Tether is a cryptographic token built on the Bitcoin and Ethereum blockchains, the value of which is tied to USD through the presence of a centralized dollar reserve. There is skepticism about Tether that the system does not actually have sufficient reserve funds. But we think skeptics are focusing on the wrong things. In published financial information, we found possible evidence of Tether's presence and influence in the Puerto Rican banking system. Tether is likely to face, or has already faced, a regulatory problem, and in our opinion, this is what Tether holders should be concerned about.
What is it?
Tether allows you to use fiat currencies such as the US dollar on the Bitcoin (or Ethereum) blockchain. Whitepaper explains:
“A digital token backed by fiat currency, giving individuals and organizations a reliable and decentralized method of exchanging value using a familiar unit of account . Blockchain developments provide a verifiable and cryptographically secure ledger. Producers of tokens tied to existing assets and other market participants can take advantage of the technology, along with the built-in consensus system, to transact in assets that are familiar to them and subject to less volatility. To ensure accountability and price stability, we propose a method that involves holding a reserve that provides a 1-to-1 ratio between a cryptocurrency token and its associated real world asset, specifically fiat currency. This method uses the Bitcoin blockchain, Proof of Reserves, and other accounting methods to prove that issued tokens are fully backed and protected.”
The main way to use Tether is financial transactions on many exchanges, which make it possible to exchange this cryptocurrency for others. There are currently approximately 2.2 billion Tether available, representing $2.2 billion. As shown below, about 85% of the holders are known, and are the largest crypto exchanges. There is likely some mechanism by which these large holders can purchase Tether directly with USD.
Tether Hack
This happened when the Tether storage wallet was hacked in November 2017. $31 million was stolen and sent to a Bitcoin cold wallet, after which the funds were frozen through the Omni layer hard fork. That's where they are now (Quarantined in the diagram above).
The incident showed that Tether effectively controls the network, and can carry out division of the entire network in order to cancel any transaction. This raised the question of the wisdom of using existing blockchains, particularly Bitcoin, rather than creating one of our own. Be that as it may, developing your own system is complex and very time-consuming, etc. implies updating the software of all exchanges using this token.
Who controls Tether?
Details about the Tether team appeared between December 5 and 7, 2017 and were the same composition as the Bitfinex Exchange. Before this, the managers of Tether were not voiced, at least on the website, although the opinion that Bitfinex was behind Tether was quite widespread. This timing of the release of their shadow is associated with the receipt of a claim from the US Commodities Futures Trading Commission (December 6, 2017). Publication of the team list may indicate a claim for greater transparency of activities.
Since the release of the Paradise Papers in November 2017, there has been little doubt about the connection between Bitfinex and Tether, because the CFO and CSO of Bitfinex were listed as the owner and director of Tether.
However, there is an opinion that Tether is not controlled by Bitfinex. So, Craig Sellars, founder and advisor of Tether, etc. the former CTO of Bitfinex wrote in the spring of 2017:
“Bitfinex is a user of Tether. If Bitfinex needs more USDT, then they make a request to Tether, just like everyone else. Tether waits for the funds to arrive, and once this happens, it creates the required amount of its tokens and transfers them to Bitfinex.”
We do not believe there is evidence that Tether misled the public about Bitfinex's involvement, as some have claimed.
Tether Audit
Tether's home page states:
“Our reserve stocks are published daily and are subject to frequent professional audits”
The accounting company Friedman LLP (FLLP) published a report in September 2017, in which it confirmed that the USD balance in Tether reserves was adequate. The report contained information that as of September 15, 2017, bank accounts in the name of Tether held $382,064,782.
However, the report did not disclose the names of the banks or even the jurisdictions in which they operate. Also, the report stated:
“FLLP does not evaluate the terms and conditions of the bank accounts listed above, nor does it make any representations about the Client's ability to access funds from these accounts or whether funds can be used for purposes other than the redemption of Tether tokens”
In January 2018, Tether stopped cooperation with FLLP, explaining via email:
“We confirm that that the collaboration with Friedman is over. Given Friedman's excruciatingly detailed procedures for the relatively simple reconciliation of Tether balances, it became clear that an audit would be unattainable in a reasonable time frame. Since Tether is the first company in the cryptosphere to go through this process and pursue this level of transparency, it faces a lack of guidance and guidance on how to successfully complete this type of task.”
Lack of transparency and insufficiency audit processes compared to those stated on the site likely gave rise to rumors in the community that Tether is a Ponzi scheme.
Lack of transparency does not necessarily mean fraud
Tether allows its users to send and receive USD. Transactions cannot be easily blocked, nor do users need permission to make these transactions.
In addition to the above, Tether potentially allows customers to gain some degree of anonymity when making transactions. This feature makes it just as attractive to criminals as Bitcoin.
This state of affairs is unlikely to please regulators, and banks are likely to be skeptical about Tether. And the need to use a bank as a storage facility for USD reserves can become a problem, because... accepting such a client may violate the procedures followed by the bank, such as anti-money laundering regulations.
So, either the company may try to hide how Tether operates from the reserve bank, or the company will need to find a bank with better security procedures than prominent financial institutions. We believe that Tether may be trying hard to find a bank that satisfies all the conditions, and may also presumably have accounts in many banks in many jurisdictions to find a suitable partner. We think this is probably the main reason for the lack of transparency, rather than a shortage of USD. Obviously, the level of accountability that some Tether holders expect is not possible in the financial sector, where the company's activities are not fully permitted and not fully controlled by the authorities.
