Regulators have waited too long to respond to so-called stablecoins, to the point where exposure to systems like the one powered by Tether has infected the entire digital asset industry – and even beyond.
This is thanks to a network of exchanges that surround and rely on Tether and that play a vital role in Tether’s ability to mint and launch new USDTs while maintaining the wafer-thin illusion that what are known as Stablecoins are supported by nothing at all. In return, the exchanges are allowed to sell the apparently worthless USDT in exchange for BTC.
That the program was so successful that companies like Bitfinex, Binance and FTX – the biggest recipients of newly minted Tether – saw unprecedented growth in the current boom in digital assets. These companies have been able to bring this growth to all types of extrinsic partnerships. For example, FTX just paid $ 135 million for the naming rights to the American Airlines Arena, home of the Miami Heat. Eric Woolworth, President of the HEAT Group’s operations, said:
“FTX.us is an exciting young company in an emerging category in the financial services industry that continues to grow at lightning speed, and we look forward to welcoming it to Magic City with open arms.”
But when the growth is sustained by the endless printing of USDT with no real support, it’s only a matter of time before the market realizes – and the whole farce collapses. Miami-Dade better hoped they got FTX prepayment.
Tether’s inner circle
Recall when Tether released its unilateral reserve report, which showed that 74.85% of Tether’s reserves were in “cash and cash equivalents.” Only 3.87% of that was cash. The majority is referred to as what Tether calls “commercial paper” (65.39%), which is 49% of the total reserve – the largest single component.
Commercial paper is a type of short-term, and usually unsecured, debt that is typically issued by one company to another to cover short-term obligations. Critically, however, there is one more category in Tether’s breakdown that covers secured loans and these are specifically labeled as non-affiliated loans. This implies that the other categories (including commercial paper) may be held by its sister company Bitfinex.
Tether is something of a link between many large and small players in the industry. Tether wants to hide this: In fact, until 2017, Tether and Bitfinex still insisted that there was no relationship between the companies: we now know that they belong to the same parent company, iFinex.
But Tether’s inner circle is clear when you can see where the newly minted USDTs go when they leave Tether. Twitter user LucaLand97 followed the journey of Tether’s $ 1 billion monster coin back in February:
The biggest target for this particular print was FTC, an offshore exchange.
What happens to the tether when it ends up in the wallets of those few exchanges? In theory, Tether should only be minted according to demand from investors using USDT as a medium of exchange to inject their fiat capital into digital assets without sacrificing the stability of the dollar.
However, according to a study published in the Journal of Finance in 2020, this doesn’t happen at all. The study found that in the case of Bitfinex, more than half of the USDT for Bitcoin exchanges at Bitfinex are related to a major player, suggesting that the USDT, which is spreading across the market, is not the result of many investors who have favourited Bitfinex to buy USDT for cash:
“After periods of negative returns, tether flows from Bitfinex to Poloniex and Bittrex, and in return Bitcoin is sent back to Bitfinex … If there are positive net hourly flows from Bitfinex to Poloniex and Bittrex, Bitcoin prices will rise in the next three hours.” resulting in predictably high Bitcoin returns. The price impact is present after periods with negative returns and periods after Tether has been printed, ie when an oversupply of Tether in the system is likely. “
“This phenomenon strongly suggests that the price effect is driven by tether emissions. In addition, the price impact is strongly linked to trading by one major player and not with other accounts at Poloniex, Bittrex or other Tether exchanges. “
It is not known what Tether will accept from these platforms in exchange for the USDT (although in the case of sister company Bitfinex we can see from NYAG’s complaint that the two are sending enormous amounts of assets to each other without a second thought) . Something like this would be almost instantly apparent if Tether did indeed publish a third party audit, but given the gaping gaps in Tether’s account of its reserves, one has to wonder if the “payment” for re-minted Tether is finding its way into Tether’s reserves “Commercial paper” or worse than digital assets.
Tether saves
People hold Tether because they assume it is fully backed by Tether’s cash reserve (or cash equivalents nowadays), but if that USDT is used – as the Journal of Finance study shows – to buy BTC, then has the price of BTC depended – for years – on how much USDT was minted at a given point in time. For its value, Tether has more trading volume than the next three – BTC, ETH, and XRP – combined.
What started out as concerned speculation has turned into an awareness of an impending crisis in the digital asset industry, and particularly the BTC community. If you’re still not convinced of the industry’s (and beyond) exposure to Tether’s scam, documents revealed by the NYAG investigation show that this is exactly what CFO Giancarlo Devasini was concerned about should Bitfinex customer withdrawals be exposed:
These selected exchanges form a critical pillar of tether fraud. Tether is used to print money, but exchanges like Binance and FTX convert the USDT into real value. Therefore, it is in Tether’s interest to save these beings in times of need.
Like earlier this month when there was a digital asset sell-off that wiped out 50% of digital asset prices almost overnight. In the chaos that followed, The Block reported on May 21 that FTX was suddenly in the middle of a funding round worth up to $ 1 billion. While the report is supported by three unnamed sources, there is no indication of who is leading the funding round and the details of its purpose are vague. It’s worth noting that Binance, another close circle of Tether, entered into a strategic partnership with FTX in 2019 that includes a stake in FTX. Under the partnership – and probably the main message of the agreement – “FTX will also help build liquidity and institutional product offerings across the Binance ecosystem ‘.
The next day, May 22nd, Tether minted USDT 1 billion.
The answer
The answer to this mess is stablecoin regulation. Tether has managed to match its current position in the market by disguising itself as a stablecoin – something Tether himself defined as a coin backed by 1: 1 cash reserves – and a look at Twitter will tell you that they buy the tethers do so on this basis. In reality, however, no one can guess the true composition of Tether’s reserves. Even taking Tether’s pie charts at face value, we can say that it doesn’t hold more than 4% of its reserve in cash.
Tether’s General Counsel, Stuart Hoegner, appeared to apologize for this in the affidavit he presented to NYAG in their investigation when he compared Tether’s model to the fractional reserve system used by banks. Hoegner undoubtedly regrets ever inviting a settlement, because the level of regulatory oversight and public disclosure associated with banking institutions would be the end of Tether’s charade of support.
And yet, Tether’s business is largely unregulated without a significant regulator. This is probably an important reason why the US Congress proposed the “STABLE Act” in December 2020, a law that would require stablecoins to obtain a full banking license and to comply with existing banking regulations. The law would surely have prevented any changing story from Tether about which assets, if any, support USDT.
Unfortunately, any action – be it by lawmakers or law enforcement – will come far too late now to save the digital asset markets from the Tether time bomb, the radius of which begins with the inner circle of Tether’s exchanges and now extends beyond the industry extends and goes as far as the NBA.
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