The Industry

Untethered

It’s time to get very worried about Tether, the “stablecoin” at the center of the crypto economy.

A gold Tether coin, a silver Tether coin, and a bronze Tether coin, all with varying amounts of cracks.
Photo illustration by Slate. Image via SergioProvilskyi/iStock/Getty Images Plus.

Many things that are terrible for you in high doses are pretty fun in low ones. For example, I enjoy some light gambling, or used to before the responsibilities of adulthood robbed me of the luxury. Two good things about gambling: It’s social—at least if you do it in person—and you can drink alcohol while doing it. Sometimes you win, sometimes you don’t, but you get time with fellow humans, an adrenaline rush, and a story to tell later. As long as you’re doing it with money you can afford to lose and you know the risks involved, it’s usually fine.

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One place where it looks increasingly not fine is the cryptocurrency industry, which Securities and Exchange Commission Chairman Gary Gensler has compared to betting in unlicensed, unregistered casinos. “We’ve got a lot of casinos here in the Wild West,” Gensler said in a chat last month with the Washington Post. “And the poker chip is these stablecoins.” In this casino, the chips themselves might be just as risky as sitting down at the blackjack table.

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A stablecoin is a digital currency whose value is directly linked to another asset, kind of like the dollar under the gold standard. The value of a stablecoin is supposed to remain constant. Such cryptocurrencies are useful because converting fiat money into and out of a cryptocurrency like Bitcoin can be slow and cumbersome; if you load up on stablecoins, you’re dealing in the coin of the realm and can make your transactions quickly. The most popular stablecoin by a country mile is Tether. According to a recent study, 70 percent of Bitcoin trading is done in Tethers. On any given day, Tether is by far the most-traded coin, its volume often double that of Bitcoin. If you want to gamble at the crypto casino, you need Tethers.

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Each Tether (or USDT) is pegged at $1, and there are approximately 69 billion Tethers in circulation. A lot of informed industry observers—and some U.S. government officials—seem to think there may be less than $69 billion of fiat cash underwriting all those Tethers. Perhaps a lot less. But it’s hard to know for sure: The company has never produced an audit, though earlier this year, Tether released an “attestation” from a Cayman Islands firm that said the company had about 3 percent of its reserves in cash; subsequent releases have claimed that the company has about 10 percent in “cash & bank deposits.”

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The reason this matters is that Tether is one of the primary engines driving the crypto economy, enabling all kinds of transactions and arbitrage opportunities. Crypto prices are frequently listed in terms of Tethers, which can be purchased on most major exchanges. It’s a vehicle for everyday transactions and sophisticated high-frequency trading. Although Tether is pegged to $1, its value can fluctuate by a few cents across exchanges, allowing savvy traders to make quick profits by buying up discounted Tethers and selling them for $1 elsewhere. It is also tremendously important in China’s informal financial sector, facilitating capital flight out of the country. If Tether were to somehow collapse or face a major regulatory crackdown, market liquidity would likely dry up, and a lot of people could lose a lot of money. Already, reporting and investigations into the company have accused executives of Tether Limited and its sister exchange Bitfinex of shuffling money between accounts to fool banks and regulators, as the Commodity Futures Trading Commission said last week in a settlement, and losing hundreds of millions of dollars in various hacks and soured business deals, as the cryptocurrency press has relentlessly documented.

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Tether almost certainly faces a near-term showdown with government authorities or criminal investigators. Last week, the CFTC reached a settlement with Tether, which included a $41 million fine (Bitfinex was also fined $1.5 million). According to the CFTC, Tether lied about its coin being fully backed by dollars. Among the behavior highlighted by the CFTC: Tether had “at least 29 [banking] arrangements that were not documented through any agreement or contract.” That’s the second enforcement action against Tether this year, and there may be more to come. But strangely, many people in the crypto industry are entirely unconcerned about the growing storm, rationalizing Tether as too big to fail or as easily replaced, or simply dismissing the suspicions emanating from the company altogether.

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Let’s run through it: As the New York attorney general’s investigation found, Tether and Bitfinex have had repeated difficulties finding banks that will take their business. Tether is currently keeping some of its assets with Deltec, a bank in the Bahamas run by the creator of Inspector Gadget. The company’s chief executive officer, Jean-Louis van der Velde, hasn’t been seen in public in years, and day-to-day management reportedly falls to chief financial officer Giancarlo Devasini, an Italian former plastic surgeon who was once linked to a software piracy ring. (Adding to the surreal cast of players, one of Tether’s co-founders is Brock Pierce, a former Mighty Ducks actor turned tech entrepreneur who sold his stake several years ago.)

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The gambling analogy is worth sticking with, though a grenade might be a better metaphor (more on that later): Imagine if one company made the chips that were used at every casino. And if that company also shared ownership with one of the casinos (Bitfinex), had investments in many of the other casinos and their offshoots (Tether makes periodic venture capital investments in crypto startups), and conducted murky financial dealings with the rest of the industry, including dispensing loans collateralized with Bitcoin. Also, let’s say that company concealed its casino ownership (only revealed with the release of the Paradise Papers) and was the target of multiple class-action lawsuits as well as, according to Bloomberg’s reporting, a Department of Justice criminal investigation.

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The recent blockbuster investigation in Bloomberg Businessweek memorably described Tether as “practically quilted out of red flags.” The company has been compared to an unlicensed shadow bank and an offshore hedge fund. (According to Bloomberg, the company is using its reserve assets to make various market bets and investments, details of which are mostly unknown.) The coin’s alleged use in manipulating the price of Bitcoin has been closely studied; one of the academics examining Tether has been advising federal agencies for years on cryptocurrency investigations. With its parent company, iFinex, registered in the British Virgin Islands, Tether has a couple dozen employees scattered around the world, according to LinkedIn. Its general counsel, Stuart Hoegner, may be best known for having been the director of compliance for the holding company of an online poker site called UltimateBet that granted select insiders the ability to secretly see other players’ cards, scamming unwitting players out of millions.

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Besides initially denying the relationship with Bitfinex—a suspicious omission potentially concealing conflicts of interest—Tether has obfuscated the composition of its asset reserves. Few banks appear willing to do business with Tether/Bitfinex, which lost $850 million that it had socked away with a Panamanian shadow bank called Crypto Capital Corp, which sounds like the villainous corporate entity in a MacGruber movie sequel. (The two financial “institutions” didn’t even have a written contract, according to the New York Attorney General. I wonder why?) Based on this dim history, regulators and industry observers have repeatedly voiced concern that Tether’s shaky financial footing could lead to the crypto equivalent of a bank run, potentially causing a cascade of market instability—not just in the crypto world but in the mainstream, regulated financial sector.

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Tether likely benefits from the fact that while its chips enter the crypto casino, they rarely leave. When an industry CEO recently asked why people don’t seem to redeem Tethers for dollars, Tether chief technology officer Paolo Ardoino, the company’s most vocal public representative, spun it as a positive. “That’s the beauty of having a super liquid stablecoin,” tweeted Ardoino. “You can go into $USDt or off $USDt anywhere. Also this proves that for a whale that decides to sell $USDt there is one that will buy gladly those $USDt.” In other words, people don’t redeem Tethers but instead take them to another exchange or trade them for other cryptocurrencies, and if they do want to unload them, a friendly whale (cryptospeak for large currency holder) will come along and buy them out. (On its website, Tether says that it doesn’t process redemptions for less than $100,000 of Tethers, leaving small-time traders in the cold.)

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Individually, some of these warning signs might provoke concern. Together, they have helped elevate Tether to an object of industry fascination and endless speculation. On Twitter, rumors are rife that Tether is engaged in seedy activity or has exposure to toxic Chinese corporate debt (the latter was confirmed in recent reporting by Bloomberg). Accusations that the company resembles a Ponzi scheme are thrown around casually; if the online investigators and crypto gadflies are right, it would be the biggest in history, surpassing Bernie Madoff’s $64.8 billion scam.

