is only as strong as the individuals and entities who participate in it. Therefore, investors and traders alike must remain vigilant and ensure that the institutions through which they conduct their business are transparent and honest.

BitcoinBro has no position or opinion on the price of Bitcoin, Tether or any other cryptocurrency and this article should not be construed as analysis of or advice regarding the current or future market price of Bitcoin or any other cryptocurrency.

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