TETHER: BITCOIN’S “CRYPTO-NITE”
Over the last few years, millions of cryptocurrency investors have been swindled out of massive sums of real money due to fraudulent investment schemes. In 2018 alone, losses from cryptocurrency-related frauds amounted to $1.7 billion USD, an increase of 400% over the previous year. As technology advances, so do the opportunities for criminals to design even more complex new scams. In the modern age, the most lucrative opportunities to defraud the public are now based on digital currencies, as they operate in an environment free from government regulation and are both unsupervised and anonymous. Fueled by cellphone applications and social media, digital currencies represent unlimited potential for criminals to fleece their marks. Buyer beware!
Crypto currencies were based on utopian ideals, a decentralized means of exchange verified by a network of peers, beyond the reach of government taxation and manipulation. Unfortunately, what may have been entirely underestimated, is the potential these products would have in facilitating money laundering on a scale never seen before. By allowing anyone to now transact on reputable over-the-counter (OTC) desks or exchanges, and to function anonymously, without any of the oversight or accountability provided by regular banking transactions and beyond the reach of law enforcement, an entire illicit payment system has been created for use by black markets operators.
One of the most common scams is the Ponzi scheme, notoriously deployed by Bernie Madoff, using the deposits from new participants to pay out returns to earlier investors. In recent years, more sophisticated and modern fraudsters use automated software that interacts with mobile apps, such as Telegram, to run pump and dump schemes. To date, the largest confirmed digital currency scam was executed by a company called OneCoin that took in close to $4 billion USD worldwide over a two-year period. Even if an honest cryptocurrency plan is legitimately established, one should not underestimate the ability of criminals to find a way to manipulate the price of its coinage in the market place. This brings us to what could be the newest and most successful of all scams to date, Tether Ltd., which some are referring to as Crypto’s Doomsday Machine. We see it in particular as Bitcoin’s potential Kryptonite.
What Is Tether and How Does It work?
Tethers (USDT) are a cryptocurrency issued by a company called Tether Ltd and advertised as a “stablecoin”. Stablecoins are supposed to function in a manner conceptually similar to that of a bank account: a place to park money with minimal market risk. This “new” genre of stablecoins like “Tether” are supposed to be backed by reserves, which marketers of crypto claim is another way for saying “fiat” money in the bank. The implication is that at anytime you can easily, and without any risk, convert your crypto, including Tethers, into real fiat currency (ie US dollars). Real fiat money, however, is in essence an IOU from the central bank of the country it is issued; so, it is backed by the taxing power of that country. This is what lends fiat money credibility. Crypto currencies are not necessarily backed by anybody or anything as they operate in unregulated environments. In essence coins like Bitcoin are nothing more than digits on a hard drive. In the specific case of Tether, each coin was advertised to be backed by one US dollar in banked reserves. The implication being that Tethers could at any time be converted into US dollars on a one for one basis.
Tether Ltd., the company that creates Tethers, claimed on their website that from the year 2014 until February of 2019 every Tether issued (USDT) was worth exactly $1 US dollar: “Every Tether is always backed 1-1, by traditional currency held IN our reserves, so 1 USDT is always equivalent to 1 USD”. In late February of 2019, Tether restated this to now say that “Every tether is always 100% backed by our reserves, [emphasis added] which include traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties, which may include affiliated entities (collectively, ‘reserves’). Every tether is also 1-to-1 pegged to the dollar, so 1 USDT is always valued by Tether at 1 USD. [emphasis added]”
The last sentence, from a fundamental perspective, would be true if they actually held $1 USD worth of real assets for each Tether they have issued. However, Tether Ltd. works by building a USD denominated ledger on top of a collection of slow databases (Bitcoin, Ether, Tron, etc). They initially promised that entries in that ledger would always correspond to demand deposits held in reserve, meaning that customers could rely on their promise that each Tether was worth 1 USD. Therefore, if Tether Ltd. issued 40 billion Tethers, the company would theoretically have $40 billion US dollars to back all of its cryptocurrency as originally claimed.
Instead, it appears that Tether Ltd. has given itself the ability to print Tethers by simply issuing Tethers in exchange for IOU’s, without any actual USD being received to back up its newly issued currency. While they continued to claim that Tethers were backed by traditional currency held in their reserves, their reserves appear to be accounting fiction. Based on their own disclosures, it would seem that a portion of their reserves were in fact held by money launderers like Crypto Capital Corp, and receivables from related parties such as Bitfinex (an exchange owned by the same company that owns Tether), and other cryptocurrencies. Recently, an investigation by the New York Attorney General showed that Tether Ltd. transferred part of its reserves to its wholly owned affiliate company Bitfinex in order to help cover up an $850 million loss suffered by Bitfinex, due to the Crypto Capital Corp money laundering fraud mentioned above.
