In light of the tether topic continuing to be a divisive issue for those in crypto who look in detail and a mystery to those that just come across it, it is a good time to put my own thoughts to “paper”.
For those of you who do not know: tether is the largest “stablecoin” in crypto land. It is based on the premise that 1 USDT (a US Dollar that Tether Inc transfers on the blockchain) is always backed 100% by real US Dollar that someone sent to Tether Inc. The blockchain-based USDT is much faster than real USD and, importantly, using it as the fiat unit of account, exchanges do NOT need to bother as much with actual regulations around fiat on- and offramps. Therefore, it has become the unit of account for between 50% and 70% of all crypto trading (depending on what volumes you use). Given it is such a large share of volume, its legitimacy impacts the entire industry.
I will address the issue at hand by looking at three areas:
- The issuance of new tether
- The backing of tether & its audit
- The impact of tether on bitcoin price
Before I do this, briefly a word on my personal position in this: I am a crypto enthusiast and I am not a “no-coiner”. I benefit from bitcoin prices rising on average, though I trade actively. Most of what I say is “Tether’s explanation” below is taken from this excellent interview of Tether leadership by Peter McCormack. So without further ado, let’s get going.
Issuance of new Tether (USDT)
Several issues arise around this topic, but clearly the main question is whether USDT is (sometimes) conceived out of thin air (ie printed without any US Dollar being sent to Tether Inc). The reason for this suspicion is simple: Tether regularly issues new USDT on weekends or holidays (most recently during Christmas and New Year) when you can be absolutely sure that institutional clients are not in the office and aren’t requesting the coins, while banks are closed and no real US Dollar will be credited to Tether Inc’s accounts. And I don’t just mean “authorize but not issue”, I mean issue and send to binance. Given the volumes are absolutely massive ($1–2bn on a single weekend have happened), it is clear that this “demand” cannot stem from retail accounts.
Tether Inc explanation: Tether explains this phenomenon in two ways. Firstly, when clients actually request their USDT after they have already sent in the real USD to Tether Inc is their call, so it could be that the money was received on Thursday, but the USDT are requested on Saturday. Secondly, and more importantly, a lot of Tether Inc’s clients are crypto exchanges and they are (1) up and running on weekends and holidays and (2) a lot of them bank with Deltec alongside Tether Inc. So with both at the same bank and Tether Inc not having denied that they are a shareholder in the bank, they claim that they just need one bank employee moving funds from one account to another within the same bank. Nota bene: exchanges, by and large, confirm that they can issue AND redeem USDT (for real US Dollar) all of the time without issues.
My interpretation: While I absolutely harbor the suspicion that USDT were printed out of thin air for most of 2017, I am unsure if this is still the case today. I think it is likely that Tether Inc’s clients are 90% crypto exchanges and the rest is Chinese businesses and individuals trying to get money in and out of the country (USDT is probably the absolutely fastest way for that). If this is the case, then the above explanation from Tether Inc is plausible.
Crypto exchanges would likely “need” to create USDT in a similar (though not the same) manner that commercial banks create US Dollar. When someone gets USDT from Tether and then sends it to an exchange to buy bitcoin at the price of $10,000 and that same person comes back to sell these bitcoin at the price of $30,000, the market maker needs to be able to satisfy this request an therefore, somehow, $20,000 in new USDT need to be created. If the exchange banks at the same place that Tether Inc does, then it is plausible that (1) Tether Inc receives the US Dollar from that exchange’s account in the bank’s internal ledgers and, similarly likely, (2) Tether Inc is probably extending some “good will” or “trade credit” to their customers. So to put it differently: If you have done business with binance for 2 years and you know they are the largest exchange and they bank with the same bank (in which you likely hold an ownership interest), you can be pretty sure that you get the real US Dollar credited on Monday and will happily extend them the missing funds in USDT over the weekend in order to keep liquidity from collapsing in the market. So this mechanism is plausible. It remains unclear though, how the exchanges will finally ensure they always have enough real US Dollar to send to Tether Inc and whether they actually do it. Instead, it seems most likely that these new prints are mostly backed by the crypto assets the market maker holds and by its creditworthiness, which is very different from real USD backing. Furthermore, as I show below, I think the end-users holding USDT bear that risk. So the suspicion remains, but a client base of mostly crypto exchanges, in my view, makes Tether Inc’s explanation a plausible one and while I think the assets that Tether Inc receives in exchange for USDT are very often not real US Dollar and very often not even direct asset transfers but “claims” on someone elese’s assets, it is not really only hot air either.
The biggest issue with this method is probably that it introduces a pretty large singe point of failure should Deltec Bank lose its US correspondence banking connection or if it should otherwise be pressured to drop Tether Inc business by regulators.
The Backing of Tether (USDT) and its Audit
This is very simply the single biggest controversy in Crypto at the moment and the most important aspect when discussing Tether. The question is whether, given the fast pace of prints and the insitutional size of them, one USDT is truly always backed by 1 US Dollar on Tether Inc’s balance sheet. The company has done its share in making sure people cannot just believe them blindly (if those people even use a small part of their brain). The following shows the changes Tether Inc’s promise of backing and transparency underwent on their own website over the years:
You can see clearly that Tether has gone from promising their USDT are backed 100% by actual fiat in their reserves, which are fully and publicly audited to basically saying “we have the money in some way” and “we show our reserves, but we don’t offer audits nor anything else that is reliable”. Pardon me if I think it a bit comical that an industry whose credo is “Don’t trust, verify!” would go for this.
