Is Tether a Wildcat Bank of Crypto Wild West?
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Is Tether a wildcat bank of Crypto Wild West?
More FUD and wild speculations about the most stable coin of them all
In the American Wild West, a wildcat bank was a type of unregulated and often fraudulent financial institution that operated in the absence of proper banking regulations. These banks were typically set up by individuals or groups who wanted to take advantage of the lack of oversight in the region to make quick profits.
Wildcat banks were known for issuing their own banknotes and accepting deposits from customers without having the necessary reserves to back them up. This often led to bank failures, causing many customers to lose their savings. In some cases, wildcat banks were set up as part of a larger scam, with the organizers absconding with the deposits and leaving customers with worthless banknotes.
The term "wildcat" refers to the practice of extracting oil from unproven oil fields, which was also a common practice in the Wild West. Just as oil prospectors would drill in untested areas in the hope of striking it rich, entrepreneurs would set up wildcat banks in areas where there were no established banks, hoping to exploit the lack of competition and regulations.
“… entrepreneurs would set up wildcat banks in areas where there were no established banks, hoping to exploit the lack of competition and regulations”
Tether was created in 2014 by Brock Pierce, Reeve Collins, and Craig Sellars. The idea behind Tether was to create a cryptocurrency that would be pegged to the value of the US dollar, which would provide a stable alternative to other cryptocurrencies that are known for their volatility. Tether is designed to be used as a medium of exchange in the cryptocurrency market, with the goal of making transactions faster and cheaper than traditional banking methods.
However, there are serious concerns about the legitimacy of Tether. For starters, Tether is not a regulated entity, which means that it is not subject to the same rules and regulations as traditional banks. This lack of oversight has led many to question whether Tether is actually backed by real dollars, or if it is simply printing its own money.
There have been several instances where Tether has been accused of engaging in shady practices. For example, in 2018, an investigation1 by the US Commodity Futures Trading Commission (CFTC) found that Tether had issued large amounts of cryptocurrency without backing them up with the necessary reserves. This raised concerns about whether Tether was actually able to maintain a 1:1 ratio with the US dollar, as it claimed.
Furthermore, Tether has been linked to the controversial cryptocurrency exchange Bitfinex, which has also been accused of engaging in fraudulent activities. In 2019, the New York Attorney General's office accused Bitfinex of covering up a loss of $850 million by using funds from Tether to cover the shortfall. Bitfinex and Tether have denied these allegations, but the controversy has had a significant impact on the credibility of Tether.
Despite these concerns, Tether remains the most popular USD-pegged stablecoin globally, with a market capitalization of almost $83 billion as of this writing. This has led some experts to warn that Tether could pose a systemic risk to the cryptocurrency market, particularly if it were to collapse or face regulatory action.
“This has led some experts to warn that Tether could pose a systemic risk to the cryptocurrency market, particularly if it were to collapse or face regulatory action”
Counterintuitively, Tether Limited and its parent company iFinex have done little to address those concerns. There hasn’t been a single audit performed by a Big Four accounting firm, despite tens of billions USD reserves supposedly held by Tether. Multiple smaller auditors have dropped Tether as a client. Tether banking relationships have been terminated on several occasions and currently there’s no reliable information where the operating capital is deposited and whether those funds are held in Tether name or in the name of some shell companies. Citing the most recent Q1 2023 assurance report completed by BDO Italia2, Tether made the following claims3:
- Tether’s net profit for the quarter was $1.48 billion, contributing significantly to strengthening its reserves
- Tether’s reserves surplus reached an all-time high of $2.44 billion, up from $0.96 billion in Q4 2022
- Tether’s consolidated total assets amounted to $81.8 billion, of which 85% were held in cash, cash equivalents, and other short-term deposits
- Tether’s majority of its reserves were invested in US Treasury Bills, and it also reduced its reliance on bank deposits and secured loans
- Tether reported for the first time its allocations in physical gold, overnight repo, corporate bonds, and bitcoin, which represented 4%, 3%, 3%, and 2% of its total reserves respectively
“There hasn’t been a single audit performed by a Big Four accounting firm, despite tens of billions USD reserves supposedly held by Tether”
Below are my personal musings about the nature of Tether based on six years of following the subject. In no way do they represent the official stance of Elementus towards Tether, Bitfinex, USDT stablecoin, and all other mentioned entities and persons.
