Some months ago, FTAlphaville’s Izzy Kaminska wrote the following:
Once upon a time, eurodollars were dollar-like liabilities issued by non-US entities outside of the reach of regulations that usually govern dollar-issuing entities. No minimum reserve requirements, no access to lender of last resort and no registration applied. Most of the time the assets which underpinned them (so-called eurobonds and eurosecurities) were also entirely bearer in form. They were dollars, but not.
This was a fun time for those who wanted to benefit from the stability of the dollar, without having to observe any of the legal structures that underpinned it.
International regulatory efforts since the 2008 global financial crisis ironed out the gappy supervisory conditions which allowed these two entirely different types of liabilities (real dollars and eurodollars) to co-exist on seemingly indistinguishable grounds.
And yet, even in the most lenient phase of the eurodollar bearer explosion, market convention still had it that issuing entities had to deliver on basic investor expectations like one-to-one parity at redemption point. Those entities which over-issued eurodollar liabilities but when called upon could not honour them, found themselves shunned by the market, reputation tattered, unable to do business.
The exception was 2008 when the scale of defaults arising from the sector got so large and so systemically-entangled that only a bailout from the official dollar lender of last resort could save the eurodollar system — much to the annoyance of taxpayers everywhere.
Fast forward to 2017 and despite the scale of the post-crisis regulation attempting to constrain offshore eurodollar issuance (especially that de-facto intermediated by US domestic institutions), it looks like digital innovation is doing its darnedest to revive the whole thing all over again.
In that vein, ladies and gentlemen, we now bring you the amazing story of Bitfinex and its tether liabilities.
Tether me lightly!
In the last few months much attention has befallen cryptocurrency markets due to the epic spree of ICO issues and all round bitcoin appreciation.
Quietly in the background, however, a much more interesting phenomenon has been brewing.
It all started when BitFinex, the Hong Kong-based cryptocurrency exchange, lost access to its US correspondent banks back in March/April.
For most users real dollar deposits got stuck in the system. They couldn’t be redeemed only swapped into bitcoin balances which then had to be moved to other bitcoin exchanges that still had dollar banking access.
Ordinarily, a financial entity would not be able to survive such a knock to its service capability. But this is bitcoin. So it did.
Many market watchers now speculate what really saved Bitfinex was its control via a related party of something much more eurodollar-like in nature, a company called Tether.
What Tether is is an issuer of eurodollar-like liabilities (effectively pseudo dollars) which it claims are backed by real dollar assets in its custody on a 1:1 parity basis. In that sense the company operates in a not dissimilar way to a money transmitter such as PayPal or even M-Pesa (which also issue units in exchange for 1:1 parity reserves), with the exception that the balances in its keep tend to stay deposited for much longer.
In recent months, however, some in the cryptocurrency community have come to doubt Tether’s asset-backed guarantee.
One anonymous blogger in particular, BitCrypto-ed, has come up with an elaborate theory about how potentially unbacked issuance of Tethers has become a key contributing factor in bitcoin’s epic price rise over the last few months.
To substantiate his claim the blogger points to Tether’s own T&Cs, which state bearers have “no contractual right or other right or legal claim against us to redeem or exchange your Tethers for money. We do not guarantee any right of redemption or exchange of Tethers by us for money.”
The analysis adds that at the start of the year there was only $6m worth of Tether dollar denominated liabilities in circulation. By the time Tether was cut off from its banking network there was about $60m worth. The latest self-reported statements, on the other hand, report total dollar-denominated liabilities of $414m. That’s a significant jump in liabilities that aren’t even real liabilities according to contractual terms.
In a follow-up post BitCrypto-ed reminded readers that upon losing correspondent banking access, Tether stressed it did not expect the supply of tethers to increase substantially until the constraints were lifted. And yet, the amount of Tether liabilities in circulation did keep going up.
Tether — a BVI incorporated entity — claims its transparency updates are fully audited, but again, say the critics, there’s not much public evidence to suggest they really are.
So what’s going on? Can crypto-currency fans trust Tether?
According to this recent statement from Tether, the answer is yes they absolutely can. Nevertheless, since it’s still a matter of their word against everyone else’s, the company adds they have appointed a US-based auditor, Friedman LLP, to corroborate the financials. As we understand it, a full audit report will be released within the week.
We find this amusing mainly because it shows that crypto companies have hardly resolved the issue of trust in finance. When it comes to the crunch they, like all financial institutions, must prove their trustworthiness to customers. In this case, ironically, that means going over and above regulatory disclosure requirements to quench internet rumours.
