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If Tether falls, FTX and Coinbase will let their users pay the price
That price is unlikely to be $1.
If you’ve been following cryptocurrencies for awhile, you may have heard that the market is down:
Above is the list of top 10 cryptocurrencies by “market capitalization.” The only three coins in that list whose price hasn’t substantially declined over the past 30 days are Tether (USDT), USD Coin (USDC), and Binance USD (BUSD).
These are known as stablecoins, and they currently have a collective market cap of around $140 billion, representing at least 15%1 of all value in the entire cryptocurrency ecosystem. Their price is theoretically pegged 1:1 to the U.S. dollar, and thus is not supposed to fluctuate with the rest of the market. Within crypto, stablecoins act as a dollar stand-in. It’s where traders park their money, and also how they deploy leverage: speculators post, say, ether as collateral in order to borrow USDT (often in order to buy even more ether).
It may seem a little odd to have a dollar stand-in instead of just using actual dollars. There are a number of reasons for this, but one of the most important ones is the relatively limited supply of on- and off-ramps to fiat currency within the crypto ecosystem.
Much (all?) of crypto activity is speculative, and the traders engaging in it ultimately want to make a profit in real currency, i.e. USD. However, while there are plentiful options for crypto-to-crypto trading (say, exchanging UNI for SHIB), the number of exchanges that allow deposits from, and withdrawals to, actual sovereign-backed currencies like dollars, euros, yen, etc. is significantly smaller.
This is in part because, to enable withdrawals, exchanges need bank accounts. And banks are historically nervous to open accounts for crypto exchanges, because banks have to follow laws and regulations under the Know Your Customer (KYC) and Anti-Money Laundering (AML) umbrellas, while broad swathes of the crypto ecosystem are a loosely-held amalgamation of insider trading, fraud, pump-and-dump operations, and Ponzi schemes. (And, presumably, some legitimate trading too.) So banks and at least some exchanges are not always a great match.
There’s also a sort of market bifurcation that happens because of this. There are exchanges that operate purely within the crypto ecosystem — especially in “DeFi,” or decentralized finance — and don’t offer withdrawals or deposits to fiat currencies: because they don’t need bank accounts and thus don’t adhere to regulations, they can offer trading on the most absurd, obscure cryptocurrencies and provide wildly irresponsible products like double-digit yields on crypto loans.2 Meanwhile, the exchanges that offer withdrawals to real currencies must comply with KYC/AML regulations and thus offer a much more limited subset of features in the relevant jurisdictions.3
So let’s say I’m a trader that wants to speculate on BlatantPonziCoin (BPC). To get funds into the crypto ecosystem, I would first deposit real U.S. dollars into one of the more “responsible” banked exchanges like Coinbase, and then use that money to buy, say, USDT (the Tether stablecoin). At that point I can trade USDT directly on Coinbase. But if Coinbase doesn’t list BlatantPonziCoin, I’m likely to transfer my USDT to wilder, less restrictive DeFi exchanges so I can speculate to my heart’s content. For example, I might use USDT to buy BlatantPonziCoin and then post it as collateral to obtain a loan for more USDT in order to buy even more BPC.
So stablecoins are a way of greasing the skids for moving funds around within the crypto ecosystem and amping up leverage. They enable exchanges and protocols that don’t have fiat on- and off-ramps — that is, banking relationships — to act almost as if they do, by providing trading pairs for USDT and other stablecoins which traders treat as proxies for actual dollars. Stablecoins are also a good place to park funds when the market is crashing, without having to fully withdraw into a USD bank account and then re-deposit back into the exchange when the market recovers (each of which can take a few days of settlement times).
Now the key stipulation here — the assumption that underpins all fiat-backed stablecoins — is that every 1 unit of the stablecoin is backed by exactly $1 in real U.S. dollars. That is, every time a new Tether is created (or “minted,” in the lexicon), that should mean — by definition — that a corresponding U.S. dollar (or close equivalent, such as U.S. Treasuries) is sitting somewhere in a Tether bank account.