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Perhaps most important, officials in Washington are now concerned about Tether and the risks it poses. Over the summer, Treasury Secretary Janet Yellen convened a meeting to discuss potential issues around Tether and other stablecoins. In addition to the looming threat of regulatory action, the company’s executives are reportedly being investigated for bank fraud, and the New York attorney general stated earlier this year that Tether lied about the amount of dollars in its financial reserves, banned the company from doing business in New York state, and extracted an $18 million settlement. In a recent denial of a FOIA request, the SEC indicated it may be investigating Tether. (On Twitter, to the media, and in defiant press releases, Tether has repeatedly denied that there are any financial issues surrounding the company. For example, it spun its recent settlement with CFTC as a positive, stating, “the CFTC’s Order makes no finding of a violation after December 2018,” which ignores the fact that Tether stopped violating its own reserve policy by simply changing the policy.)

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This is the strange, shady, and confounding company at the heart of the crypto economy. But if you’re willing to take on the potentially tremendous risks, then perhaps the questions surrounding Tether don’t matter. The sentiment is embodied in the title of a report by a small financial research firm: “Tether USDT Is Possibly a Scam but It Can Remain Valuable.” Recently, a crypto trader who goes by the handle @TensaiCapital offered a novel perspective on how industry insiders see the controversial stablecoin. “The bottom line is that those of us who regularly transact in Tether are not unaware of the questionable behavior and red flags associated with the company,” the user tweeted. “We have simply determined that the opportunity cost of avoiding Tether is higher than risk of being exposed to it.”

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The question of whether Tether is a fraud, then, matters less than the questions that animate so much crypto trading: Can I make money from it? Is the gamble worth it?

A prominent Tether critic who goes by the pseudonym Bitfinex’ed defined Tether’s profound risk by way of a vivid thought experiment. “I’m going to give you a grenade, and this grenade has a random timer,” he said. “It could be 30 seconds. It could be six months. I’m going to pull the pin. And for every 10 seconds you hold that grenade, I’m going to give you a thousand bucks in cash. How long are you going to hold the grenade for?”

This danger might be tolerable for some professional traders or large funds. They’re not afraid to hold onto the grenade. But it means something else entirely for everyday investors who might be playing the market with money they can’t afford to lose and under terms they don’t understand. As Kenny Rogers sings, “If you’re gonna play the game, boy/ You gotta learn to play it right.” The problem is, in many areas of American life, the rules are different for the big fish, or they’re mostly kept secret. In crypto, retail investors operate on totally different terms than the pro traders and well-connected insiders who enjoy tremendous asymmetries of information, relationships with industry executives, and the ability to quickly respond to changing market conditions.

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Should Tether collapse under the weight of regulation, criminal investigation, or a bank run, it would be a major blow to the crypto industry and to retail investors. Imagine if you were at a blackjack table and the dealer suddenly announced that your chips were worth 50 percent less—or nothing at all. That probably wouldn’t stop the whales and day traders from extracting their profits; they make money on volatility as much as price appreciation. For some, market disaster brings potential opportunity, and Tether may just become another useful distressed asset.

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“They would trade human beings, I guess, if they were allowed to,” said Tim Swanson, the head of market intelligence at blockchain firm Clearmatics. Swanson has written about the role of stablecoins in the crypto economy and thinks that the market would probably weather a Tether crash: “If you ever met some of these people, they just don’t care what the ethical implications of trading are.”

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I was never into betting on crypto for the same reason I was never into online poker: There’s no human interaction involved, and drinking at my desk while watching numbers flicker by on a screen is not my thing. (Apparently others disagree: In one recent survey, 59 percent of Gen Z investors said they had made trades while drunk.) I’m also not eager to gamble on things where I don’t know the risks involved and when I may be playing by different rules than others. For all of its talk about ensuring trust via strong code and decentralized authorities, the crypto industry remains, like many pockets of its mainstream finance counterpart, profoundly concentrated and often untrustworthy.

For those who look past all this and end up on the losing end if this $2 trillion bubble pops, it might be catastrophic, especially as crypto exchanges increasingly resemble unlicensed banks, with some now encouraging users to directly deposit their paychecks into crypto. For the average investor/gambler (is there a difference anymore?), one would be best advised to heed a popular saying in Vegas: Look around the poker table; if you can’t spot the sucker, you’re it.

Ben McKenzie and Jacob Silverman are working on a book about crypto and fraud.

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