As to how and why Tether issuance is expanding when the company still lacks formal banking services…. Tether says both it and Bitfinex have been working hard to resolve their banking issues.
Their problem is that banks capable of providing dollar deposit services (especially US-based ones) don’t want the headache of accidentally enabling transactions that break anti-money laundering or know-your-customer regulation.
Banking companies like Bitfinex/Tether poses a problem because their legacy offshore/light-touch status may have introduced customers who don’t pass regulatory scrutiny. Running checks on every single small-scale dollar redemption, meanwhile, may not make economic sense either for Bitfinex/Tether or for those banks offering gateway services into the dollar system. That banks may have been persuaded to service large-scale institutional flows, as Bitfinex/Tether claim is the case, is entirely plausible since that would reduce the KYC/AML burden significantly.
As for the contract terms that state Tether has a right to decline redemption for money, it seems likely the clause is there for compliance purposes. Tethers, as it stands, change hand independently in the secondary market, meaning the company has no control over who may or may not show up with a bearer claim over its asset pool. This is because the tethers are unregistered. In the event a claimant turned out to be Kim Jong Un, it seems conceivable they would want some legal recourse for declining redemption.
It’s very likely Tether understands unjust enforcement of the clause could prompt a customer panic with the potential to tarnish its reputation permanently. Then again, this is Bitcoin, and Bitfinex has already survived imposing obligatory haircuts on customers following a 2016 hack which saw it lose 120,000 bitcoins, worth a collective $72m at the time. So who knows.
That leaves the question of how and why Tether balances have been exploding in number in recent months. Since Tether operates like a cross between PayPal and an exchange traded fund the straightforward answer is that it is likely down to strong demand for creations from regular customers. Tethers, for example, are issued into existence in large blocks when demand from the Bitfinex exchange is looking toppy. Bitfinex, in that sense, operates a bit like an authorised participant in Tether’s units (using the ETF analogy).
Since Bitfinex and Tether share the same banking arrangements, the dollar funds backing the tethers on exchange are cross-pooled between the two entities and settled periodically explaining the creation of Tether during the evening, weekends, and on holidays. As we understand it, the management believes when a customer opts to withdraw their USD balance on Bitfinex via Tether, then the Tether is debited from Bitfinex’s reserve of Tether, transferring the customer’s USD into Tether’s reserves. If Bitfinex runs out of Tether, they need to get more from Tether Ltd. by paying USD for it.
That’s complex but not unreasonable practice. Moreover, if any shenanigans are going on we should know all about it once the audit report is released.
So that there is the story of Tether. What’s fascinating about it though isn’t the controversy over whether it is or isn’t acting in line with fiduciary duties. It’s the de facto eurodollar service it has begun providing to cryptocurrency customers who want the benefit of dollar exposure and stability but who, for whatever reason, cannot easily get access to dollar markets directly themselves.
What’s exceptionally fascinating is where this might take us next.
Today Tether remains — at least on paper — a fully reserved dollar-backed system, anchored to the US dollar-issuing banking system. Theoretically at least, however, there’s no reason why it can’t evolve into something more akin to Alibaba’s Yu’e Baofund, the largest money market fund in the world, which manages its RMB peg through active asset management.
In the crypto world, of course, some share of assets could theoretically be other crypto currencies or ICOs.
While the risk of asset swapping in this way would obviously be huge, it’s nothing ETF managers or Delta One desks desks haven’t tried before. It is, as it has always been, a question of marking everything to market and hoping both liquidity and correlation sticks.
That said, there is one turn off. As it stands, the only reliable source of income for providing such a service currently is the interest received on the underlying dollar balances in your keep. That means unless a management fee was charged, some element of under-collateralisation, speculation on underlying assets, rehypothecation or securities lending would have to go on for the exercise to be profitable. The question is: would crypto customers be happy to expose themselves to so muchintermediary risk?
Hmmm…hello liquidity risk! What happens when the thing crashes for real and everyone wants their money back? There is no lender of last resort. Or is there? From an MB reader:
…the presence of USD “Tether” that can be found on many online exchanges. This is product has enabled many online exchanges to evade the US Banking laws by not actually dealing or handling US currency. Tether is effectively a crypto currency, supposedly backed on a one for one basis in USD… supposedly, but there has been no proper audit to date.
Initially, I did not understand the connection between the two, or what it signified. The real issue is that from a rather convoluted process Tether emerged from the Bitfinex hack, and BOTH entities, Bitfinex and Tether, are controlled by related parties, parties who you wouldn’t leave your wallet lying in front of.
But the real red flag here is BOTH Bitfinex AND Tether have lost access to all USD bank accounts and haven’t provided any details of other bank accounts – how are they getting their money?