- Tether is a fractional reserve banking operation - there is no doubt about that. Just looking at the disclosures made in the most recent Tether “assurance report” non-USD denominated assets (physical gold and Bitcoin) comprise 6% of total reserves while reported surplus is less than 3% of reserves, which invalidates the narrative of full backing by USD cash and equivalents4. This is also the first time ever Tether admitted having Bitcoin as a reserve asset.
- As any fractional reserve bank, Tether is engaged in accepting deposits and originating loans while maintaining adequate capital reserves to honor redemptions. It’s a fact that Celsius has borrowed 1 billion USDT after posting their customers’ BTC as collateral, which was promptly liquidated when Tether issued a margin call to Celsius. That 1 billion USDT issued to Celsius clearly wasn’t backed by real dollars when it originated but was in fact a secured loan.
- If Tether has a majority of reserves invested in US Treasury Bills to the tune of tens of billions USD, why have the primary dealers never heard of such prominent treasury market participant as Tether? That may have been answered in a WSJ article stating that Tether treasury operations are conducted exclusively through Cantor Fitzgerald.
- Tether rarely processes redemptions because the main mechanism for conversion to fiat is through off-ramps such as Kraken, which natively support USDT, or through an intermediate step of swapping USDT for BTC and subsequently selling Bitcoin for fiat USD.
- USDT peg is maintained by a number of arbitrageurs with close relationship to Tether (Cumberland DRW, Mitchell Dong’s Pythagoras Investment Management and others). The co-dependent nature of Tether’s relationship with affiliated arbitrageurs enables the latter to borrow billions worth of USDT at attractive rates to finance not just USDT arbitrage operations but also proprietary trading strategies that often move crypto markets.
- Tether and Bitfinex is the same organization (sharing executives per Paradise Papers leak), which has been acting as the Central Bank of Crypto by maintaining price stability of Bitcoin as “reserve currency of crypto” along with USDT dollar peg5.
- The veil of secrecy and ambiguity surrounding Tether is intentional because it allows arbitrageurs to profit from significant USDT discounts due to “Tether FUD” during market panics. On top of that, as the panic around the safety of USDC reserves during the Silicon Valley Bank crisis has shown, it’s better when nobody knows at which bank a stablecoin’s reserves are deposited in a bank run or asset seizure scenario
- USDT market capitalization is dominated by ERC-20 token on Ethereum and TRC-20 token on Tron, with the latter being widely used in Asian shadow banking system and inter-exchange capital transfers due to the lower cost of transactions on Tron. There’s a hypothesis based on FTX/Alameda court case details that one of the main revenue streams for the Hong Kong-based FTX was the business exchanging Chinese customers’ USD for USDT newly minted on Tron6.
- The need to continuously maintain the stable peg close to $1 results in leakage of information based on USD/USDT premium or discount as well as implied Tether price derived from BTC/USDT and BTC/USD market prices. I have been successfully using that information to extract alpha for Bitcoin trading strategies.
- There are several important use cases, which are enabled by Tether
- Agile dollar capital transfer mechanism facilitating profitable inter-exchange arbitrage strategies, which operates at the speed of crypto rather than banks
- Equivalent of a portable margin account, where traders borrow USDT from Tether and deploy that leverage across all crypto exchanges supporting pairs with USDT quote currency
- Safe haven asset - an alternative to hedging crypto portfolio exposure during market declines and high volatility is to simply swap crypto for a stablecoin such as USDT
- Pillar of the shadow banking system in Asia and the developing world, among other things enabling capital flight from China and cross-border USD transfers outside of Swift, which is subject to transaction censorship by US authorities
- Tax avoidance on gains made trading crypto at offshore exchanges or on income received as USDT payments
Sources:
1 https://www.cftc.gov/PressRoom/PressReleases/8450-21
6 https://protos.com/tether-papers-crypto-stablecoin-usdt-investigation-analysis/