What’s behind the Tether/Bitfinex affair, Part #2

If it turns out that Tether Limited makes fractional reserve with its tokens without an equivalent reserve in dollars, what would happen to the cryptocurrencies market?

Whether it’s true or not, we certainly can’t give a definite answer, but we can invite you to make one o two logical considerations.

First of all, Tether is used by various exchanges, not just Bitfinex. However, only considering the latter, we know that the value of bitcoins in its cold wallet is about $1 billion and then there are all the hot wallet addresses. Given that the market capitalization and Bitcoin volumes are less than 1/3 of the total cryptocurrencies, we could hypothesize that Bitfinex has in reserve users’ cryptocurrencies for a countervalue which, on the whole, is twice its Bitcoin reserves in cold wallet, let’s say $2 billion. At this point, do the 2.2 billion tether dollars still seem so many? And to the reserves and volumes of Bitfinex, we still have to add all the other exchanges that use Tether. It takes little to understand that we arrive at really considerable figures.

Zhao Dong, a well known Bitfinex shareholder, said: “Lao Mao and I had a look at the USD accounts of Tether and Bitfinex […] and the account of Tether amounts to $1.8 billion, while the one of Bitfinex $1.1 billion. The total number of the two accounts is about $3 billion USD, or higher than the current amount of USDT”.

So the USDT issuance could simply correspond to the entry of new people interested in investing in the cryptocurrencies world, depositing dollars that are put in reserve and converted into tether dollars. In fact, since the summer of 2017, Bitcoin has started to be at the center of media and masses’ attention, the exchanges have increasingly had difficulty managing the entry of new users and, as we have seen recently, in December many of the main exchanges even closed to new registrations due to too much turnout (Bitfinex, The Rock Trading, Binance), or even completely suspended the service, to make an upgrade to the platform’s capacity (Kraken).

It’s not surprising that until December the price of Bitcoin has risen due to the entry of new users, so the entry of new dollars into the system and, consequently, also tether dollars.

As can be seen from the graph above, the entry of new tethers (blue line in the lower chart) corresponds to the increase in the price of Bitcoin (green line in the upper graph).

Someone has a different theory: Bitcoin has risen not because of the entry of new users, but because BTC was bought by tether “created out of thin air”, without reserves in dollars. This explanation, however, is ill-suited to the macroeconomic data that are available. It’s really hard to believe that the rise of BTC from $2,000 to $19,000 (May-December 2017) was pushed by the creation of USDTs, when before Christmas Tether market cap hadn’t even reached the 700 million USDTs in circulation. The market cap of all the cryptocurrencies was already very high. The aggregate of daily volumes in all fiat currencies (dollar, euro, yen, yuan, etc.) has increased from $5 billion to $50 billion a day in few months. The dollar value of the total cryptocurrencies market cap was already $300 billion in December. The influence of Tether, even if it were a real scam, would have been really limited.

In any case, this conspiracy theory wouldn’t explain the recent entry of 600 million Tether on the market coinciding with the collapse of Bitcoin. In short, there is no correlation between the input of USDTs and the Bitcoin pump. Indeed, Tethers have been issued in large quantities also in other big dumps of the Bitcoin price: in November, while the market cap of Bitcoin went from $150 billion to $100 billion (-35%), Tethers rose from 500 to 600 million (+20%); similarly, in September Tethers rose from 320 million to 445 million (+40%), while Bitcoin market cap dropped from $80 billion to $56 billion (-30%). In short, we can’t reconnect the creation of Tethers to a particular uptrend or downtrend of Bitcoin price. The only information that we can deduce is that a new issuance means that many users have recently deposited large amounts of dollars that are there, ready to buy cryptocurrencies. A signal that would agree with the exchanges difficulties to manage the mass of incoming users of last December. In short, macroeconomic data don’t seem to undermine the authenticity of Bitcoin’s market price as a genuine expression of users’ demand/supply.

But apart the catastrophic theories, could Tether and Bitfinex still exploit the situation, achieving profits through malicious behavior? The answer is easy: “Yes, just like all the other exchanges and banks in the world”. In fact, there is no difference between Bitfinex and dozens of other exchanges from this point of view. We don’t see any reason to worry about Bitfinex in particular, which for months (or maybe years) has been with the spotlight on and for the average user, therefore, could be a wiser choice than a less known exchange.

In fact, if a user buys USDs on Bitfinex, he/she is buying USDTs, since Bitfinex doesn’t show the difference between the dollars and the token that represents them (Tether). Is this an incorrect or a correct behavior? Since Tether and Bitfinex are almost the same entity, we would say that it is correct. Why? Because any exchange uses a token or a digital information representative of dollars it holds in reserve. This reserve is generally an entry in a bank. We can hardly expect that when we buy USDs on Kraken, the CEO of this exchange physically moves the banknotes. If X sells BTCs to Y on Kraken, the dollars that go from Y to X remain in Kraken’s account, in its bank. What actually moves is a digital entry: a certain amount of dollars have passed to X. If the exchange uses a token such as Tether or another type of accounting, such as an excel spreadsheet, what changes for the end user? Tether’s movements are even more transparent than the accounting held in a banking database, since they are written on blockchain.

After all, all exchanges could engage in fractional reserve banking and therefore risk being insolvent, just like traditional banks do. The difference between Bitfinex and a bank like Monte dei Paschi is that at least Bitfinex’s cold wallet, with all its reserves, is observable by anyone, in all its movements, at any time, with a simple click, since it’s transparent and registered on the blockchain. Probably, if it were the same thing for Monte dei Paschi, taxpayers shouldn’t have to pay €8 billion to keep up the fraud of fractional reserve banking.

Having said that, it is always better not to trust anyone. The beauty of Bitcoin is that you can keep it and transfer it anywhere in the world without having to rely on a bank or an exchange. If we withdraw our bitcoins from the exchange and keep them on our wallet, we wouldn’t worry about these headaches.

What about the other exchanges that list USDT? If Tether turned out to be a fraud, would a domino effect occur? No. The exchanges don’t bear any responsibility: if Tether fails and the value goes to zero, users incur a loss exactly as if he/she kept on the exchange any other cryptocurrency. No exchange except Tether Limited guarantees 1USDT = 1USD conversion.

So no exchange would be affected: the responsibility of the loss lies with the individual user. The exchanges that use USDT as Poloniex or Bittrex don’t allow deposits or withdrawals in dollars, so the only way to get USDTs is actually to transfer bitcoins (or other cryptocurrencies) and sell them in exchange for USDTs. Anyhow, the slogan that is repeated to the exhaustion is: “Keep the bitcoins on your wallet, not on the exchange”.

In the end, what does the “market” think about Tether? This allows us to understand if there is trust in USDT. If there was no trust, traders would have short USDT, borrowing and then selling them in exchange for dollars, believing in an impending collapse of USDT against USD. If many users were doing so, the price of USDT would have collapsed against the dollar and, to maintain the exchange rate, Tether Limited would have to withdraw large quantities of tethers from the market. So if there were any distrust, the amount of Tether in circulation and consequently the market cap would have decreased drastically. Instead there is trust: Tether is issued in large quantities and the price against the dollar remains 1 to 1. There is no way to circumvent this mechanism, since it is transparent in USDT/USD pair on various exchanges.

In the meantime, Tether Limited declares to respect the 1USDT = 1USD ratio in its reserves and has demonstrated to 4 official audits carried out periodically in 2016 and 2017 by the Taiwanese agency TOPSUN CPAs & Co. Thereafter, Tether Limited turned to Friedman LLP to perform the auditing. The agency has issued a document showing the correctness of the accounts from 6 October 2014 to 15 September 2017, as we can read in the full document.

However, the document is not an official audit, but a “consultancy service” dating back to September. In January of this year Bitfinex terminated the relationship with Friedman LLP without giving particular explanations. Why? The answer may be given to us by Zhao Dong, who states that Giancarlo Devasini is not currently in a position to openly disclose the status of bank accounts due to pressure from the United States, which is trying to block Tether by various means and, in the future, Tether may no longer be anchored to the dollar, but to another currency, such as the euro or the yen. If Tether demonstrates to the United States that it is issuing a cryptocurrency using $2 billion as an underlying asset, Tether’s problems are likely to be accentuated rather than diminished. In short, it seems more probable that all limits to bank transfers and Tether’s opacity are due not so much to attempts at fraud, as to the effort to get around the stakes placed by the US authorities.

=> You can read Part 1 here: https://medium.com/@melis.io/whats-behind-the-tether-bitfinex-affair-part-1-9da97c2cd7d3