The key question, of course, is who would have any use for something like Tether and why does it affect Bitcoin or any other cryptocurrency. Bitcoin and other cryptocurrency investors can always buy or sell cryptocurrencies directly on many exchanges with fiat money. Tether was created by BitFinex (the exchange that Tether Ltd. owns) around the same time period that BitFinex itself ran into financial difficulty. They were also the ones to introduce Tether on their exchange to encourage investors selling Bitcoin and other crypto currencies to accept Tether rather than an actual fiat currency on the basis of “speed” and “cost effectiveness”. By making investors feel like they liquidated their risk without actually doing so, Bitfinex retains the fiat currency with the money ending up in their bank accounts earning interest for BitFinex, and not the personal bank accounts of the Bitcoin sellers who now received only interest free Tethers for their Bitcoin sales. Ultimately the key to Tether’s success has been in the willingness of crypto sellers to accept Tethers as a means of payment and hold these Tethers in their accounts trusting in the value of its purported peg to the USD. It is particularly alarming that Tethers now represent the majority of the demand for the top 10 available cryptocurrencies on the market today.
Let’s just look at Bitcoin for example:
The left side of the chart above shows the different currencies used to buy Bitcoin on a daily basis. It is clear that the largest contributor to Bitcoin’s daily liquidity is Tether, representing $15.4 billion on March 3, 2021. This represents 58% of the daily volume. The right side of the chart shows which currencies Bitcoin is being used to buy. This chart is alarming on a stand-alone basis; but when coupled with the fact that every major crypto currency, such as Litecoin, Ethereum and Caradano, all have very similar looking charts showing Tether as the dominant inflow, it then becomes extremely concerning.
Putting their faith in company statements that claim that each Tether is backed 1-to-1 by USD reserves, cryptocurrency buyers are treating each Tether as if it was equivalent to one US dollar. However, in reality, Tethers can and have been issued time and again, backed by loans with no disclosure of the credit worthiness of the buyer or whether any real collateral has been put up. This should worry any one that holds Tethers as it violates the basic premise of what it claims to be, a riskless stablecoin backed by credible assets available on demand. Tethers are being printed and placed into circulation in big enough volumes to drive up the price of crypto currencies including Bitcoin.
The key point is that Tethers make up over 50% of the daily volume of Bitcoin and up to 70% of the daily volume of some of the other major crypto currencies. This is important because if, at some point, Tether is audited and deemed fraudulent as our research would indicate, you could see the majority of the liquidity used to purchase cryptocurrencies devalued overnight. The impact on Bitcoin and the other major cryptocurrencies would be devastating.
One might naively assume there must be a huge daily inflow of USD into Tether Ltd. so they can provide the necessary liquidity for any major sell off. For a company claiming it promotes full transparency, it is unusual that there is no data available on what Tether Ltd. actually receives as payment when they issue Tethers. Tether Ltd.’s reserve position is completely based solely on company statements. The company’s executives have conveniently refused to perform any sort of independent third-party audit to prove that Tether’s reserves actually exist. Tether provides none of the government guarantees on banking deposits, nor does Tether follow any of the credit management techniques of banks, nor does it have a shareholder’s equity to cushion downside in the reserve portfolio. Tether is not audited and regulated by government agencies to ensure stability or offer anywhere near the level of disclosure that a bank provides. This is “trust” and “don’t verify”: the exact opposite of what cryptocurrencies are advertised to be.
Money flow from/to as of March 3, 2021
As can be observed from this chart, Tether represents the main buying power in the four cryptocurrencies above. This strategy they are deploying is dependent on people continuing to believe that 1 Tether (USDT) is exchangeable for 1 US dollar (USD). The key to keeping this PEG stable is limiting the ability for Tether (USDT) and USD to meet on an open exchange, but it appears there are very few places you can go to exchange your Tethers directly for US dollars. This is where it is important to understand how the various crypto exchanges operate.
Some exchanges, like Coinbase, are licensed and use real due diligence to curb money laundering, while the majority of the other exchanges are still part of the “wild west” offering little to no real due diligence. Tether operates exclusively on the latter. Below you will see how crypto trades typically flow through Coinbase Pro in a 24-hour period:
If you look at the left side of the chart above, all the funds going into crypto are almost all in fiat money: actual dollars, Euros and British Pounds. In contrast, in the charts below, three other major crypto exchanges, Binance, Bit-z, HitBTC, clearly do not share Coinbase’s enthusiasm for compliance as Tether is what is being used for the purchase of these currencies:
The charts above show a clear pattern, as the majority of the crypto currencies being sold on these exchanges are being bought with Tether. None of them are being bought with fiat currency and the volume of transactions on these exchanges are enormous. Coinbase Pro is responsible for around $4 billion in crypto trades each day. Binance alone can account for up to $50 billion worth of crypto volume at its peak. Therefore, you can conclude that the majority of the crypto being bought each day is being bought on these unregulated exchanges and traded for Tethers, rather than a real fiat currency, as we know it.