Otherwise, Tether could be minting USDT out of thin air and manufacturing demand for cryptocurrencies that doesn’t actually exist, thereby artificially propping up prices. This would also mean that, during a panic — when everyone’s trying to get out of cryptocurrencies and back into real ones — Tether could face a bank run where more people are trying to “redeem” their USDT for U.S. dollars than Tether actually has in the bank.4
So the single most important fact to establish, if you’re a stablecoin, is that you actually have U.S. dollar reserves (assets) that are equal to, or greater than, your total liabilities in issued stablecoins, which your customers can redeem for U.S. dollars at any time.
This is especially important for Tether, which — as the largest stablecoin in the world — has $67 billion of liabilities paired with an extremely concerning and well-documented history of not having fully backed reserves.
Tether shares a parent company (iFinex) and most of its executive team with Bitfinex, a cryptocurrency exchange:
This relationship is central to the nearly $20 million settlement Tether reached early last year, after it was sued in 2019 by the New York attorney general for “[engaging] in a series of conflicted corporate transactions whereby Bitfinex gave itself access to up to $900 million of Tether’s cash reserves, which Tether for years repeatedly told investors fully backed the tether virtual currency ‘1-to-1.’”
The 2021 settlement of this lawsuit required Bitfinex and Tether “to end all trading activity with New Yorkers,” and the AG’s statement announcing the outcome did not mince words:
In the case of Tether, the company represented that each of its stablecoins were backed one-to-one by U.S. dollars in reserve. However, an investigation by the Office of the Attorney General (OAG) found that iFinex — the operator of Bitfinex — and Tether made false statements about the backing of the “tether” stablecoin, and about the movement of hundreds of millions of dollars between the two companies to cover up the truth about massive losses by Bitfinex…
“Bitfinex and Tether recklessly and unlawfully covered-up massive financial losses to keep their scheme going and protect their bottom lines,” said Attorney General James. “Tether’s claims that its virtual currency was fully backed by U.S. dollars at all times was a lie.”
Seems bad! But things got even worse last fall, when the U.S. Commodity Futures Trading Commission settled its own separate case with Tether, this time for another $41 million. Perhaps inspired by the New York AG, the CFTC announcement didn’t shy away from its conclusions either (emphasis mine):
However, the Tether order finds that from at least June 1, 2016 to February 25, 2019, Tether misrepresented to customers and the market that Tether maintained sufficient U.S. dollar reserves to back every USDT in circulation with the “equivalent amount of corresponding fiat currency” held by Tether and “safely deposited” in Tether’s bank accounts. In fact Tether reserves were not “fully-backed” the majority of the time. The order further finds that Tether failed to disclose that it included unsecured receivables and non-fiat assets in its reserves, and that Tether falsely represented that it would undergo routine, professional audits to demonstrate that it maintained “100% reserves at all times” even though Tether reserves were not audited.
As found in the order, Tether held sufficient fiat reserves in its accounts to back USDT tether tokens in circulation for only 27.6% of the days in a 26-month sample time period from 2016 through 2018.
On top of all this, the Department of Justice is investigating Tether executives for bank fraud, which may stem from an earlier-reported DOJ investigation into “whether [2017’s] epic [Bitcoin] rally was fueled in part by manipulation, with traders driving it up with Tether.”5
Stranger still, given its role as a stablecoin, Tether’s own legal terms are remarkably clear that redemptions to fiat aren’t guaranteed:
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.