By the way, in case of problems with Tether, Bitfinex may have enough resources to save the system. In addition, the very existence of such an expensive asset as Bitfinex in the hands of people who own Tether makes the scams or Ponzi schemes that skeptics often fear less likely.
Financial data from Puerto Rico
There are rumors that Tether may be associated with the unincorporated organized US territory of Puerto Rico. We decided to look at public financial information to look for evidence of unusual activity or strong growth.
We noted strong growth in cash accounts (and deposit accounts) at International Financial Institutions (IFEs) in the banking category. This sharp increase in cash reserves may be due to Tether. It is also likely that this is a consequence of plans to turn Puerto Rico into a crypto-utopia, not directly related to Tether.
The chart below shows the relationship between Tether issuance and the balance of deposits in the Puerto Rico IFE. The coincidence is far from ideal, and there is no possibility of building a strong dependence. However, it would be interesting to look at the region's future data.
In addition to the overall increase in the number of monetary assets, it is worth noting the relative increase in the amount of cash in accounts in total assets.
Puerto Rico IFE Cash Relative to Total Assets (Source IFE Accounts, BitMEX Research)
< p> Such a structure of banks' balance sheets is atypical. Typically, banks lend out most of their assets and keep only a small portion in cash on their balance sheet.Example of balance sheets of a regular and 100% reserve bank (Source: BitMEX Research)
This kind of situation in the banking sector is visible even when assessing the macroeconomic situation. As of September 2017, the ratio of cash to total assets in this category of financial institutions in Puerto Rico has sharply exceeded 70%. This may be an indicator of the development of reserve banking in the territory.
Noble Bank
We took a look at the situation in the IFE category in Puerto Rico and identified two banks that can lay claim to the title of reserve banks: Euro Pacific International Bank and Noble Bank International. Banks like this are rare, and while other possibilities cannot be ruled out, they are certainly unlikely.
Extract from the list of registered IFEs in Puerto Rico (Source: Commissioner of Financial Institutions of Puerto Rico< span style="color: var(--basic_text_black);">)
Euro Pacific Bank was created by Peter Schiff, a famous Austrian economist and Bitcoin skeptic. In accordance with this attitude, it is unlikely that this bank can be associated with a structure as close to Bitcoin as Tether.
Noble Bank, in turn, has its place in the crypto world. A letter to the regulator in 2015 said the following:
“Noble intends to use a network of integrated financial markets to trade, clear and regulate real currencies, Bitcoin and other digital currencies”
Noble also entered into a Bitcoin business partnership with NASDAQ in 2015.
Noble Bank founder and CEO, John Betts, was also behind Sunlot Holdings in 2014, willing save MtGox. Sunlot was sponsored by Brock Pierce, one of the founders of Tether.
We suspect that the growth in reserves in this industry in Puerto Rico is related to Noble Bank and cryptocurrencies, whether that includes Tether.
Of course, all of the above does not prove anything. I would just like to point out that even if Noble Bank is the main reserve bank for Tether, there is no evidence that this bank did anything inappropriate or illegal.
The model above may well be the basis of the Tether structure, etc. explain how he is backed by dollars. In this case, the dollars that Tether reserves are in the Puerto Rican banking system, the reserves of which are held by the world's largest depository bank, BNY Mellon. If this is true, then Tether is not a Ponzi scheme, since USD reserves exist and are reported to the authorities, etc. that the reserves are relatively safe.
Be that as it may, we will show further that this does not provide complete peace of mind for Tether holders in the long term.
Use Examples
As stated earlier, Tether has the following characteristics:
- no permission is required to send or receive Tether
< li>transactions cannot easily blocked- users may have some degree of anonymity
Such properties can attract criminals and other money launderers into the system, In this case, the authorities will most likely want to shut down this system. This has happened more than once in the past, examples of which we will give:
- Liberty Reserve(06–13) is a centralized digital asset service that allows you to buy domestic currency for real money and send it. Closed in 2013 on charges of participating in the laundering of $6 billion.
- GoldAge(99–06) - before the creation of Liberty Reserve, the same founders made a payment platform backed by gold. Closed on accusation of laundering $4 million.
- e-Bullion (01– 08) - centralized Internet payment. In 2008, the co-founder was murdered, as a result of which the US Government confiscated the company's assets, destroying the system.
- DigiCash (94–98) - a payment system with a high degree of anonymity, the progenitor of Monero and the like. Bankrupt.
Also, the US Department of Justice gives examples of closing Internet payment systems, including the following:
- E-gold (96–07) - charge of laundering.
- ShadowCrew - laundering, etc.
- WEICEC (02–05) - cyber crimes, laundering.
Conclusion
History shows that centralized solutions with characteristics similar to Tether tend to be closed by authorities. At the moment, the token may be attractive to criminals and meet the same fate as the above projects.
In our opinion, Tether has two options:
- Rebuild the system to introduce KYC/AML procedures, which will allow operators to easily block transactions and freeze funds. To achieve this, Tether will be forced to rebuild the core architecture, etc. leave the public blockchain, becoming just a traditional reserve bank
- Continue as is, but always be under threat of closure from the authorities for any reason
In any case , criminal use of Tether is relatively low, while speculative use predominates. Additionally, we have not found any evidence that criminals are using Tether to launder funds. We believe that the threat of closure is unlikely.
If the system cannot block transactions, it does not require permission to use, etc. offers anonymous use, the likelihood of its collapse through the efforts of the authorities is high. A possible way around this is to build a distributed system that cannot simply be turned off. In our opinion, the ability of Bitcoin or other PoW systems to achieve such a solution for the system is still unproven.
