The New York AG Issues Tether a Speeding Ticket

By John Banks

On Feb. 5 we asked the following question: “Has Bitcoin (and the Entire Crypto Space) Been Boobytrapped by Tether?”

Our answer was “no,” and you can read why here.

The short version is that Tether, a popular U.S. dollar stablecoin, is probably not a systemic risk.

An elegant analysis from someone named “Crypto Anonymous” had argued otherwise, claiming that Tether was essentially a giant counterfeiting scheme that could blow up at any moment.

The “Crypto Anonymous” view naturally generated significant levels of fear and concern, as Tether stablecoins generate roughly $100 billion per day in trading volume and play a meaningful role in the crypto ecosystem.

We pushed back on those concerns, doubting the assertion that Tether is a brazen counterfeiting scheme with some of the largest crypto exchanges in the world being in on the con.

Last week, on Feb. 23, the Tether-as-fraud question took a significant step toward resolution, allowing many worried crypto investors to breathe a sigh of relief.

The important news was the announcement of a settlement between Bitfinex, the crypto exchange that runs Tether, and the New York Attorney General’s office. Letitia James, the New York AG, had opened an investigation into Bitfinex nearly two years ago, in April 2019.

The settlement means Bitfinex and Tether will pay a fine of $18.5 million — an amount considered by observers to be a “speeding ticket” relative to the sums involved — with no admission of wrongdoing.

In addition to the $18.5 million, Bitfinex will also cease all trading activities for New York state residents and provide New York authorities with quarterly financial reports on the state of Tether’s dollar reserves for the next two years.

The settlement was a major win for Bitfinex, for Tether, and for crypto on the whole. In word, the New York AG’s office rained fire and brimstone on Tether; but in actual deed — the $18.5 million settlement — not much was done at all.

There are still plenty of things not to like about Tether. Certain aspects of the Bitfinex operation continue to be questionable, and the reason the New York AG investigated in the first place is enough to raise eyebrows.

In 2017, it appears Bitfinex lost the eye-bulging sum of $850 million when Crypto Capital Corp., a Panamanian firm Bitfinex had entrusted $1 billion in capital to, either blew up or saw its founders run an “exit scam” (the crypto-world term for when founders take the money and run).

In order to stay afloat, it then appears Bitfinex had at least $625 million worth of Tether reserves transferred to its own accounts, to cover the gaping hole created by the implosion of Crypto Capital Corp. (Bitfinex is still trying to recover the lost $850 million, though whether it will is anyone’s guess.) 

Fast forward to 2021, and the New York AG has apparently found Bitfinex and Tether to have behaved in an awful way in 2017 — but not to be perpetrating a present-day fraud.

The commitment to provide quarterly financial statements for two years is a key aspect of the Tether settlement. In addition to the New York AG wrapping things up with a fine, a forced measure of accounting transparency helped many crypto community worriers to conclude that, in spite of the lingering questions, Tether is probably okay.

For whatever reason, Tether is wildly popular in Asia, primarily as a liquidity source for moving funds into and out of other coins. We maintain the view that, were Tether to lose popularity, another U.S. dollar stablecoin — like USDC, which has a market cap of $8.8 billion — could easily take its place.

In terms of systemic risk, the key question is whether or not Tether is being used to artificially inflate the value of Bitcoin. For that to be happening, Tether would have to be an active and deliberate counterfeiting operation, with willful agents deliberately creating unbacked Tethers on a routine basis.

If that isn’t happening, though — if the Tether supply is legitimate — then the extremely high volume shown by Tether (around $100 billion per day) is probably a function of the Matthew Effect: To those who have, more will be given. The more popular a liquidity provision tool becomes, the more that other users will adopt it by default, which increases the liquidity edge even more.

In certain parts of the world, they really like Tether — and the liquidity created by that volume generates a self-reinforcing feedback loop. A key consideration here is the ease with which Tether can be swapped for some other stablecoin, and the many nodal points at which Tether and Bitcoin can be exchanged for fiat currency.

To run an effective Ponzi scheme, you need a closed system with very few points of access; the crypto space is an open system with myriad points of access. This increases our confidence that, while Tether is still sketchy in some respects, it is neither a large-scale counterfeit operation, nor an inflated source of demand, nor a true source of systemic risk for crypto assets.

Were it otherwise, the New York AG likely wouldn’t have concluded its digging with an $18.5 million fine and little more — a sum Wall Street firms would consider a cost of doing business. (In December 2020, Robinhood paid a fine of $65 million; hardly anyone noticed.)