As if this weren’t enough red flags, Tether’s CEO, JL van der Velde, and (ex-plastic surgeon) CFO, Giancarlo Devasini, are both almost entirely missing in action. They rarely speak publicly or grant interviews, leaving their CTO, Paolo Ardoino — who, incidentally, is married to their COO, Claudia Lagorio — to face the media. These interviews haven’t always gone that well:
Ah yes, this brings us to Tether’s audits. Well, lack of them. In the July 2021 CNBC interview referenced here, Tether general counsel Stuart Hoegner stated an audit was “months” away. Which would be great: given all of the sketchiness just recapped above, such an audit of Tether’s books is precisely the sort of thing that could help clear up its murky financing.6
The problem is, Tether has yet to deliver an audit despite promising one for years (note the tweet timestamps):
Bizarrely, simultaneously with making these promises that they will soon be audited, Tether has also stated that being audited is impossible (emphases mine):
"The bottom line is that an audit cannot be obtained," Hoegner told CoinDesk, claiming that this problem is not unique to his company but one faced by the entire cryptocurrency industry.
He went on:
"The barriers to getting audited are simply too big to overcome right now, and not just for us."…
Hoegner would not discuss the severing of ties with Friedman. However, he said Tether hasn't given up on the audit process. "We continue to be in discussions with a number of professionals and firms about what can be offered and when," he said.
Today, an accounting company called MHA gives quarterly attestations of its reserves, and Tether is working on a full audit – something other stablecoins also lack – but not with one of the big four auditors, according to Ardoino, because auditors are concerned about reputational risk, due to the lack of regulatory definitions around stablecoins[.]
“I think it’s one of the top 12, so not that bad,” he says. “The big four are a bit more cautious about providing a full audit when the rules are not clear.”
First, there’s an auditing Big Four: PwC, Deloitte, E&Y, and KPMG. There’s not actually a top 12 to speak of.
But even leaving that aside, why does the CTO of Tether not seem entirely sure who his own auditor is (“I think”), despite the fact that, nearly a year ago, his colleague stated its release was just “months” away?
In the glaring absence of these audits, Tether has instead provided third-party attestations, which bear caveats like this:
Our opinion is limited solely to the CRR and the corresponding consolidated total assets and consolidated total liabilities as of 31 March 2022, at 11:59 PM UTC. Activity prior to and after this time and date was not considered when testing the balances and information described above. In addition, we have not performed any procedures or provided any level of assurance on the financial or non-financial activity on dates or times other than that noted within this report.
This caveat is a giant loophole, especially considering that one of the CFTC’s key findings was that Tether moves funds into and out of their accounts as needed, specifically to pass attestations:
In addition, the order finds that Tether failed to complete routine, professional audits during the relevant time period. According to the order, Tether retained an accounting firm to perform a review of Tether reserves on a date Tether selected in advance, and Bitfinex transferred over $382 million to Tether’s bank account in advance of that review. The order recognizes that Tether has not completed an audit of the Tether reserves.
In fact, as Patrick McKenzie has pointed out, even if one generously accepts Tether’s attestations as gospel truth, one is inexorably led to the distinct likelihood that Tether is currently unbacked. Tether’s most recent attestation evaluates its assets as of March 31st, 2022. At that point, its net assets — assets minus liabilities — were $162,391,022. Meanwhile, its assets included approximately $5 billion worth of “other investments (including digital tokens).”
Since that date, the global aggregate market cap of cryptocurrencies has declined by 56%. Assuming Tether’s crypto assets fell at a rate broadly representative of the ecosystem as a whole, this means that even if Tether invested a mere 6% of that $5 billion “other investments” pool in crypto, these losses would more than wipe out its entire net assets cushion (presuming no other investments appreciated during that time), making Tether not fully backed.
Separately, just under a quarter of Tether’s total assets are comprised of “commercial paper & certificates of deposit,” where commercial paper is defined as “short-term debt issued by corporations.” This amount would make Tether one of the largest commercial paper holders in the world, and yet last year the Financial Times reported:
But this reported accumulation has largely gone unnoticed on Wall Street, according to several of the biggest players in the market including bank traders, analysts and money market funds.
“We’ve got lots of inquiries and heard lots of discussion, but have not seen any active participation,” said Deborah Cunningham at Federated Hermes.
“Until last week we hadn’t really heard of them,” said a trader at a large bank. “It was news to us.”