So this is the biggest issue today: USDT is supposedly a “stablecoin” that is backed by US Dollar and in order to really function as such, its users need to believe this and be able to verify it somehow. Yet that is impossible as the company has never provided the promised full audits and has admitted numerous times that Cash only makes up a (large) fraction of the reserves backing USDT.
Tether Inc explanation: Tether has had to defend this issue in ongoing court proceedings in New York and their current leadership team has also become more vocal in explaining this, which is a good thing. They say that they “have not been able to get an audit” due to the vastness and complicated nature of their business and in its absence have provided (irregular) balance attestations by their (own) bank and lawyers from time to time but they maintain that they have the assets that 100% back the value of outstanding USDT and that they have maintained this at all times. They acknowledge that, at some time, cash made up only 74% of these reserves and that loans to affiliated businesses (which remain in good standing and where interest is paid) sometimes make/made up other parts of it. They are always fast to add that “USDT is always pegged at one US Dollar and ‘valued’ as such by Tether” (which means nothing).
My interpretation: Two things first: Tether Inc’s allegation that they “tried to get an audit, but nobody could do it” is simply the biggest bullshit (pardon my language) I have heard in finance. A Top 4 auditor might be expensive, but to pretend that they “couldn’t do it” is just madness. I don’t really understand how cypto buys that explanation. I am not saying auditors always do a good job (see Wirecard), but there is no doubt in my mind at all that a Top 4 auditor would gladly undertake an audit of any business IF given access to all the books (which may be the real issue here ;-) ). Side point is that Tether Inc actually goes further by saying that “a business that is as much under the microscope as ours could not operate for such a long time if it were not legit”. To this point I would like to just retort that the FT first attacked Wirecard in 2015 and it took till 2020 for the company to collapse. Financial fraud tends to go on and even increase in value until it collapses very, very suddenly. So that point is just moot.
Secondly, it is important that readers understand the difference between a balance attestation that shows you have assets to back up the value of USDT and a full audit of Tether Inc’s business. A balance attestation (the latest one of which is more than 2 years old!) shows that you had some mix of assets at one point in time to back up the USDT value. That is not enough. An audit would show how those assets came into Tether Inc’s possession. It would show whether there ever were US Dollar receipts in the same value and at the same time of Tether issuance, and (in my mind) more importantly, it would show if Tether Inc actively traded with customer funds, bought and sold large amounts of bitcoin and exposed their clients to a significant amount of investment and market risk when they thought they were buying a “stable” US Dollar equivalent. I cannot stress this enough: this is a gigantic issue.
So if I look at their explanation and the fact that no company “cannot get an audit” if it is a legitimate business, my view here is that Tether Inc understandably does not wish to show its books and all its transactions to a Top 4 auditor and then make the findings public because it would endanger their claims of always backing up USDT 1-to-1 with USD (which is verbatim what they promised in 2017). I believe it is more than likely, given their own admittance, that an audit would clearly show that 1 USDT was backed by a very diverse mix of bitcoin holdings, intracompany loans, receivables from third parties (exchanges) and actual cash at most times. I am inclined to believe that the mix of these assets did indeed back USDT at (more than) 100% all of the time, so I don’t think USDT has been unbacked in the bookkeeping sense of the word (ie Tether Inc always booked some sort of receivable for every USDT print).
It is still a massive problem. The reason is that USDT is marketed and accepted in the crypto community as a 1-to-1 replacement for the US Dollar. A “stable” coin. This means users believe that Tether Inc always has exactly the assets to back up its volume of Tether. However, even just using their own words, the asset mix has not been stable and while the loan they made to Bitfinex is “in good standing”, you have to ask yourself: why is it okay for a “stable”coin provider to take its customer’s assets and make any kind of investment decisions with it (like loaning it out to another firm)? It means the customers take all the risk of the investment (if it goes poorly, USDT is no longer backed), but receive none of the gains (does the interest in the bitfinex loan accrue to USDT holders?!?). And even IF they were to receive those gains — how could a participation in an open-ended investment scheme where somebody simply chooses what to invest your money in, EVER be considered a STABLE coin?
So in summary on this point: I do believe that USDT is fully backed at the time of writing, but I believe that it is a risky asset that should not trade at 1–to-1 to the US Dollar because the underlying assets are risky too. Plus your legal claim on these assets as a USDT holder is at least questionable vis-a-vis other creditors of the business should they ever go belly up.