Based in HK if there is actually money flowing into Tether, then there is a high likelihood that it is being funded by the Chinese Halawi system of blackmarket banking.
At the start of 2017 there was only $6m in Tether, by the time Bitfinex finally lost access to the US banking system it had grown to $60m – since then it has grown exponentially tracking the rise in BTC price to over $600m. With a further $30m going in on Sunday – what Bank transmits money on a Sunday!!
A blogger and twitter user has been documenting all of these details, and has shown that whenever BTC is under threat of a serious correction, flows of Tether into the BTC surge.
This lack of any meaningful correction is something that I have noticed myself and have grown increasingly uneasy over – a meaningful correction has never come. IMHO Bitfinex are only able to survive, and they have survived for 7mths without access to any form of banking, by ensuring that the BTC price continues to rise and on any inflows from the Chinese Halawi.
There may be some money trickling in from that source, but from my experience of the markets and previous events in the cryptocurrency world, it is highly like that real surge behind BTC price and the issuance of Tether, is that there is a massive fraud going on.
In my opinion Bitfinex, Tether and their owners (who are of VERY dubious character… you wouldn’t leave your wallet in front of them if you were drinking with them went to the dunny) are effectively running a private QE operation, providing market liquidity in the form of USD Tether every time a major sell off threatens. They are effectively electronically counterfeiting USD which ensures BTC never falls and continues to attract new money into the ponzi.
The start of BTC’s tremendous run up pretty much coincides with the moment Bitfinex and Tether lost access to their bank accounts.
If you remember the cause behind MtGox’s collapse was a similar fraud, what is not so well know are some of the details, including the fact that ppl trading coins on MtGox were not actually trading BTC, but rather Gox Coin, while their BTC were supposedly safely in the vault.
Through shear stupidity Gox also carried out their own form of inadvertent quantitative easing – they simply minted Gox coin on the assumption that BTC had been transferred to their cold wallet – MtGox systems were so bad no reconciliations were ever done.
But MtGox’s QE was effectively internal, Bitfinex and Tether‘s QE is on a far, far more massive scale. Tether has bleed out across numerous online exchanges that have popped up in order to avoid use Banking regulations, it has infested the system and in the liquidity constrained market has helped blow a 120 billion dollar bubble, built around a fraud.
Most of what I’ve just written is the source of one blogger @Bitfinexed. So perhaps it may be a story of revenge, maybe he was part of Bitfinex’s legitimate users who were made to wear a haircut… except that there are so many red flags that point to a fraud, the massive increase in Tether despite no access to USD banking, the timing of the Tether flows, the fact that there have never been any draw downs in Tether, only increases, the time that Tether started growing exponentially relative to Bitfinex losing its bank accounts, the dubious character of those running the exchange.
This is the real clincher as to how precarious the whole situation is – effectively EVERY crypto asset not on a main exchange with hard currency values itself against USDT, Tether. How much USDT would I have to sell in order to effect a 50% reduction of USDT and therefore every crypto asset?
The one exchange that actually has a pairing of Tether that you can exchange for real USD is Kraken – it would only take $250k to wipe out the value of Tether. It has become the proverbial pin upon which is balanced one of the biggest ponzis the world has ever seen.
I’m a big believer of crypto currency and have spruiked its potential, while hazarding caution. But I am desperately liquidating and transferring ALL my crypto to the handful of legitimate exchanges.
When the shit hits the fan and the fraud is uncovered EVERYONE on these online exchanges will be trapped in crypto – no one will be able to hedge into USDTether as it will be worthless or suspended – there will be no liquidity. Everyone locked in those rooms will die – people will likely suicide over this.
Over view of the scam http://www.ofnumbers.com/2017/11/09/a-note-from-bob-on-the-transparency-of-tether/
No Audit https://medium.com/@bitfinexed/the-so-called-tether-audit-that-isnt-an-audit-at-all-5a40cfcc2a75
Blogger denies it is a personal grudge https://twitter.com/Bitfinexed/status/931595575048404998
Chinese pawnbrokers as lenders of last resort printing God only knows what to support God only knows what in support of God only knows what. Or is it something else entirely?
You really ought to know before you buy it.
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For those of you who dare, we are doing a big MB Fund webinar on Thursday at 12.30pm dedicated entirely to Bitcoin:
Bitcoin or Bitcon?
Damien Klassen, David Llewellyn Smith and Tim Fuller discuss the pros and cons of the uber-popular cryptocurrency and what it can mean for your porfolio. It will include live Q&A.
All are welcome. Sign up here.