That’s not a thing! That’s not a thing at all! Every money-market fund just lists all of its holdings, by size and issuer and CUSIP! Tether has broken new ground in the concept of commercial-paper privacy rights! But, why?
Or as Hindenburg Research short-seller Nate Anderson put it:
Now, what does this all of this mean? Does it prove that Tether is definitively unbacked? No. But as legendary short-seller Jim Chanos memorably detailed on a podcast last month:
The way I would describe Tether…is it’s as if you’re outside a door that’s red hot, where the doorknob is red hot to touch, the door itself is hot, there’s smoke coming out from underneath the door, and yet they’re telling you nothing is wrong inside the room.
That could be! But boy oh boy, there’s an asymmetric sort of situation here if that’s not the case. And the fact that they could just simply open the door and show you that there’s nothing wrong, by way of an audit, appears to be something that they are studiously avoiding.
In short, if the above was too long and circuitous to read through, the synopsis is this: Tether is profoundly unreliable, and there are very real and serious concerns about the extent to which their issued stablecoin is backed by dollar (or dollar-like) reserves. This uncertainty, given Tether’s size and dominance, necessarily transforms any investment anywhere within the entire cryptocurrency ecosystem into a harrowing proposition.
All of which makes it that much more bizarre that major exchanges like Coinbase and FTX continue to support USDT-based trading pairs on their platforms. Keep in mind that there are safer alternatives: for example, Centre and Coinbase jointly issue U.S. Dollar Coin (USDC), the second-largest stablecoin with a roughly $55 billion market cap. Centre publishes monthly reports on its reserves, which are executed by a third party accounting firm, Grant Thornton LLP, and — crucially — USDC does not have a long and sordid history of run-ins with law enforcement or regulators.
It is, therefore, little surprise that Coinbase’s web site explicitly states: “For customers with a US dollar bank account, 1 USDC can always be redeemed for US$1.00.” FTX’s site does the same: “You can deposit [TUSD, USDC, PAX, BUSD, or HUSD] and be credited 1:1 with USD, and you can withdraw USD as any of these 1:1.”
This is an important feature. You can’t log onto Fidelity and click a button to sell Microsoft stock to them at a fixed price at any time. But you can do that with USDC on Coinbase and FTX precisely because, from the exchanges’ point of view, USDC and the U.S. dollar are functionally interchangeable.
But just as importantly, neither exchange guarantees that Tether will be redeemable at par to the dollar. FTX’s help pages make this explicit: “Note that tether (USDT) is not part of the USD Stablecoins basket on FTX. We do support USDT though.” Coinbase similarly lets it float as if it’s any other token.
Given the availability of USDC, why bother listing a potentially dangerous rival product like Tether while nevertheless not promising to redeem it at par? I wondered this aloud on Twitter and got a quick response from an FTX exec:
But this is a red herring. Tether charges a max 0.1% fee for redemptions, and even this small fee is only applied for conversions between Tether and fiat currencies. If FTX truly believed in Tether being fully solvent, they could simply “deposit” any excess Tethers with Tether when no longer needed, and withdraw them during periods of high demand, without incurring any fee whatsoever. The fee only comes into play if FTX wanted to trade in their Tethers for U.S. dollars. But why would FTX need to do that on a regular basis?
They wouldn’t. Unless, of course, they’re not sure Tether is fully backed. If a USDT token in FTX’s Tether account is just as good as a U.S. dollar, why bother paying a fee to jump back and forth between USDT and a U.S. dollar?
Even leaving this incongruity aside, Protos reported late last year that FTX’s parent company, Alameda Research, was the single largest destination of Tethers. You’d think that monopsony position would buy it some leverage over a 0.1% redemption fee.
Salame’s argument doesn’t make much sense from Tether’s perspective either. Why would Tether let a 0.1% fee get in the way of being treated as equivalent to their stablecoin competitors (to whom they’re rapidly losing market share at the moment) by being listed as redeemable 1:1 with U.S. dollars?
