Tether's market capitalization has surged in the past few months from $5 billion to $10 billion because of the recent DeFi expansion, and the proliferation of decentralized exchanges/swapping protocols, such as Uniswap. Despite its lofty status as the fourth highest valued coin on coinmarketcap.com at time of writing, I have never owned any. Based on my research, here's why I think you should avoid Tether, and why the token is a risk to DeFi.
What is Tether?
Tether (USDT) is a cryptocurrency that was created in 2014. Originally called Realcoin, it was designed as a stablecoin that pegged its value to fiat currency, the US dollar, and was backed by reserves of the same amount of money.
Because market prices for many cryptocurrencies have fluctuated wildly in the past, there are many use cases for stablecoins. Most obviously, it just makes buying things easy for the consumer if commodities can be priced with some semblance of stability. It is also great for liquidity, and works as a hedge against volatility.
It's notable that although 1 USDT is equivalent to $1 US dollar, its market value can fluctuate, depending on supply and on demand.
Table 1 from coinmarketcap.com showing historical data for Tether pricing (July 31, 2020 to August 13, 2020)
Table 2 from coinmarketcap.com showing Tether statistics
How is Tether minted?
Tether tokens are issued by Tether Limited:
Tether converts cash into digital currency, to anchor or “tether” the value of the coin to the price of national currencies like the US dollar, the Euro, and the Yen. Tether (USDT) is issued on the Omni, TRON, and ETH blockchains, - Coinmarketcap.com
Tether's history of controversy
What is Tether's relationship with Bitfinex?
From my research, I have learned the crypto exchange Bitfinex and Tether Limited are both headquartered in Hong Kong, both registered in the British Virgin Islands, and are both owned by iFinex Incorporated. Not only are the two entities owned by the same individual(s), they also have the same CEO, Jan Ludovicus van der Velde. Based on my understanding of the hierarchy, it appears Mr. van der Velde is in a position where he has a conflict of interest. It's pretty clear that the decisions he makes with one company can have direct ramifications on the other.
Allegations of fraud
Currently, Tether and Bitfinex, are in the middle of a fraud investigation led by the New York Attorney General’s office over allegations that they conspired to cover up $850 million dollars of losses in Bitfinex’s finances.
Those transactions treat Tether’s cash reserves as Bitfinex’s corporate slush fund, and are being used to hide Bitfinex’s massive, undisclosed losses and inability to handle customer withdrawals, - New York Attorney General Letitia James
Tether's finances face scrutiny
Observers in the crypto community have been suspicious of Tether's finances for several years. It started when Tether itself was hit by a $31 million hack in November 2017. However, a more interesting revelation came from the ongoing investigation by the New York Attorney General's office:
...Tether’s reserves of cash and cash equivalents alone (without the line of credit) would cover approximately 74 percent of the outstanding amount of tether, - Zoe Phillips, Counsel for Tether, Morgan, Lewis & Bockius
This contradicts statements by Tether made not long ago that it was originally designed to always be worth $1.00, maintaining $1.00 in reserves for each Tether issued.
It's also notable that Tether Limited's Terms of Service states that owners of Tether Tokens have no contractual right, other legal claims, or guarantee that Tether Tokens will be redeemed or exchanged for dollars:
Paragraph 3 from Tether's Terms of Service from August 28, 2020
It always pays to read the fine print! Tether Limited is allowed to redeem Tether Tokens in-kind, which means even if you purchased the Tokens with US Dollars, Tether Limited can buy them back with Yen, or with something else they feel is equivalent.
Is Tether hiding something?
If Tether was confident that its finances are in good order, then they would be easily step out from under their cloud of suspicion by simply allowing an independent 3rd party to audit their books. Although other stablecoins, such as USD Coin (USDC) issued by Coinbase, or Gemini Dollar (GUSD) issued by Gemini have released their own audit results, this has never happened with Tether. That's right, Tether has never released an independent audit of their finances!
Allegations that Tether was used to manipulate Bitcoin's market price
Professors John Griffin and Amin Shams, of the University of Texas at Austin’s Department of Finance, claimed there was a link between the issuance of Tether and Bitcoin’s prices during the 2017 price increases. The published study found that Bitcoin purchases with Tether were timed following market downturns and resulted in sizable increases in Bitcoin prices.
Although this matter has yet to be resolved, recent research suggests there may have been no link as reported by Dr. Griffin and Dr. Shams.
How does Tether pose a risk to DeFi?
I'm not going to explain DeFi, because Publish0x has no shortage of excellent articles written about it. I would like to acknowledge a fellow author, The Part Time Economist, who has posted an extremely well-written article that examined Compound Token. (Yes, I also found out that he even wrote a similar article to the one you are currently reading, written by me!)
It's important to remember that a common strategy in the DeFi world is to use stablecoins as collateral when borrowing crypto. This is because their low price volatility will help to mitigate the risk of liquidation in the event your collateral rapidly loses its value.
Table 3 from compound.finance showing Markets - August 28, 2020
We can see that Compound Finance allows customers to both lend Tether, or to provide Tether as collateral when borrowing.
Automated market maker Curve disclosed in June that it was seeing users depositing USDC as collateral to borrow USDT and using that borrowed USDT as a deposit for borrowing the USDC back again. Some users repeated this process up to 30 times – the maximum leverage on Compound – which they use to maximize their COMP Token allocation.
Remember the investigation by the New York Attorney General's office? I noticed the below headline as I was writing this article.
BREAKING NEWS: Bitfinex Must Face New York's Accusations Over the Loss of $850M in Co-Mingled Funds - August 29, 2020
Tether was fighting the legal proceedings for months, but a judge has just ruled against them at time of writing.
What would happen if Bitfinex and Tether were found to be guilty of fraud? Would everyone try to sell their Tether Tokens all at once? Would customers be able to get their fiat money back, or would they be forced to take something in-kind? More importantly, if the value of Tether was to drop rapidly, there's a chance every Tether collateral position would be liquidated all at once. What would happen to the Defi ecosystem then?
Final thoughts
It appears that Tether's legal problems are only beginning. Although the outcome of the investigation will not be finalized for some time, are you willing to take the risk to hold Tether Tokens in the interim? If only Tether could do away with all its controversy, it could be a well respected stablecoin, like DAI. Oh wait, maybe Tether isn't the only stablecoin to pose a risk to DeFi....
Thanks for reading, and stay safe!
Follow me on Twitter: @kragle_t
Cover art: Tether logo by Tether Limited
Last edited September 11, 2020
It's the perfect time to start earning free crypto while you learn about it!
The Publish0x community is always looking for new members and for aspiring authors. Previous writing experience is not required! This is a friendly environment where you can earn ETH, BAT, or LRC tokens for free! I invite you to create an account using my referral link here.
I'm earning up to 8.6% annual interest compounded monthly on my crypto deposits at BlockFi, and you can too. When you sign up for a free account using my referral link here, we can both receive a bonus!
BlockFi hack: You can even choose which cryptocurrency to receive your interest payments in!
Did you know that crypto tokens can be sent from your Coinbase account to another crypto wallet with zero fees? Register for your free account using my referral link here, and we can both receive a bonus!
Coinbase hack: You can also earn free crypto such as EOS or XLM by watching Coinbase Earn videos!
Thanks for your support!