Interestingly, neither of the two most reputable and regulated USD-banked exchanges (where you can exchange crypto for cash), Coinbase and Bitstamp, support Tether trades at all. If Tether was a legitimate product, there would be no reason for them to forego the fees on that trading pair. The fact that these exchanges don’t allow you to trade Tethers for USD should be of concern. This prevents USD and Tether from meeting in a transparent open market ensuring that the true price of Tether stays opaque, making it hard for an outsider to dispute its $1 USD peg.
It appears the biggest exchange where you can sell Tethers for USD is an exchange called Kraken that according to Wikipedia has been found to be in potential violation of New York’s virtual currency regulations in 2018. Wikipedia also claims that In February of this year, “Kraken suffered a flash-crash that drove the price of popular currencies like Ethereum to 60% below market value triggering a large selloff. In a span of less than 3 minutes thousands of user positions were liquidated resulting in millions of customer losses”. The market for the trading pair of USD/Tether on Kraken is fairly modest, under $20 million in daily volume. The reality is whenever someone sells Tether for USD on Kraken, one would assume that Tether Ltd. would have no choice but to step in and buy it, because if they don’t, they risk letting the peg slip, which would unmask the whole charade. What is important to note is that there does not seem to be nearly enough USD as reserves on Kraken to exchange them for all the Tethers in the market place today.
The chart below is an example of the unlimited ability to print money as Tether’s market cap has risen to exponential levels as a result:
Based on recent activity, it appears that Tether is printing as much as it can. From 2014 to the beginning of 2020 the company had issued a total of 4.1 billion Tethers. From the beginning of last year to March 3, 2021 the company has issued a further 36 billion Tethers, an increase of 778% over 14 months.
Since Tether Ltd. has been pumping the volumes of cryptocurrencies, we are seeing a corresponding major price appreciation across the board. This price appreciation across various cryptocurrencies appears to correlate directly with Tether Ltd. printing more and more Tethers.
The aforementioned New York Attorney General’s inquiry into Tether started in April of 2019. If there was a chance they would be shut down following the investigation, it is possible that they would have wanted to print as much as they could before that happened. The aggressive printing of Tethers starts in the summer of 2019 and increases exponentially over 2020. With this in mind, is it surprising to see Bitcoin’s chart look like this?
The last piece of this puzzle is how do they print and get these Tethers into circulation without taking in the proportional amount of USD or any other real currency. This is where unregulated exchanges come in handy. They offer promotions and deals that give users the ability to leverage their account from 5-100x the value of the underlying investment. When doing a promotion, however, they don’t pay the users out in actual dollars, rather they pay them out in TETHERS, with the catch that you can’t sell your Tethers back into USD.
Loans made to third party affiliates work similarly (and they confirm they do this on their website) meaning that an exchange like Bitfinex (owned by Tether Ltd) can purchase, for example, 1 billion Tether coins with an IOU (no cash exchange). Bitfinex would then use the Tethers (paid with a mere IOU) to buy Bitcoin and other major cryptocurrencies from investors. This allows Bitifinex to create demand for Bitcoin without a single additional US dollar entering the market. The investor assumes that at any point in time they can sell their 1 Tether for 1 US dollar, but this is not the case because as we mentioned previously, the majority of exchanges do not offer US dollars for Tethers. If every investor tried to sell their Tethers through Kraken, the main exchange where they can trade Tethers for USD, the exchange would not be able to accommodate all the transactions as there aren’t sufficient USD in reserve to do this.
It is argued on some online platforms, that even if Tether were to be found to be fraudulent, since the market capitalization of Tether is only $40 billion it only accounts for a fraction of Bitcoin’s $1 trillion dollar market cap, so it won’t have much impact on the price of Bitcoin if Tethers are found to be worthless. What is missing from this argument is that the market cap of Bitcoin is irrelevant except as a benchmark for the probable dollar amount of trading that occurs daily. Ultimately, the only thing that really matters in determining the price will be the volume of buyers wanting to buy versus the volume of sellers wanting to sell on any given day. When the buyers have a printing press and constitute most of the buying it doesn’t take a rocket scientist to understand what will happen to the price of what is being purchased.
How Does It End?