In short, it is difficult to escape the conclusion that FTX and Coinbase want to have it both ways: neither of them is willing to financially guarantee the USDT-USD 1:1 peg by promising to redeem USDT at par for their customers.
And yet both exchanges continue to list USDT on their platforms not simply despite the risk that Tether has manipulated crypto prices but, in some sense, because of it: if indeed the nightmare scenario is true and Tether is printing unbacked tokens at will, then the benefits of cryptocurrencies’ elevated prices and increased trading volume accrue to Coinbase and FTX (which, after all, accepts USDT as collateral for margin trading). But if the peg ever snaps, their customers will be left on the hook for all of the risk, holding USDT that’s worth less than a dollar each.
And such a seismic event is not a particularly unthinkable outcome. Last month’s spectacular collapse of the $40 billion ecosystem built around the algorithmic stablecoin TerraUSD (UST) and its paired token LUNA — which was backed by little more than marketing and deliberately obfuscatory tokenomics — kickstarted a cascade of panic-selling, forced liquidations, and insolvencies in crypto that has yet to end.
Tether’s size is nearly four times that of TerraUSD’s. And while it is true that fiat-backed stablecoins are an entirely different animal from algorithmic ones, this only holds true if they’re actually backed.7 The whole point with Tether is that no one can be sure.
FTX CEO and founder Sam Bankman-Fried (or SBF, as he’s commonly known) has made a sort of cottage industry out of slyly winking at fraud-adjacent practices while simultaneously facilitating them on his platform and then pretending the gruesome endgame was obvious once they collapse.
For example, on a much-discussed Odd Lots podcast episode this April, SBF vividly and accurately described yield farming — a popular but highly risky (and often extremely-leveraged) crypto strategy involving staking collateral in order to receive improbably large, unsustainable yields — as a magical box into which investors indiscriminately throw their money:
And now all of a sudden everyone's like, wow, people just decide to put $200 million in the box. This is a pretty cool box, right? Like this is a valuable box as demonstrated by all the money that people have apparently decided should be in the box. And who are we to say that they're wrong about that? Like, you know, this is, I mean boxes can be great. Look, I love boxes as much as the next guy. And so what happens now? All of a sudden people are kind of recalibrating like, well, $20 million, that's it? Like that market cap for this box? And it's been like 48 hours and it already is $200 million, including from like sophisticated players in it.
To which Bloomberg’s Matt Levine astutely replied: “I think of myself as like a fairly cynical person. And that was so much more cynical than how I would've described [yield] farming. You're just like, well, I'm in the Ponzi business and it's pretty good.”
Or take the TerraUSD (UST) / LUNA fiasco last month. Immediately following its collapse, SBF tweeted:
And yet here was SBF’s own exchange, FTX, announcing it would list LUNA just three months earlier:
This nihilistic approach to (not) protecting their own clients from harm isn’t confined to SBF or FTX.
Binance, by far the world’s largest crypto exchange by volume, is run by Changpeng Zhao (more commonly referred to as CZ). Following Terra / LUNA’s collapse, CZ described Terra founder Do Kwon’s LUNA 2.0 plan as “wishful thinking:”
You’ll never guess what CZ’s exchange announced just two weeks later:
The straw man response to all this would be that CZ and SBF run agnostic exchanges, so why should they be making investment decisions on behalf of their clients? And the answer is that both Tether and the original TerraUSD (UST) token are stablecoins: they are unlike standard investments, which everyone understands can and will fluctuate in value over time.
People — and, crucially, the markets, based on their stable prices — treat stablecoins as a separate category from other investments and consider them fully interchangeable with actual U.S. dollars. But these stablecoins have none of the protections of U.S. dollars (for example, being insured for up to $250,000 in a bank deposit). Holding a stablecoin that could fall apart is a far more pernicious and dangerous risk than simply buying a random altcoin that fails to gain traction, because the baseline expectations are so wildly different.
