The Risk tethered to Exchanges

I was hoping to make this article into a multi-part series. half a year later, I haven’t and I probably won’t because my personal life got in the way. However, what I had planned to discuss, has been addressed throughout the crypto community. In this chapter, I will examine the purpose, the utility and the risk of Tether exposed by the market movements and behaviours. In the second chapter, I would have explored the dangerous ties to the shady exchange Bitfinex as well as the risk exposure other Crypto Exchanges face. In a third chapter, I would have suggested some solutions and how any problems might affect the entire Crypto Currency world.

Part I: The misleading purpose of Tether

These two statements are some pretty disappointing definitions. They neither tell you what Tether is nor do they provide any information on how Tether manages to be what it is. These descriptions merely clarify Tether’s trading utility as a strategic trading instrument. This is rather disturbing. Behind Bitcoin and Ethereum, Tether currently gets the bronze medal in 24h Trading Volume and has been alternating with Ripple on the monthly volume. It is used as a trading device on nearly all crypto exchanges and most exchanges back major position in Tether (Bittrex and Poloniex are currently leading the Tether rich list).

24h Volume on the 14th of January 2018

So where does Tether come from and what does it claim to be?

As the name says, Tether is tethered to the USD value at a 1:1 ratio. The company Tether Limited backs every supplied Tether token with exactly 1 USD in the company’s reserve. In theory, any company or individual can hand over any amount of USD to Tether Limited and will receive the equivalent in Tether tokens to use on most exchanges. Meanwhile, if you have bought Tether tokens with crypto on an exchange in order to lock down a profit (as it is far less volatile), Tether Limited will buy each token for 1 USD each. The romanticised Tether will be used on all exchanges as a substitute for the Dollar. As a strategic instrument, this seems pretty useful, considering legal guidelines make it far more complicated for exchanges to trade between fiat and cryptocurrencies.

As so often, contrasting the romanticised fantasy, the real picture is a disappointment. We have established that the two key characteristics that Tether necessitates to survive are:

I. 1:1 backing to USD

II. the ability trade between USDT/USD, ideally through Tether Limited

In the following paragraphs, I will argue that neither of these fundamental characteristics are feasible realities nor are they the markets perceived purpose and applied utility of Tether.

How much Tether is there?

we can see how since November 2017, the Market Cap (blue line) has gone from $500M to almost $1.6B

One might simply dismiss these financial concerns, arguing that the entire crypto market has also tripled in the last season, going from 250 billion USD to roughly 750 billion USD. A clear correlation seems intuitive, yet this mirage can be very misleading. The worth of a single Tether hasn’t tripled the way, for example, Bitcoin has. Tether’s supply has. Tether Limited has tripled its backed holdings by printing tokens and selling these to other companies in the crypto sphere.

The question that immediately comes to mind will most likely be: where are these enormous reserves?

If the company’s business lies in backing every token 1:1, surely somewhere there has to be a treasure chest or (at least a bank account) with a big green “T” on it containing 1.5 billion dollars. This account is most likely located in a shady Taiwanese bank Tether Limited has been doing its business with.

The sheer size of these numbers might give some sceptics vertigo, but most people wouldn’t be too alarmed by this. after all, one might argue that compared to the size of the market, if 1.5 billion dollars disappeared overnight, it would barely be a crypto hiccup.

This argument is nonsensical for three reasons. First of all, unlike actual crypto assets, Tether is a strategic trading instrument, not a financial technology. Secondly, Tether is beholden to a company, and its entire value is centred around the company’s promise. if Tether Limited fails, Tether is useless. These first two reasons lay out why it makes no sense to compare the Tether tokens to the Crypto Market. Thirdly, even if we were to compare it to the market which includes thousands of different currencies (most of which have trading pairs with Tether) once we exclude the top 10 or so currencies we are left with a market that is only a quarter of the size. In this environment, a Market Cap of 1.5 billion dollars is a pretty substantial stake. It is important to remember that the vanishing of Tether will also mean a large chunk of the trading volume going up in smoke.

We can see how the “other” category, that includes most Altcoins, makes up 25% of the market.

All of these calculations take into account the highly unlikely assumption that Tether’s supply will not continue to grow.

Unfortunately, the worst-case scenario isn’t these positions disappearing. The far more concerning doomsday would be these infamous reserves not existing. After all, Tether Limited’s last audit dates back to September 2017, and the audit only includes data up to March 2017, when it’s Market Cap was at 170 million dollars. Curiously, if we look at the graph, this is where the printing begins.

the growth of the Market Cap seems to begin between March and May of 2017, shortly after their last known audited data.

The shady illegal activity behind the Tether curtains, the questionable reserves that a whole trading strategy realise on, the exuberant free printing of tokens and other features that we haven’t delved into (like the legality of the whole operation: they are basically printing Dollars) are enough to point at the Tether ecosystem as a ticking time bomb inside a highly unstable and volatile market.

What is Tether actually used for?

out of the top 20 trading pairs, only one of them trades USDT/USD

Although Tethers only value as a financial instrument lies in the possibility to trade it for exactly one dollar, no one is doing this. The volumes speak for themselves. And even if you wanted to pair this trade, its security is based on a questionable, legally grey promise given by an obscure company.

If we look at the Market Cap graph, we can see how virtually no withdraws have been made, otherwise, we would have seen some sort of substantial drop in the Market Cap (remember the Market Cap for Tether, by definition should be equal to its supply). We can see that the supply has never gone down, meaning that almost no tokens have ever been redeemed. And how likely is it that? In the words of Crypto Investor “How believable is it that everyone is in a rush to deposit their fiat for Tether at a company facing banking issues, yet no one wants to redeem those tokens for US dollars?”

The simple fact is that if people want to withdraw their balances, they trade it for ETH, LTC or BTC, send it to a fiat exchange and trade it for actual Dollars. We can prove this through trading volumes or through anecdotal evidence.

If traders ever want to use Tether, they are going to use it on an exchange, because of its 1$ value that will never change, in order to have a quick safe space in order sell high and buy low. Who knows how the market would react if the strategic utility of Tether is not backed by reality.

It only takes one highly due audit to prove that the 1:1 ratio is bogus. Tether has been hacked before and it will happen again. Crucially, nobody uses it in a way that confirms its value (excluding the wash trading that keeps it floating). It might as well be worthless, as it’s worth is basically unconfirmed, yet it has the third highest 24h Trading Volume on average.

This volume is mostly undertaken on some of the biggest crypto exchanges. The exposure these exchanges face will be illustrated in the next chapter.

Economics student, trying to share my biased opinions