Tether and Bitcoin price
I will keep this part short, because I do not really think it is the major issue (we just covered the major one above). However, the allegation is that Tether Inc prints USDT without full backing, then buys bitcoin with it (or possibly wash trades it) to achieve a certain price and then sells those bitcoin for real US Dollars. Next to pumping the price of bitcoin, this would be a blatant example of market manipulation and while I too enjoy getting richer from it on paper (because of occasionally holding bitcoin), these kind of actions seldom end well. There have been scientific papers showing the correlation between USDT prints and BTC price increases, but these have been debated and shown to have flaws. In any case, you can see this for yourself pretty easily. Looking at the last month or so, this is what has transpired (using whalealerts to show Tether sends to exchanges):
The correlation is clearly there. However, correlation does not imply causation.
Tether Inc explanation: I don’t really think there is an “official” explanation here. Tether Inc just simply says that they do not print USDT to buy BTC and push its price higher, but without a full audit by a Top 4 auditor you simply can’t be sure.
My interpretation: As I said, to me this isn’t the main issue here and it is quite clear to me that there are currently three drivers of bitcoin price:
- The Fed and other Central Banks are engaging in massive monetary stimulus, which means that all financial assets (whether it is shares, watches, art, old cars, Gold, real estate or potentially even hockey player cards) rise in value. As bitcoin is a potential alternative currecny and all other potential alternatives are engaging in the same quantitative easing as the US Fed, it is logical that bitcoin benefits from this.
- Instiutions are dipping a toe. While this may not be a huge amount of firms yet, order books on real US Dollar bitcoin exchanges are thin and an amount of 100–200m USD is difficult to fill without market impact. It is a myth to pretend that institutions are not experiencing some sort of FOMO here and aren’t buying spot. As a matter of fact, during the phases I marked as “Tether sends new prints to Binance” above in the chart, often times spot bids were driving parts of the rally.
- Tether printing is having an effect. You can explain it any way you like, but a $10m send from treasury to unknown to binance has had the average effect of a $500 price rise in bitcoin over the time frame of the above chart. Of course there is an influence — people get USDT to buy bitcoin after all.
I do not know the proportion of these three influences. What has been puzzling to me is that, if the Tether allegation that clients simply request and then receive the USDT when they want were true, it would be quite strange that this never seems to happen when BTCUSDT (Bitcoin denominated in tether) is trading at a premium to BTCUSD (Bitcoin denominated in US Dollar) [AKA the “tether premium”]. That, to me, says that there is more central planning behind this. To just explain this briefly: when BTCUSDT is trading higher than BTCUSD that means the market is valueing one USDT below one USD and if there were to be massive bitcoin buys on top of that using USDT (ie further increasing BTCUSDT price), Tether Inc would risk its biggest asset: the 1–to-1 peg in the market. People say this would be arbitraged away, but again for that to be true you’d need everyone to believe in this peg, so I think that isn’t likely given the volumes involved and the fact that there are fully compliant stable coin alternatives that could be used. Looks more like Tether Inc is holding back on its prints when the premium gets too high. Think about that what you like, it is just a suspicion.
In summary, I think what this all shows is that there was enough activity around reserves that Tether Inc wishes to hide from the market to believe that it wasn’t all the cleanest and best kind of behavior. But I think the main takeaway is one the market seems to not appreciate:
Given Tether Inc is simply using a wide range of assets on its balance sheet to back the value of USDT, USDT is in essence NOT a stablecoin. It is a contract with the company Tether Inc that represents an IOU of 1 US Dollar. That is fine as a concept. The problem is that the market is not being given enough information to assess the creditworthiness of this IOU and its holders receive no compensation for the risk they are taking. It is a blackbox and Tether Inc’s investment decisions could just as well have gone badly. So in my mind, USDT price should be much more volatile vs the US Dollar if everyone understood this concept. Tether Inc are, in essence, not custodians of US Dollars, but just a company with a business that is borrowing funds and gives out IOUs. Nothing more and nothing less.
If the above were better understood by the market and people would stop saying “but it’s fully backed” and instead focus on “but we do not know how and we need to take the risk of this backing into account”, I think it would no longer function as a stablecoin. That is why Tether Inc is vehemently trying to avoid that impression by adding “USDT is always valued at 1 US Dollar by Tether” to their explanations. That means absolutely nothing if Tether Inc does not have the funds. And a loan to bitfinex could have gone wrong, ya know…
I hope this helped shedding some light on the discussion. For what it’s worth, again, I am not a no-coiner, I have an interest in bitcoin price rising and I actually believe that the current Tether Inc leadership wants to run it as a clean organization going forward (that is just the vybe I am getting), but they have to hide the past. In any case, I really do detest scams and so I think it is important to look closely. In the case of tether, I think if you hold it, you face the risk of Deltec bank being closed off from the US financial system and the risk that some of the investments that back up USDT go poorly. For me personally, that is way too much risk to trust it. You are also not being compensated for it.
I want to stress — all of the above is personal opinion. None of it is financial or any other type of advice. I can be wrong with my research and you should do you own to get comfortable with your decisions.
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Lastly, the all important disclaimer: this is my personal opinion, not my professional advice. Most of all this is not investment advice in any way. Crypto assets can fluctuate widely in value and all of your capital can be lost. I have a 50/50 chance of being right. Any negative views expressed, if any, are solely aimed at the token in question, never at the development teams behind them for which I have utmost respect (if they are sincere).