THE CRYPTOCURRENCY WORLD, with its volatility, is all about FUD—fear, uncertainty, doubt. And nothing is generating more FUD right now than an unusual currency called tether.
Unlike bitcoin and its many siblings, tether is what is called a stablecoin, an entity designed to not fluctuate in value. With most cryptocurrencies prone to wild swings, tether offers people who dabble in the market the option of buying a currency that its backers say is pegged to the US dollar. Trading bitcoin for dollars at a bank can be cumbersome and costly; by comparison, acquiring tether is simple, cheap and fast.
But in recent weeks a chorus of skeptics has called into question nearly everything about tether. The root of the controversy is whether the company behind it, also called Tether, is telling the truth when it claims that every unit in circulation is matched by a US dollar it holds in reserve. If the company has a dollar for every tether, that means in theory any holder can sell tethers back to the company for an equal number of dollars at any time. This belief keeps the value of a tether pegged to a dollar.
Critics on Twitter, Reddit, in blog posts, and at a recent bitcoin conference have been demanding that the company prove its reserves through external audits. Not only has Tether failed to do so, last week it confirmed rumors that it had severed ties with Friedman LLP, the accounting firm on tap to perform those audits. On Tuesday, Bloomberg reported that the US Commodity Futures Trading Commission had sent subpoenas to Tether. A Tether spokesperson said, “We routinely receive legal process from law enforcement agents and regulators conducting investigations. It is our policy not to comment on any such requests.” The spokesperson declined other comment.
If tethers are not backed by a matching number of dollars, then Tether can print an arbitrary amount of money. (Other cryptocurrencies, by contrast, create new tokens according to strictly prescribed, predictable rules.) Other problems ensue, including suspicions that Tether is timing the release of new tethers to coincide with drops in the price of bitcoin and then using those tethers to scoop up bitcoins. Some observers fear that these purchases are artificially inflating the price of bitcoin. “It’s possible that a nontrivial rise in the price of bitcoin and other cryptocurrencies has come from this asset being printed possibly out of thin air, and that is very concerning,” says Jill Carlson, a former Wall Street trader who now invests in and consults for cryptocurrency startups.
If traders lose faith in tether, they could end up triggering the crypto version of a bank run. Tether helps stabilize cryptocurrency exchanges in various ways, so its collapse could also cause some exchanges to topple, wiping out billions of dollars of investments overnight and potentially undoing much of the public’s growing interest in new technologies like bitcoin.
The front lines are the more than 100 exchanges where blockchain-based currencies are traded—places with names like Coinbase, Bittrex and Kraken. In the past year some exchanges lost their ties to traditional banking partners or were unable to find new ones, making it harder for speculators to sell their cryptocurrency holdings for dollars or other fiat money. Tether grew popular in this climate because it offered traders a way to escape the volatility. They could buy tethers with some confidence that the currency would not suddenly plummet in value.
Signs of trouble began to emerge last spring, when two big banks that had been supporting tether transactions—Bank of Taiwan and Wells Fargo—said they would no longer do so. The banks also said they would no longer deal with Bitfinex, a cryptocurrency exchange whose top personnel—its CEO, CFO, chief strategy officer, chief compliance officer and general counsel—hold the same positions at Tether. Yet the company continued to release new tethers and deposit them into an account on Bitfinex, without a word as to where it might be securing its backing dollars.
In lieu of an audit, Tether released a document in September purporting to substantiate its reserves, but with the names of its banking partners blacked out. Since that time, the number of tethers in circulation has risen roughly five-fold, to 2.28 billion, from 450 million. In January alone Tether has released 850 million new tethers.
The rapid creation of new tethers has fueled questions about the company’s motives. Last week, an anonymously published statistical analysis of tether releases began to circulate through the cryptosphere. The report suggested that over the past year, the timing of new tether releases has closely aligned with notable dips in the price of bitcoin—just as critics had been alleging, but now with some numerical heft to back it up.
The report also looked at random samples of tether transactions after a new release, and concluded that they violated Benford’s Law—a statistical principle that in numerical data sets, more numbers tend to start with 1 than any other number, with a diminishing percentage of entries beginning with 2, 3, and so on down to 9. Tether transactions, however, show a different distribution, suggesting, in the words of the report, “something ‘artificial’ in the vein of market manipulation.” The unnamed author is described in an accompanying slide presentation as a “former Googler, machine learning/statistics,” who was funded by 1000x Group, a new “private community dedicated to finding the highest quality information in the crypto markets.”
If Tether has sufficient dollar reserves (and euro holdings for its smaller euro-pegged currency), these observations don’t necessarily spell big trouble. That’s why many observers are clamoring to see an audit. Yet last week web sleuths noticed Tether and Bitfinex no longer appeared on the website of Friedman LLP; days later Tether confirmed in an article published by Coindesk that the relationship with its auditor had “dissolved.”
Tether’s resilience amid these troubles underscores the important roles it plays within the cryptocurrency trading ecosystem. Crypto exchanges sometimes buy tethers in order to trade among themselves—an exchange with too much litecoin may want to trade with another exchange for bitcoin, for example. Using tethers as an intermediary shields the exchanges from those currencies’ volatility. Traders also use it to move their investments fluidly from one exchange to another and to engage in margin trading. As Jesse Powell, the CEO of Kraken, explained in a tweet about why his exchange supports tether, traders can “skip two bank wires, $100 and 4 days of latency” by using tethers rather than US dollars to move between exchanges. Tether “might seem risky but they are only holding it for minutes at a time.”
Tether still trades close to $1. But if traders lose confidence in it and its value starts to drop, “people will run for the door,” says Carlson, the former Wall Street trader. If Tether can’t meet all its customers’ demand for dollars (and its Terms of Service suggest that in many cases it won’t even try), tether holders will try to snap up other cryptocurrencies instead, temporarily causing prices for those currencies to soar. With tether’s role as an inter-exchange facilitator compromised, investors might lose faith in cryptocurrencies more generally. “At the end of the day, people would be losing substantial sums, and in the long term this would be very bad for cryptocurrencies,” says Emin Gun Sirer, a Cornell professor and co-director of its Initiative for Cryptocurrencies and Smart Contracts.
Another concern is that Bitfinex might simply shut down, pocketing the bitcoins it has allegedly been stockpiling. Because people who trade on Bitfinex allow the exchange to hold their money while they speculate, these traders could face substantial losses. “The exchanges are like unregulated banks and could run off with everyone’s money,” says Tony Arcieri, a former Square employee turned entrepreneur trying to build a legally regulated exchange.
Whatever the precise chain of events, “I think we’re at a turning point with Tether,” says Sirer.
To some, a loss of faith in tether is long overdue. “I honestly thought it would have crumbled a lot earlier, and have been consistently shocked at how long the façade has been kept up,” says Jackson Palmer, the creator of dogecoin and a vocal Tether critic. Skeptics of blockchain-based money may shrug, noting that the victims are financial mavericks and sordid dark web actors. But with people now taking out mortgages to invest in bitcoin, the tether episode comes at a time when cryptocurrencies have entered the mainstream—potentially leaving the mainstream to foot the bill.