Cryptocurrencies, specifically Bitcoin, have been advertised as a superior method for conducting transactions because of transparency and decentralization. There could certainly be value in the decentralization of currency that is instant and does not require the regular slow and bureaucratic banking system; but when operating mostly outside a regulated financial system, as many crypto currencies currently are, it is impossible to estimate how much of that value is real today, and how much of it could be plain fraud.
The most legitimate crypto exchanges, like Coinbase and Bitstamp, do not support Tether on their platforms. With the only real volume trading on Kraken, this limits the ability to exchange Tethers into USD to a small amount, reflecting what they have in USD reserves and not what they pretend to have. By not being on these other exchange platforms, Tether Ltd. can control how much liquidation of Tethers into USD can occur. If other exchanges were to control the process, and larger liquidations were attempted, any level of fraud would be instantly obvious.
One way this could end is if governments start to enforce 100% reserve requirements on all USD-pegged crypto stablecoins, with mandatory audits.
There is a lot of genuine potential in crypto, but that potential won’t be realized if the industry is riddled with fraud and other questionable behaviour. While over-regulation is a legitimate concern, the fact that the market is enabling Tether Ltd. for so long and at such a scale, is a clear sign that there is a much-needed mechanism to validate the reserves of stablecoin issuers.
Healthy and reasonable regulation makes a market more valuable, not less. Bitcoin could be a valuable product but if it is being bought using a potentially fake currency, then one can conclude its quoted valuation in dollars is questionable. If more than half of the daily volume in Bitcoin is from a currency of dubious value, one can only assume that the value of Bitcoin is of dubious value itself.
This is the one time in your life that you might actually want to read the legal agreement (on their website) for clarity on what would happen if you actually tried to redeem a Tether.
Some of our favorite highlights are summarized below with the referenced part of the legal agreement:
a) Our interpretation: Tether redemptions are subject to us having liquid and sufficient reserves and we don’t have to give you USD back. We can also use anything we want as Tether reserves at our sole discretion.
“The composition of the Reserves used to back Tether Tokens is within the sole control and at the sole and absolute discretion of Tether. Tether Tokens are backed by Tether’s Reserves, including Fiat, but Tether Tokens are not Fiat themselves. Tether reserves the right to delay the redemption or withdrawal of Tether Tokens if such delay is necessitated by the illiquidity or unavailability or loss of any Reserves held by Tether to back the Tether Tokens, and Tether reserves the right to redeem Tether Tokens by in-kind redemptions of securities and other assets held in the Reserves. Tether makes no representations or warranties about whether Tether Tokens that may be traded on the Site may be traded on the Site at any point in the future, if at all.”
b) Our interpretation: You have to be a verified customer of Tether to redeem Tethers. Tether, in their sole discretion, gets to decide if you are a customer.
“In order to cause Tether Tokens to be issued or redeemed directly by Tether, you must be a verified customer of Tether. No exceptions will be made to this provision. Based on documentation, information, or records provided by you, requested by Tether, or otherwise available, Tether in its absolute and sole discretion may determine that you are a customer of TIL or TLTD. Such determination will be communicated to you.”
c) Our interpretation: You can’t sue Tether in a court of law with a jury judging the lawsuit.
“JURY TRIAL WAIVER: TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, THE PARTIES HEREBY IRREVOCABLY AND UNCONDITIONALLY WAIVE ALL RIGHT TO TRIAL BY JURY IN ANY LEGAL ACTION OR PROCEEDING OF ANY KIND WHATSOVER ARISING OUT OF OR RELATING TO THESE TERMS OF SERVICE OR ANY BREACH THEREOF, ANY USE OR ATTEMPTED USE OF THE SITE OR THE SERVICE BY YOU, AND/OR ANY OTHER MATTER INVOLVING THE PARTIES. [emphasis added]”
We highly recommend you use the link mentioned above to read their legal agreement.
2. JP Morgan Concerns:
3. Press Release from the New York US attorney on recently resolved Tether case:
4. Tether also has had difficult building a relationship with any reputable financial institution. Their only bank appears to be Deltec Bank out of the Bahamas:
Although we cannot look at the assets of Tether or Deltec as they conveniently do not disclose them, we can look at the assets of the Central Bank of the Bahamas which would include Deltec’s information.
5. Additional information on manipulations in the crypto markets:
6. Nouriel Roubini ‘s view on Crypto and how he was right back in 2008:
7. The Initial Lie:
8. How Cryptocurrency scams work:
9. Bitfinex and Tether’s Relationship further explained:
10. Bitfinex’s response to the NY Attorney General:
11. Podcast with the CTO of Tether and General Counsel of Bitfinex “defending” their position: