Tether could be guilty of perpetrating a huge fraud, just not the one we think

What if USDT was actually backed 1:1 by real dollars – but the way those dollars were acquired is decidedly shady?

 Speculation around Tether has been rife for months but is now reaching a crescendo. At the heart of the matter is whether the company has the $2 billion or so in reserves that it would need to back its ‘pegged’ currency USDT on a 1:1 basis. If not, the company is running a fractional reserve and would be guilty of inflating the price of bitcoin – leaving traders holding the fake currency used to do it, with serious consequences for them and potentially the wider crypto markets.

Since Bitfinex and Tether are essentially the same entity, it would be easy for them to create USDT at will and use it to buy BTC on their own exchange. These fears could have been allayed by conducting the audit the company has long promised, but Tether recently dissolved its relationship with Friedman LLP, so this much-needed transparency will not be forthcoming. Fears about the integrity of USDT now overshadow the crypto markets, with critics suggesting a deep correction could be the result if the company has acted fraudulently.

For now, the market is not pricing this fear into the value of USDT, which is still worth $1. There is, however, another explanation to the slew of warning signals that traders and other members of the crypto community have noticed. What follows is necessarily speculative – Tether’s lack of transparency leaves no alternative – but it is one interpretation that fits the facts. In summary, USDT may actually be backed 1:1 by real dollars. However, the means but which the company obtained them could be highly suspect, to say the least.

Tether’s stated business model is:

• Accept customers’ dollars
• Issue one USDT for every real USD received
• Deploy these USDT on exchanges for customers to purchase bitcoin and other cryptos

An alternative explanation of the evidence suggests that they may in fact be:

• Minting unbacked USDT
• Using this fake money to buy BTC
• Selling these bitcoins OTC for real dollars

If that is the case, USDT is backed, possibly even fully, but retrospectively, and by dollars obtained from selling BTC bought with fraudulently-created USDT. The OTC markets for bitcoin are very large and active, possibly larger than the on-exchange market, and there would be no great trouble finding buyers for these BTC – possibly brokers or wealthy Chinese investors, given their location.

None of the evidence is conclusive by any means, but there are a few things that point in this direction.

• Their (lack of) banking relationships. Tether used to receive money from retail depositors, who would be credited with USDT in return. Last year this arrangement was ended and ordinary customers could no longer use the fiat gateway, with Tether citing interference from Wells Fargo. They now claim they exclusively work with large corporate partners and remain secretive about their banking relationships for fear of further reprisals from US banks. But who are these corporate partners, and why are they happy to deposit hundreds of millions of dollars with Tether? More likely, Tether are not holding funds on behalf of any customers at all. Instead, the funds they hold were deposited after the fact, from the sale of bitcoins they purchased with money that was – at the time it was deployed into the market – unbacked by real dollars.
• Dropping Friedman LLP as auditor – not because they didn’t have the money to back USDT, but because Friedman, with its rigorous audit, would discover the USDT and real USD had arrived in the wrong order.
• Zhao Dong witnessing $3 billion in Bitfinex/Tether’s accounts. Zhao Dong is a well-known and respected Chinese trader. Assuming he’s not simply lying or has been deceived, he saw enough to know the money is in the right place – just not how or when it got there.
• The timing of the creation of new USDT. Analysts have noted this often happens at critical moments, for example when the market is falling sharply or is threatening to breach a significant technical level. That would make sense if Tether are using those opportunities not only to buy cheap BTC, but potentially to manipulate prices higher in order to sell them at a better rate.
• The fact that the market still has confidence in USDT, when so many traders must be dropping it like hot potatoes right now. By rights, the market value of USDT should be well under $1. But if there are real dollars behind USDT, Bitfinex/Tether will be quite happy to accept them back again in return for BTC, profiting on the spread in the process. They are the buyer of last resort.

The silver lining to all this would be that USDT could be backed to a greater degree than feared, perhaps even 100%. In this scenario, Tether are effectively arbitraging the Bitfinex exchange and wider OTC markets using fake money that is only retrospectively backed, after the sale. This would, at least, reflect real demand for bitcoin – rather than the fear that the rise in the price of BTC over 2017 has largely been caused by fake money.

It should be stated once again that the above is speculation. It is one interpretation of the evidence. But it is one that fits the evidence, arguably better than the popular alternative narrative. If it is correct, then Bitfinex/Tether are indeed guilty of an enormous and ongoing fraud – just not the one we first thought.

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