The auditor Friedman LLP interrupted the inspection of Tether’s financial statements without a final verdict. Similarly, no official news followed the subpoena launched by the US authorities. If Tether is compliant, why Bitfinex nor US authorities have released any information? This article provides an answer to this question, revealing also why this story hides something much bigger, which could change the equilibrium of the economy and finance of the world as we know it.
– A few words about Tether and the Omni Protocol
On each platform where cryptocurrency and dollars can be exchanged, the USD ticker represents the dollars that the user owns. If Alice buys 1,000 USD from Bob on Kraken, she sees the 1,000 USD digit to appear in her account. This is simply because some data is modified on the Kraken database due to an input from the trading engine.
Since the internal accounting operations of the exchange are not transparent to the public, Alice does not have the certainty that Bob really owned the 1,000 USD he sold to her. Bob may be a Kraken employee who just changes the number in the database as he likes, crediting 1,000 “USD” to be exchanged for Alice’s bitcoins. When Alice tries to clear her bank account, she will find out that those dollars do not exist, but now she has sold her bitcoins. That this scam occurs is unlikely, but theoretically possible, and a well-known twitter account accuses the world’s largest cryptocurrency exchange, Bitfinex, of attempting this fraud.
Bitfinex makes no difference between tether dollars and real dollars, USD and USDT: when we use USDT, we trust that behind the digit on the platform there are actually dollars, which is the same assumption we do about the USD on Kraken or GDAX. Until the withdrawal, we can’t be sure those funds exist. In reality, this certainty does not even exists for the euro and dollars in traditional banks, since they practice fractional reserve and literally have never enough funds to cover the quantities nominally available to the account holders.
The difference between USD and USDT token is essentially the way of book-keeping: USDT is not just a number in a centralized database, but is registered in blockchain, then it can be used as a cryptocurrency. In fact, USDT movements outside an exchange are public and transparent to anyone, which is why users can move tether dollars from wallet to wallet without having to rely on Bitfinex or any intermediary, bank or central bank. Tether then becomes a bearer security, like a dollar bill, redeemable exclusively at Bitfinex.
1. The Tether transaction on Bitcoin blockchain
The Tether transaction (USDT) is written in the Bitcoin blockchain through the Omni Protocol, thus ensuring the certification and publicity of transactions. This is a Tether transaction seen with the well-known Bitcoin block-explorer blockchain.info:
https://blockchain.info/tx/23407cc132443fe5eff94d19ca016705623ca490c74d1a215a1026d801972263
Blokchain.info is a blockexplorer used to read Bitcoin transactions, so it does not recognize the output of this transaction: “unable to decode output address” (written in red in the screenshot). In fact the receiving address is not Bitcoin, but Tether, though it benefits of the security of the Bitcoin blockchain. There is obviously a bitcoin input, of very small amount, which is needed to pay the miner to validate the data into the blockchain, but this data can only be decrypted using specific software capable of reading the Tether protocol, such as Omniexplorer.info. In the specific case, it is a transaction of 250 million USDT, whose hash corresponds exactly to the hash of the relative bitcoin transaction:
https://www.omniexplorer.info/tx/23407cc132443fe5eff94d19ca016705623ca490c74d1a215a1026d801972263
Some of the biggest exchanges have installed a Tether wallet to list the crypto USDT, so that users can withdraw tethers from Bitfinex and deposit them on Poloniex, Binance, Bittrex etc.
Any exchange trading USD dollars is forced to verify users through KYC & AML procedures, but at least in certain jurisdictions, it can completely bypass these checks if it only exchanges cryptocurrencies, such as USDT (Bitfinex requires ID verification in any case). As long as Tether is commonly considered a valid security on the underlying dollar (regardless of the legal status), it is possible to transfer a title of ownership on dollars bypassing completely the banking circuit, freely moving value over geographical barriers and jurisdictions. However, this security can only be redeemed on Bitfinex, so the system only holds if for every tether in circulation there is actually a dollar in the treasury of the exchange.
Currently there are more than 2.5 billion USDT, which should imply that users have deposited at least this amount of dollars on Bitfinex and that these dollars have remained in the availability of the exchange. The question posed by many is whether these numbers are real.
2. The main Tether movements between exchanges
The main movements of Tether are between exchange platforms (especially Bitfinex, Binance, Poloniex and Huobi) because users and especially big traders (the so-called whales) send huge amounts from one platform to another to do arbitrage. Thanks to Tether, moving a token that is stable and tied to the dollar is very quick (and without “bureaucratic” friction) compared to a transfer in dollars, so traders take advantage of this speed to speculate on the price differences of the other cryptos.
