Thread by @smdiehl

Let's talk about the Tether scandal, why recent disclosures about it are such a big deal, and why it represents a form of systemic risk for the already shady crypto market. (1/) 🧵

Stablecoins are virtual currencies that are always supposed to have the same real-dollar value. People that day trade cryptocurrencies often want shift their unstable tokens to safe real currencies (like the dollar) because wild market fluctuations make it unsafe to hold. (2/)

However when a company transacts in dollars they have to follow the rules of the bank that holds them and by proxy the rules US govt imposes on the bank. If you're trading crypto, then you probably don't like those rules since you're probably doing something shady. (3/)

The crypto exchange ecosystem has major problems getting access to normal banking. So enter Tether or USDT, a surrogate crypto dollar that theoretically has the same value as a dollar, but can be traded without following regulation on dollars. (4/)

The model is simple, you give the company a real dollar, they store that real dollar and give you one tether. You trade that tether for whatever you want, and at any point you can redeem that tether back for one dollar. Simple enough. (5/)

It's a simple pitch:

Have dollars, buy tether, do shady things, redeem tether, get dollars.

"The virtual dollar for regulatory arbitrage." (6/)

However this depends on one centralised point. The company that runs this service needs to keep an accounting book of all the money that flows in and out.

Every dollar in has to be matched with a tether issued, every tether redeemed a real dollar that flows out. (7/)

The real dollars held in the so-called "reserve" has to be precisely equal to the number of tether dollars issued.

If that's not the case, (i.e. unbacked tethers) then a certain percentage of holders of this coin can't actually redeem because the money is not there. (8/)

What is clear is that the company has allegedly issued $59 billion virtual dollars.

At that scale, it is highly unlikely any bank in the entire world would those reserves on behalf of a crypto company. Not even the dodgiest banks would take on that insane level of risk. (9/)

So where is the money? Most financial journalists have speculated that the company is engaged in some opaque accounting skulduggery where instead of matching tethers to inflow dollars, they produce *vast* amounts of tethers that aren't backed by anything. (10/)

Now the company that issues these products is notoriously opaque and set up shop in the tax haven of British Virgin Islands to avoid any regulation and reporting obligations. So we really don't know much.

What we do know comes from lawsuits and investigative journalists. (11/)

In 2020 the New York Attorney General investigated the US entity associated with trading Tether and indeed found massive amounts of misrepresentation in their findings. In the AGs words: (12/)

"Tether's claims that its virtual currency was fully backed by dollars at all times was a lie. These companies obscured the true risk investors faced and were operated by unlicensed and unregulated entities dealing in the darkest corners of the financial system." (13/)

"Tether made false statements about the backing of the 'tether' stablecoin, and about the movement of hundreds of millions of dollars between the two companies to cover up the truth about massive losses." (14/)

ag.ny.gov/press-release/…

Last Wednesday, we finally got the court-mandated disclosures of what's actually in the reserves. And not surprisingly when the vault is opened, the money isn't actually there. (15/)

What we see is a lot of "commercial paper". Which is a form of short-term debt, a company-to-company unsecured loan. It's put on the books for the face value of the loan, but in reality that value depends on the credit risk of the other counterparty to the loan. (16/)

If the counterparty isn't good for the value of the paper then it's worthless, just an accounting trick. And we don't know who the other parties are.

Every Tether is backed by a giant pile of IOUs to strangers. And that's worth exactly what you think it is. (17/)

A mere 2.9% of Tether treasury is actually in real dollars held by a bank.

So for every 1 USDT there is $0.03 real dollars. (18/)

ft.com/content/529eb4…

Now this is a huge problem because by volume Tether is BY FAR the most traded cryptocurrency in the entire world. Surprising every other token by a significant margin. (19/)

Also the most traded cryptocurrency FOR bitcoin. 80% of bitcoin volume is where one party is trading Tether for bitcoin. If price of bitcoin is quoted in dollars, and sold in tether, that price isn't reflecting the the vast risk/value differential between the two. (20/)

It's widely suspected that many exchanges are receiving large deliveries of unbacked tethers, using them to wash trade with themselves for bitcoin to drive up demand, and thus the synthetically inflate the price.

This is illegal in other markets.
(21/)
papers.ssrn.com/sol3/papers.cf….

A significant portion of bitcoin price formation is therefore quoted in dollars, but paid for in USDT dollars that are only actually backed by three cents.

Which would make most of the price formation of bitcoin completely synthetic. (23/)

Which leads to the obvious inconvenient truth that most people who look at the crypto space come to understand.

Most exchanges are *vastly* undercapitalised and will never be able to pay out even a tiny fraction of their customers in real dollars. (24/)

Crypto markets are not significantly different than Ponzi schemes.

Short-term dollar inflows are used to pay-out short-term outflows and the whole thing stays afloat so long as there's not too many withdrawals. When that day comes, it implodes. (25/)

It seems inevitable that at some point in the near future everyone that holds tethers will see all of their holdings go poof. They'll go from being worth 1.0x a dollar to 0.0x a dollar probably in a very short period of time. (26/)

Some fintech bloggers have described Tether as "the internal accounting system for the largest fraud since Madoff."

If that is the case, and the allegedly $800b bitcoin market collapse, that truly will be a scandal for the history books.

/fin

https://twitter.com/patio11/status/1392871423853568001