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Breaking Down the Tether Controversy: Where’s the Money?

October 14, 2022
6
min

The company has raised doubts about Tether’s integrity by failing to maintain adequate reserves and being slow to provide audited reports on how it backs its stablecoin.

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Volatility is the watchword in cryptocurrencies. Few asset classes have soared and crashed like digital tokens, over and over again. Bitcoin, the most valuable and widely held crypto, regularly records double-digit percentage moves in the space of a day—or even hours. Unlike stocks, there are no company financial reports or economic data to analyze with an eye toward how cryptocurrencies might behave. 

Still, there is one haven in the crypto markets free from volatility: stablecoins. As the name suggests, this type of digital currency is designed to be immune to the gyrations of Bitcoin and its ilk by pegging their value to fiat currencies such as the U.S. dollar, euro, British pound, or in some case even gold. In the stormy seas of crypto, stablecoins are a safe harbor. 

Or at least they’re meant to be. Doubts about the integrity of stablecoins have long dogged the biggest of the bunch, Tether. When another major stablecoin, Terra USD, collapsed in May and vaporized $40 billion of market capitalization, stablecoins became targets of scrutiny by investors and regulators.

What is Tether?

Tether crypto is the No. 1 stablecoin in terms of market capitalization, which is the value investors place on tradable assets. For years, it has been the No. 3 cryptocurrency, ranking just behind Bitcoin and Ethereum, and is worth tens of billions of dollars. Tether’s USDT coin is pegged to the U.S. dollar, and one token is supposed to always equal one greenback.

Tether is not a speculative asset like Bitcoin. It’s a trading tool. Investors convert fiat currency—dollars, euros, pounds—into USDT and hold it in reserve for use in the crypto markets. This makes it easier and faster to trade Bitcoin and other cryptocurrencies. 

Likewise, when traders want to exit crypto without the hassle of converting back into fiat currency they can buy USDT. In this way, investors are poised to reenter the market without the worry their holdings will fall in value even if the rest of the crypto market swoons.

What is the Tether controversy? 

Ever since Tether was founded in 2012 by iFinex Inc., a Hong Kong-based company, questions have dogged the venture about the method it uses to peg its stablecoin, USDT, to the U.S. dollar. Tether said it had amassed a reserve of cash and cash equivalents, mostly securities such as U.S. government and corporate bonds, to support USDT’s exchange rate on a 1-for-1 basis. That means there should be $1 (or its equivalent) in assets for every USDT token.

The issue was transparency. Unlike a bank, which is licensed and strictly regulated in most industrialized nations, Tether operates with little oversight, which is typical in the cryptocurrency industry. So it wasn’t required to disclose an audited breakdown of the reserves backing USDT. For years, investors just had to take it on faith that the stablecoin was fully backed by cash. 

Complicating the picture was the fact that Tether was linked to a sister company—Bitfinex, a crypto exchange. It, too, operated under the umbrella of parent company iFinex and was led by a trio: Chief Executive Officer Jean-Louis van der Velde, Chief Strategy Officer Phil Potter, and Chief Financial Officer Giancarlo Devasini. 

After Tether started trading on BitFinex in 2015, it became a popular instrument with crypto investors looking to quickly trade Bitcoin and other digital tokens. As Tether grew in market value—USDT rose 10-fold between 2019 and 2021, to $20 billion—the business attracted the attention of regulators. As they probed the company, they found evidence that it didn’t maintain the reserves it claimed to back the value of USDT.

What did U.S. and New York state authorities uncover at Tether?

In February 2021, Letitia James, the New York attorney general, said Tether and Bitfinex “deceived” clients by overstating reserves and concealing $850 million in losses. “Tether’s claims that its virtual currency was fully backed by U.S. dollars at all times was a lie,” James said in a statement. 

Tether had no reserves to back its stablecoin for periods of time between 2017 and 2021, the attorney general said. Even though Tether published a “verification” of its reserves in 2018, New York investigators found that cash had been placed in a bank account in the Bahamas on the morning it released the report. The next day, Tether transferred the cash back to Bitfinex. 

Under a settlement, Bitfinex and Tether paid $18.5 million in fines and both were barred from doing business in the state of New York.

In October 2021, the U.S. Commodity Futures Trading Commission which regulates derivatives, also ordered Tether to pay a penalty of $41 million for making “untrue or misleading statements” in connection with USDT. 

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How does Tether affect the price of Bitcoin? 

Critics also questioned whether Bitfinex was using Tether to manipulate the price of Bitcoin. In 2018, an academic study found that Bitfinex was using Tether’s stablecoins to buy Bitcoin whenever the token fell and pump up its value. The authors of the study concluded that  “unbacked digital money” was inflating cryptocurrency prices.

By 2021, half of all trades in Bitcoin were executed using Tether, fanning the controversy that far from being a useful tool the stablecoin was actually exerting undue influence on the cryptocurrency market, which hit $3 trillion in market value that November. 

How did Tether respond and what is it doing now? 

At the time it settled the New York case in February 2021, Tether started publishing an “Assurance Consolidated Reserves Report” that laid out the assets it held to support its stablecoin. The eight-page report was prepared by an accounting firm in the Cayman Islands. Since then, Tether has published a disclosure every quarter. 

As of June 2022 according to a report prepared by BDO, an accounting firm in Milan, Italy, Tether had reserves of $66.4 billion. About 8%, or $5.6 billion, is cash and bank deposits. The remainder is U.S. Treasury bills, bonds, other debt securities, and commercial paper, which are short-term corporate obligations.

Tether has rejected speculation that a substantial portion of its commercial paper portfolio is tied to Chinese companies, and that those securities trade at a 30% discount to their face value. The company has pledged to reduce its commercial paper holdings to $3.5 billion from $8.4 billion because those obligations are riskier than U.S. Treasury bonds. 

The bottom line

Tether has cemented itself in place as a key piece of the architecture in the cryptocurrency markets. Its stablecoin has become the tool of choice for traders to move in and out of Bitcoin and other digital assets. 

By failing to maintain adequate reserves and being slow to provide audited reports on how it backs its stablecoin, the company has raised doubts about Tether’s integrity. If investors lose confidence that Tether can maintain its peg to fiat currencies, the stablecoin could sink in value and become the very thing it’s not supposed to be—just another volatile cryptocurrency.

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