The cryptocurrency space is seldom without drama, but the 25th of April 2019 was special even by the industry’s inflated standards. That day, the market suffered a $10 billion loss, when the New York Attorney General’s office alleged that Bitfinex, one of the world’s largest exchanges, may have defrauded investors.
Founded in 2012 and based in Hong Kong, Bitfinex has become a cornerstone of the cryptocurrency world. In 2014, the first Tether coins were minted and it has since come to light that both Tether limited and Bitfinex share the same management team.
Aiming to circumvent price volatility, a hallmark of most cryptocurrencies, Tether is the world’s first stablecoin, claiming that each digital token is backed with cash. Of course, the trading platform and digital currency make strange bedfellows, and it is this relationship that is at the heart of the Attorney General’s allegations.
According to the statement, the Bitfinex platform never disclosed a significant financial shortfall – roughly $850 million dollars – to its stakeholders. Damningly, the Attorney General claims that Bitfinex subsequently accessed around $900 million of Tether’s cash reserves in order to cover the loss. Of course, Bitfinex treating Tether’s cash reserves as a personal slush fund would be deeply unethical and fraud proceedings are already underway.
Tether has since filed a motion to dismiss the allegations on the grounds that, as a corporation based overseas, the Attorney General lacks jurisdiction over both Bitfinex and Tether. We will see how the case develops and the outcome will resonate around the entire cryptocurrency space.
But what is the stable coin at the heart of this story? How does Tether maintain its value and what role does Bitfinex play?
Let’s find out.
What is Tether? (USDT)
Tether is the company behind the world’s first stablecoin, USDT. The aim of a stablecoin is to remove the price volatility which has dogged digital assets for years and instead provide a token with a predictable market price. By ensuring that 1 USDT is equal to 1 USD, USDT seemingly combines the fast, efficient payments of crypto with the stability of fiat currency.
In 2014, USDT was first issued on Omni, a secondary layer on the Bitcoin blockchain. Since then Tether has also launched on Ethereum and EOS, with Tron supposedly coming soon. Worryingly, there is little transparency regarding the team behind Tether. The whitepaper does not name an author and the website only lists three executives – all of which work for Bitfinex. The relationship between the trading platform and Tether is not explained on the website (June 2019). This is particularly concerning because the website has a section titled “transparency”, which almost seems insulting to the readers intelligence.
Interestingly, we know from the paradise paper leak that Tether was established in the British Virgin Islands by Bitfinex’s Philip Potter. Until 2018, Potter was the CEO of Bitfinex when he was replaced by Jan Ludovicus van der Velde, who is also named as Tether’s CEO.
How do Tether’s stablecoins work?
The first thing to understand is that USDT is more like MPesa’s phone credits than a cryptocurrency like Bitcoin. The token is controlled and issued by Tether Limited and does not espouse the trustless, decentralized philosophy of its forebears.
In simple terms, USDT retains its value because it is backed with cash. If you go to the Tether website, you’ll find an explanation like this:
“[USDT tokens] are anchored or ‘tethered’ to real-world currencies on a 1-to-1 basis and backed by our reserves.”
The implication here is that Tether Limited manages the flow of USDT much like the central bank pursues its monetary policy for the US dollar. More specifically, you and I can head over to Tether’s exchange and purchase USDT tokens.
If USDT is indeed backed 1-to-1 with cash, this means that Tether simply holds on to the funds, ready to redeem our USDT tokens in exchange for dollars whenever we like. This has become a point of contention which we will discuss a little later.
For now, it’s clear how Tether controls the value of its USDT and EURT tokens. By providing assurances that the tokens can be redeemed for a stable value at any time, Tether has effectively pegged their value. Nobody is willing to spend $20 on a token which can only be redeemed for $1, just like no one will sell for $0.50 when they know that they can receive $1 from Tether. This is how volatility is removed (mostly) from the market.
Are Tether’s tokens really backed with cash?
As has become clear, the value proposition of both USDT and EURT rests entirely on the assurance that Tether will redeem the tokens for the cash equivalent at any time. If Tether Limited was hacked or tricked out of significant amounts of money, this assurance could not be upheld.
Intuitively, it seems unlikely that Tether can afford to simply hold on to the money it receives. As a business, there will be significant operational costs, including lawyers fees and staff salaries. Who is paying for those and where is the money coming from?
Well, the short answer is likely: Bitfinex.
Nevertheless, Tether needs to be able to prove that it has the cash reserves to back each and every USDT in circulation. For this to be proven, we would need to see an audit from a reputable source – this has been surprisingly hard to get a hold of.
Yes, the company seemingly lists its current balances on the website, but you cannot trust the cat to take care of the milk. Worryingly, Tether dissolved their relationship with their first auditors and the prominently displayed “Proof of Funds” states categorically:
“The above confirmation of bank and tether balances should not be construed as the results of an audit and were not conducted in accordance with Generally Accepted Auditing Standards.”
To an impartial observer, the lack of a comprehensive audit is rather damming. Adding to this sense of unease, I want to point you in the direction Bitfinex’ed, an author on Medium who has seemingly cataloged many of the platforms illegal activities. If even 50% of his work is correct, both Bitfinex and Tether have a long history of financial misconduct.
Who is using USDT and EURT?
Clearly, Tether is not the bastion of transparency and trustworthiness we would all hope it to be. Nevertheless, cash-backed stablecoins have a place in a modern digital asset ecosystem and USDT is leading the charge.
According to Coinmarketcap, USDT experiences a daily trading volume of just over $21 billion, with Bitmax and Coinall generating most of it. Although these numbers are likely inflated, it is understandable why exchanges might use a stablecoin.
With significant amounts of crypto changing hands every second, traders aim to use stable coins to control their exposure to price volatility. USDT allows traders to enter and exit highly volatile positions in a much safer manner.
If for example, you want to sell your BAT, the traditional choice would have been to exchange it for BTC or ETH. If however, the price of BTC collapses, at it has been known to do, your freshly exchanged token have lost much of their value. USDT provides an antidote to this ailment.
Is Tether manipulating the Bitcoin price?
The final point I want to raise regards a paper published by the University of Texas entitled “Is Bitcoin Really Un-Tethered?” In this alarming study, John Griffin and Amin Shams suggest that Tether may have been used in a concentrated campaign to manipulate the price of Bitcoin.
More specifically, the paper alleges that a group of people used Bitfinex to exchange large volumes of USDT for BTC whenever the price of Bitcoin began to sag on other exchanges – thus pushing up the price. The paper claims that these transactions follow a clear pattern which is a strong sign of price manipulation.
It’s important to point out that the study does not include emails or documents which prove that Bitfinex was aware of the supposed price manipulation. Nevertheless, the pattern of transactions captured on the distributed public ledger paint a very clear picture and the U.S. Justice Department has opened a criminal investigation.
Tether is a shining example of why we need decentralization. The lack of believable audits, oversight, and regulation create the perfect environment for financial misconduct.
The cryptocurrency, now valued at roughly $3 billion (with a b), is knee-deep in trouble and it’s hard to make a case for its defense.