And SBF knows this. We know he knows this because he and fellow FTX (and parent company Alameda Research) executives have deployed the same knowing wink in their defense of Tether as he has in the other areas mentioned above:
This is classic misdirection. FTX’s ability to redeem Tethers for U.S. dollars does not demonstrate that Tether is fully backed, any more than a wildcat-era bank’s ability to redeem a single customer’s IOUs demonstrates that it is fully backed. The proof comes when the entire customer base is banging down your door asking for their cash.
In an August 2021 appearance on Odd Lots, SBF was asked for his opinion on Tether and gave a long and rambling answer in which he acknowledged being perceived as “a Tether apologist,” repeatedly described Tether’s redemption process as “a messy process,” and yet ultimately concluded that “the funds are there” and that “everything sort of checks out in a messy way:”
And then you can sort of get to the question of: what's their business model? It’s probably getting yield on the dollars. How are they doing that? I dunno. You know, like some commercial paper-like stuff.
And you know, I think it's like one of these things where, if you want to try and argue about whether Tether’s worth 99 cents or a dollar and a penny, I think that's a pretty reasonable argument…
And I think the other thing is you get to know the people involved here. They really, really aren't scammers.
Presaging Jim Chanos’ later description of Tether, SBF summarized: “There’s sort of a case where there’s a lot of smoke, but I don’t think there’s really much fire. But there is smoke.”
So why is SBF smelling smoke on his exchange?
CORRECTION: This post originally, and incorrectly, stated that FTX had listed the revived LUNA token for trading on its exchange. In fact, FTX simply airdropped the new token to holders of the legacy LUNA and UST tokens. FTX does not appear to currently support active trading of the new LUNA token.
It’s almost certainly higher than 15%, as “market caps” in crypto bear little to no resemblance to real money invested. (See the “Market cap doesn’t represent real money invested” section here for more on this.)
Several of these exchanges operate specific subsidiaries for U.S. residents that are separate from their international businesses. For example, the FTX exchange operates both FTX.com (unavailable to U.S. residents) and an exchange with a narrower set of features for their American customers, FTX.us. Binance does the same thing with Binance.com and Binance.us.
It’s actually worse than this, because most people actually have no ability to redeem their Tethers whatsoever. First of all, the vast majority of “U.S. persons” are banned from transacting directly with Tether. And secondly, the minimum fiat deposit or withdrawal from Tether is $100,000. This obviously eliminates the vast majority of people who’ve ever interacted with Tether from redeeming their tokens with them. In effect, it’s mainly a small cartel of exchanges that deposit and withdraw directly with Tether.
First, Tethers are created by the parent company Tether Ltd., often in large chunks such as 200 million. Almost all new coins then move to Bitfinex, he said. When Bitcoin prices drop soon after the issuance, Tethers at Bitfinex and other exchanges are used to buy Bitcoin “in a coordinated way that drives the price,” Griffin said in an interview…
Griffin’s paper describes several patterns uncovered in a yearlong period. First it found that flows weren’t symmetric. When Bitcoin’s price fell, purchases with Tether tended to increase, helping to reverse the decline. But during times when Bitcoin rose, Griffin said he didn’t see the reverse occur. That’s “suggestive of Tether being used to protect Bitcoin prices during downturns,” he wrote.
A 2018 Bloomberg article noted that Tether had recently “cut ties” with its auditor, Friedman LLP, complaining of “the excruciatingly detailed procedures Friedman was undertaking for the relatively simple balance sheet of Tether.”
Circle’s Chief Strategy Officer Dante Disparte, in a blog post published after Terra’s May collapse that was titled “The Importance of Being Stable,” none too subtly jabbed Tether on this very point: “These risks are not unique to certain algorithmic stablecoins alone. They may also may be present in larger asset-referenced stablecoins…where collateral and the composition of reserves is too opaque to inspire confidence or too correlated with illiquid assets with questionable credit quality to endure periods of stress.”