Binance has greater trading volumes than Bitfinex, but it doesn’t allow to deposit or withdraw fiat money, only cryptocurrencies. That explains why Binance holds the greatest USDT wallet with over 700 millions. Also other colossi of crypto trading, Huobi, CeX and Bittrex, replace dollars with tethers. Here is the list of the richest addresses:
https://wallet.tether.to/richlist
This table is not updated at the last minute. For example, the Poloniex cold wallet is not in the list when I am taking this screenshot. For quicker updates, check the richlist on blockspur: https://blockspur.com/tether/richlist
Here it is possible to see 220 millions USDT in the Poloniex cold wallet (click the link to see the live quantity):
https://blockspur.com/tether/addresses/1Co1dhYDeF76DQyEyj4B5JdXF9J7TtfWWE
This is the Poloniex hot wallet:
https://blockspur.com/tether/addresses/1Po1oWkD2LmodfkBYiAktwh76vkF93LKnh
The Bitfinex hot wallet has 130 millions:
https://blockspur.com/tether/addresses/1KYiKJEfdJtap9QX2v9BXJMpz2SfU4pgZw (Bitfinex hot wallet)
At the time of the audit the Tether treasury address (cold wallet) was 3BbDtxBSjgfTRxaBUgR2JACWRukLKtZdiQ (as it is possible to see from the documents below). Today the treasury moved to the following address: 1NTMakcgVwQpMdGxRQnFKyb3G1FAJysSfz:
https://blockspur.com/tether/addresses/1NTMakcgVwQpMdGxRQnFKyb3G1FAJysSfz (Tether cold wallet)
It’s easy to trace tether movements from the creation address to the Bitfinex cold wallet and hot wallet, just start from the creation address:
https://www.omniexplorer.info/address/3MbYQMMmSkC3AgWkj9FMo5LsPTW1zBTwXL (Tether creation address)
It is also interesting to observe the transactions between Huobi hot and cold wallet (of about 80 and 330 million dollars respectively): between these two addresses there is a constant back and forth with infrequent transactions of very high amounts (12 millions on average).
https://blockspur.com/tether/addresses/1HckjUpRGcrrRAtFaaCAUaGjsPx9oYmLaZ (Huobi)
Just a curiosity: the following is the address of the hacker who attacked Tether. The USDT have been frozen and can no longer move: https://www.omniexplorer.info/address/16tg2RJuEPtZooy18Wxn2me2RhUdC94N7r
As we can see from the blockchain, there are billions of USDT actually circulating between exchanges (and probably some personal wallets), which means that Bitfinex should hold at least an equal amount of dollars. But what if not? In that case the truth will sooner or later come to the surface and Tether price will collapse. The loss doesn’t affect the exchanges, but only the users who at that time are holding tethers in their accounts, exactly as it would be in the case of any other cryptocurrency deafult. Those who believe Tether will drastically fail are free to open a short position on Kraken. Thanks to the possibility offered by Kraken to bet on USD against USDT, it’s transparent how much the players in the market are confident in Tether, even after the news of the subpoena launched by the CFTC.
– Relationship between Tether and Bitfinex
1. Deposit and withdrawals at Bitfinex
The generic users deposit and withdraw funds on Bitfinex through the company Cryptocapital, which deals with payment, anti-money-laundering and know-your-customer procedures on behalf of Bitfinex and other exchanges like CEX. Cryptocapital is specialized in opening banking channels, ensuring there is always an alternative way if some financial institutions close the doors to the cash flows. This solution has been necessary after that Wells Fargo shut down the transfers to the Taiwanese banks serving Bitfinex. Until summer 2017, Bitfinex relied on many different banks, but all in the same jurisdiction and all of them have been target of the ban from the correspondent US banks, suddenly preventing Bitfinex from sending and receiving money to the United States. Given the difficulties in moving dollars, the users quickly adapted to an alternative system and the use of Tether has increased dramatically: the chart shows the growth between June and December 2017. It should be noted that the 12 billion USDT moved in this period are much greater than the circulating supply, since a single coin can be moved back and forth many times.
2. USDT emission and parity with the US Dollar
The tether dollars are issued when the Bitfinex hot wallet is about to finish the USDT reserve. Assume that a user has deposited USD 1,000 via Cryptocapital on Bitfinex: at the time of the bank deposit in dollars, it is not necessary to create tethers, simply the depositor will find 1000 USD on his account. However, if this user withdraws 1000 tethers on his personal wallet, or sends them to an exchange like Poloniex, the user account is emptied of 1000 USD and the Bitfinex hot wallet sees an output of 1000 USDT. The number of Bitfinex dollars is likely to be greater than the tether dollars in circulation, since we expect there are not so many traders who move tethers outside Bitfinex as the number of those depositing dollars to keep them on the platform. As a result of the withdrawal in USDT from the Bitfinex wallet to another exchange, Bitfinex wallet may be short of USDT, so it requires a new supply from Tether ltd, in order to cover upcoming requests of withdrawals from the users.
The Tether emission take place in two consequential steps:
- First, Bitfinex make a transfer to the bank account of Tether ltd. This transfer is internal to the same bank where both Tether Ltd and iFinex Ltd have an account, so it is practically immediate (we will see later which bank it is).
- When Tether ltd receives the money it moves USDT from the creation address to the Bitfinex wallet. The transaction is done on Bitcoin blockchain via omniprotocol, thus requiring the times of the Bitcoin blockchain
The issue occurs exclusively towards a Bitfinex wallet, there is no other USDT distribution hub. For every single tether actually in circulation there is a dollar deposited on Bitfinex, because if a user withdraws 1000 USDT he has necessarily deposited at least 1000 USD, or he sold a cryptocurrency traded for the USD deposited by other users.
Could there be any USDT not covered by dollars? Even if it were so, there is no certainty it is a scam, at least we can imagine situations in which it’s not. The creation of USDT isn’t instantaneous and automatic for every dollar deposited, since tethers are created in blocks. If a user intends to transfer them, he will not be able to do so without the existence of already issued tokens. So if the Bitfinex hot wallet tends to zero, we can expect that Tether Ltd will issue a block of USDT to cope not only with a withdrawal request already forwarded by some users, but with a future series of expected withdrawals, in such a way that it’s not necessary to constantly organize new tokens emissions to meet users’ requests of withdrawals. In this case there is the (merely theoretical) possibility that non-covered tether dollars get into existence (in the creation address, not in “circulation”) and even such a situation could be legitimate, because it does not mean that any user can spend these newly created USDTs buying bitcoins or other cryptocurrencies. As long as users on Bitfinex have empty accounts in USD they cannot transfer tether dollars and make them circulating, at least without executing a new deposit in USD. Then the tether dollars would have been created in advance for a mere technical reason.
3. Where is the scam?
Suppose the operators behind Bitfinex were criminals, how could their fraudulent activity benefit from the use of Tether? As we have already mentioned, any exchange that does not use Tether could credit “from nothing” a fictitious USD amount on the platform and exchange it for other cryptocurrencies, keeping in reserve only a fraction of the USD cash deposited by users, so to cover a moderate request for withdrawals (expected in the short term). This system is well known to traditional finance and is called fractional reserve, so dear to all the old beloved banks. After creating some fictitious USD (or USDT) credited to some account on the platform, the exchange could disappear into nothing with btc, eth and other cryptos bought without actually giving anything in exchange for. From this point of view, Bitfinex has no advantage over any other exchange, since it is a scam that every trading platform, at least potentially, could put in place.
The risk for those who try a fraud of this type is that at some point user understand they can no longer withdraw the entire amount of dollars, realizing that the nominal amounts in their accounts is not real. When this scam is revealed there are serious consequences for the company, while owners and managers involved are punished by law. In the MTGox case, the exchange failed and was forced to pay compensation to users. The history of MTGox teaches that the justice works better for crypto exchanges than for the “highly regulated” traditional banks: when a “too big to fail” bank actually fails, those who bear the costs are the taxpayers, not the bankers and not even specifically the account holders who chose that institute as the bank in which to place their faith. If Tether is not covered instead, those who pay are Bitfinex and in general any user who owns USDT and who has misplaced his trust in the platform.
Bitfinex operators can issue tethers not backed by dollars, send them to other platforms and here exchange USDT for other cryptocurrencies. This is something that the operators of other exchange platforms cannot do. Still, the situation is only apparently different from the one described above. In fact, the risk is the same: sooner or later someone will be back to deposit these USDT on Bitfinex and claim for the USD. If this happens and there are no dollars enough, it will be a legal battle and iFinex will lose its reputation and business. When you are in the lead of such a money machine like the biggest crypto exchange in the world, the reasons to make in place a scam of this kind are not really clear.
=> Click here to read Part 2: https://medium.com/@melis.io/the-end-of-tether-scandal-a-new-financial-order-part-2-608b9f20ad79
