What’s behind the Tether/Bitfinex affair, Part #1

Bitfinex is the largest exchange in the world, but not only that, it also owns the richest Bitcoin address on the planet.

From the Bitfinex site, it is said that to move bitcoins from this address one needs at least 4 out of 7 signatures, belonging to 7 people who are usually located in very different places on the globe. How the exchange secures its funds is a fascinating issue: if we consider a value of $7,000 per bitcoin, that wallet holds a value of $1 billion. And that’s just the Bitcoin wallet, because the exchange also has a reserve for each crypto listed on its platform, as well as a reserve in dollars and, of course, in Tether dollars (USDT).

But what are the Tether dollars?

Theter is a cryptocurrency issued by Tether Limited, a Hong Kong company (with subsidiaries in Virgin Island) born within Bitfinex, sharing the same CEO, Jan Ludovicus van der Velde. The purpose of this cryptocurrency is to hedge itself from volatility. In other words, if you have a cryptocurrency like Bitcoin on the exchange and you’re afraid of a price drop, you can convert it to USDT, which have a value that always tends to be equal to the dollar, so 1USDT = 1USD. Equality is maintained through the monetary expansion arbitrarily managed by Tether Limited, through the creation and destruction of Tethers.

Why use Tether dollars instead of the usual USDs? Three reasons stand out in particular:

  1. For the user, the question no longer stands. If he/she owns 50 thousand USDT instead of 50 thousand USD, he/she has a cryptocurrency like the others, which falls within the gray area of regulation.
  2. The exchange can operate without the Know Your Customer and Anti Money Laundering (KYC/AML) policies dictated by governments, because it is not in any way storing dollars on behalf of users.
  3. The dollars cannot be moved around the world crossing national laws and borders, while USDTs can be sent everywhere with a click. Tether is a cryptocurrency and its public register is written on the Bitcoin blockchain

For this reason Tether is increasingly used by exchanges all over the world that don’t have licenses to operate as traditional financial intermediaries, or don’t have a support bank, so they can only allow cryptocurrencies trading. For example, Poloniex or Bittrex.

There are two elements that make Tether a special case compared to other cryptocurrencies:

  • The emission and destruction of tokens is completely centralized in the hands of Tether limited.
  • Owning Tether dollars entitles the user to an equivalent amount in dollars held in reserve by Tether Limited.

This in theory means that whoever owns USDTs will be able to claim his/her USDs. But it’s not that simple: exchanges do not allow you to directly claim dollars on your bank account, for two reasons:

  • Dollars are held in reserve on the banks supported by Tether Limited. So if you aren’t a customer identified by Tether and haven’t passed the KYC/AML checks, you can’t receive the funds in your bank account. It’s clear that this isn’t due to a Tether limit, but to government regulation.
  • Even if you are a verified customer of Tether Limited, you may not be able to receive dollars on your account due to additional national restrictions. This is the case of US citizens who haven’t been able to make withdrawals from Bitfinex. Not because of Tether, but the US bureaucracy: the main Taiwanese banks on which Tether Limited operates have been blocked by the corresponding US banks (i.e. Wells Fargo).

So the only way in which you can actually withdraw dollars is to interface directly with Tether, or Bitfinex. With the exception of legal issues, Tether declares that holders can regularly convert their USDT into sound dollars: “Absent a reasonable legal justification not to redeem Tether Tokens, and provided that you are a fully verified customer of Tether, your Tether Tokens are freely redeemable”.

The legal issues, however, have all been a hindrance to Bitfinex, which has even stopped serving the US verified accounts, mainly due to the US Securities and Exchange Commission’s claim to subject the ICOs to traditional finance regulations. The exchange, in August 2017, justified the decision to suspend the service for US citizens stating that “an incredibly small percentage of [Bitfinex] revenues comes from US individuals’ verified accounts, while a huge amount of resources is spent for these users, including support requests, regulations, legal fees”.

Despite the struggle with the bureaucracy, Tether has had a great success, obtaining an ever-increasing adoption by the exchanges all over the world. The blue line in the following chart shows the market capitalization which in 1 year has gone from 0 to $2.2 billion.

According to Tether’s Terms of Service, this means that there should be over $2 billion in reserve in Taiwan’s Tether Limited banks.

A twitter account very active and very followed, the anonymous user Bitfinex’ed, is particularly fierce against Bitfinex and write articles related to Tether and Bitfinex. In some of these op-eds, there is the hypothesis that Tether invented such high numbers and actually “printed” 2 billion tethers without having the corresponding dollar reserves. Tether would have “invested” them on Bitfinex, buying and selling Bitcoin, therefore manipulating the market price. This fact scares the users a lot: if a user “discovers” that he paid 1 bitcoin $18,000 just because the price was manipulated by counterfeiters, it will be more easily induced to panic sell. After all, two billion dollars are a figure so high that it isn’t surprising that has risen malicious rumors. To these rumors is added the work of the American authorities that, as we can imagine, don’t frown upon Tether. After all, it is as if the Hong Kong company had joined the Federal Reserve, issuing tokens representative of the dollar, but operating without being subject to any US regulation and creating/destroying these tokens on the basis of an (alleged) reserve in dollars. For this reason, the US authorities have recently sent a subpoena to Tether. This does not mean that Tether is accused of something in particular, but certainly replacing the central bank of the most powerful nation in the world is a daring action that doesn’t go unnoticed. The news has stirred even more a market already in the “bear” phase, contributing to the collapse of the Bitcoin price.

Tomorrow, in Part 2 we will speculate if the price of Bitcoin has really been manipulated by Tether over-issuance or not.

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