The “Is Tether a fraud” question isn’t new. For at least a year market participants have been asking. Tether may represent a systemic risk to the cryptocurrency market since it is widely used as a stable asset to store buying power.
Our goal is to provide investors a non-biased analysis of the big questions in crypto. So without further delay let’s discuss Tether (USDT).
Tether is a fiat pegged cryptocurrency. The peg is 1:1 Tether to US Dollar. Why is this necessary?
Until recently many cryptocurrency exchanges did not deal directly with fiat currency. For example, when we first funded our account on a crypto exchange we had to wire-transfer dollars to a bank whom the crypto exchange we were dealing with had a relationship. Over a few days the wire amount appeared in our crypto exchange account as Tether (USDT) not Dollars (USD). The exchange and bank worked out the particulars so that the exchange wouldn’t touch the fiat dollars, hence the crypto account being funded with Tethers.
Tether and other stable coins, provide a means to store value at a constant price while retaining the benefits of cryptocurrency (i.e. fast settlement of funds, ease of transfer). Many traders and investors may sell Bitcoin for example and keep the funds in Tether until another buying opportunity arises.
Below is a graphic of how the Tether creation/redemption process works from page 7 of the Tether whitepaper.
Per the graphic above, Tether Limited is where the fiat reserves are held. The Tether Limited account should hold a balance of fiat currency greater than or equal to the total amount of Tether (USDT) in circulation. This relationship is central to the 1:1 peg. Therefore, we have to TRUST that the account actually holds the correct amount of fiat in reserve to support the Tethers in circulation.
If this central requirement is proven to have been violated, then the peg will break. The risk being that all the Tether held in crypto accounts become worthless, and massive amounts of buying power evaporate quickly. A panic would ensue in the entire crypto market. Investors would dump crypto assets as market confidence plummeted. The loss of confidence combined with liquidity drain (loss of buying power in the form of now worthless Tether) would create a massive gap down. In simple terms, this would be a very bad thing.
What’s the worry? Could an outright fraud be taking place?
There are some worrying signs. In January 2018 Tether announced that it had dissolved its relationship with its third party auditor. That’s never a good thing.
A study in early June 2018 concluded that Tether creation occurred at “pivotal” moments in Bitcoin trading. The study went on to say that “Tether seems to be used both to stabilize and manipulate Bitcoin prices”.
Sometimes things aren’t what they seem to be, but most of the time things are exactly what they seem to be. This is sketchy at best.
In late June 2018 Tether hired a high profile law firm to attest in an unofficial audit that its reserves were sufficient. Although unofficial the firm led by a Former FBI Director certified that the reserves were sufficient.
Coin Savage performed a quick survey itself to test the validity of the claims in the Tether white paper. On page 8, the paper summarizes how Tether can be redeemed and thus removed from circulation:
Step 4- The user deposits tethers with Tether Limited for redemption into fiat currency.
Step 5- Tether Limited destroys the tethers and sends fiat currency to the user’s bank account.
Since Tether (USDT) is a stable coin with a pegged 1:1 ratio to the US Dollar, then supply should equal market capitalization. The graph below shows an ever increasing supply, with a few dips.
Since an outright fraud bent on manipulating Bitcoin prices higher would want an ever increasing supply of Tether, we asked the Reddit Community if anyone had actually ever redeemed Tether for fiat. A dip in supply could represent actual redemptions which would, in a small way, validate the concept in the whitepaper.
With over 3000 views, one person replied:
I can sell usdt for AUD on coinspot.
At least there is one person. Not an overwhelming amount of evidence, but at least the process seems to be in place per the whitepaper.
There is no definitive proof that Tethers are being created out of “thin air” without the fiat to back them. Given the international nature of cryptocurrency and the ability to hop from jurisdiction to jurisdiction to avoid a true audit, we may never know the complete truth.
What is important is to be cognizant of the risk. In our view three (3) scenarios exist on how this could play out: