Tether, Part One: The Stablecoin Dream. October 28, 2018 Snippets

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This week’s theme: setting the scene to understand one of the most sophisticated and multi-level scams we’ve ever witnessed. Plus Relativity Space introduces a new key team member.


Last week in Snippets, we walked through five commonly occurring scams that we frequently see during bubbles. We talked about wash trading (trading with yourself to manipulate volumes and prices), pump and dump schemes (exploiting the public’s reaction to successful washes), spoofing (issuing fake buy and sell orders in order to manipulate the market from moment to moment), boiler room scams (setting up hard-to-find trading desks that give themselves a de-facto put option on their clients deposits by simply being able to vanish), and finally Ponzi schemes (paying back early investors with newcomers’ principal). Now, as promised, over the next couple weeks on Snippets we’re going to talk about an alleged fraud, currently unfolding in the cryptocurrency world in real time, that is so brazen and so sophisticated that it contains elements of every single one of these scams, all in one. It’s called Tether, and we’re going to try to explain what’s going on here in the next few issues. As an added bonus, the scheme appears to be collapsing in real time before our eyes; so we’ve got a front row seat. Buckle up.

First, we need to talk about the idea of stablecoins, and the numerous past and future attempts at making that “holy grail of crypto”: a token that trades on a decentralized exchange, but can faithfully hold a price of one US Dollar. It’s pretty easy to understand why developers, promoters and investors continue to be enthralled by the possibility of a true stablecoin gaining mass adoption: it would be a huge blow for freedom for the crypto community, freeing developers, e-commerce providers, and other users from the wild reflexive price swings of genuine cryptocurrencies like Bitcoin as they build crypto applications like, say, buying in-app purchases in a video game. This makes sense: not knowing what the BTC/USD exchange rate will be tomorrow, ten days or even ten minutes from now is a pretty big risk for anyone who wants to actually sell real-life goods and services over the internet that are denominated in cryptocurrency, and dynamically adjusting the price will make you a sucker: you’ll just end up losing money relative to people who have more information than you do.

So how would you make such a stablecoin? The crucial test that any stablecoin must pass for the market to actually trust it is: if a user wants to redeem their stablecoins for genuine dollars, under any reasonable circumstance, can they do so? Well, there are two ways you could try to do this: a real way, and a not-so-real way. The real way, which you could do today if you wanted to, would be to simply create a token that is fully backed, one-to-one, by US Dollars in a bank account. Now this would work; it would just be overwhelmingly expensive from a cost-of-capital perspective to actually run the thing. So you could build it; it’d just be a bad investment to do so (unless you were building it explicitly as a cost center that supports some larger legitimate operation; Coinbase appears to be trying something like this.)

The second way you could do this is by creating a token that automatically adjusts its supply and/or price, by some magic algorithm, in order to ensure that the bid/ask spread on an exchange will perpetually straddle the $1 USD mark. If that sounds like magic, well, that’s because it probably is! As Preston Byrne (noble Stablecoin critic and marmot fan) has written about convincingly, algorithmic stablecoins that aren’t backed one-to-one by dollars in a bank account are no more than perpetual motion machines dependent on a continual influx of money to function: as he puts it, “A free-floating digital commodity devoid of intrinsic value that doesn’t assume the market prices it, but rather that it prices for the market, only works by devouring new investment money at every available opportunity.” The phrase, “dependent on a continual influx of money to function” should ring a bell to anyone who read Snippets last week: does it remind you of anything? It should: you can make all kinds of schemes appear to function when new money keeps coming in. Doesn’t mean it’s real, though!

But let’s say you did manage to create a stablecoin, and the market does in fact trust that this stablecoin is sound: they trade for an even dollar, flat, on real exchanges frequented by real buyers and sellers. There are two huge business opportunities available to you. The first, as we talked about, is providing a dollar-demoninated token for merchants, developers, and other people who want the ability to transact over the counter in USD, but over a decentralized crypto exchange. Fine. The second is far more lucrative, and more systemically dangerous: you can use this stablecoin to create US Dollar liquidity in cryptocurrency exchanges, giving them a way to accept US Dollars as currency without having a bank in the real world. I could set up an exchange with the following policy: “We use Stablecoin in order to create US dollar liquidity. If you buy Bitcoin or Ethereum or whatever on our exchange with US dollars, send them to a third party friend of ours who will convert them to Stablecoin and then pass them onto us. If you want to sell them and get US dollars back, we will give you back a corresponding amount of Stablecoin. You can then take these to any number of banked exchanges that will give you back fiat dollars; as you can clearly see, the market is valuing this coin at exactly $1.00, which clearly shows that this very trustworthy. If it weren’t, they’d trade below a dollar. See? You can trust us.”

If this sounds insanely dangerous to you, well, you’re right. This is WAY more dangerous than some random token getting pumped up that’s worthless, because it would have massively destabilizing systemic effects. But I have bad news: a huge percentage of the cryptocurrency world has been infected with exactly this scheme. At the center of it all is a stablecoin called Tether, that purports to do exactly what I’ve described.

If that sounds bad, just wait: it gets worse. In this setup, we can see how a widely adopted Tether would have a pretty great opportunity to manipulate markets: since they aren’t literally and transparently backed one-to-one by US Dollars, they can effectively “print” new Tethers in the dark and unleash them into the cryptocurrency market, creating the illusion of cash inflow when it isn’t really there. But if Tether had a close partnership with a major exchange — or, if they were secretly one and the same — their ability to manipulate the price of Bitcoin and other cryptocurrencies up and down, at their whim, would be massive. And that, as it turns out, is exactly what happened last year during Bitcoin’s incredible bull run, which may have turned out to be mostly a product of market manipulation. Next week we’ll go deeper into what happened, but in the meantime, we’ll end with the critical question to ask when trying to determine if Tether is legitimate or not: is the demand for Tether tokens actually coming from real customers, or is it getting “pushed” onto the market regardless of demand? It’s a very hard question to actually know, given the pseudo-anonymous nature of encrypted blockchain transactions. And it’s precisely the question that John Griffin and Amin Shams from UT, well-known experts in scam behavior, sought to answer with a paper published a few months ago.

Is Bitcoin really un-Tethered? | John M Griffin & Amin Shams

Next week, we’ll dive into what they and others have found: a story of brazen manipulation and systemic grift that blew our minds.


Speaking of fraud, one of this week’s must-read articles is from Craig Silverman, who walks us through a recently uncovered and sophisticated ad fraud scheme:

Apps installed on millions of Android phones tracked user behavior to execute a multimillion-dollar ad fraud scheme | Craig Silverman, Buzzfeed News

The scammers would first acquire legitimate Android apps (with real users and good reviews), and then parse through its audience to determine how, exactly, its users are behaving when they interact with the app authentically: what do they click, how long do they look at each page, how do they generally carry themselves. They then create large numbers of fake users, programmed into bots, that they then use to “pad”, or supplement, the legitimate traffic on those apps, earning additional ad revenue. Unlike most simple bot scams, which are now readily detectible using standard fraud detection, these bots are much harder to catch, since they are being spotted acting “authentically” across multiple apps at different times — as a human user would. It’s yet another turn in the cat-mouse game of scammers and security — as one becomes more sophisticated, so the other evolves in a never-ending arms race.

Moving away from scams for a minute, Jon Choi wrote a fantastic post a few weeks back about “The Crypto Idea Maze”: taking a long look about how many of the theses and stories in the cryptocurrency world have gotten tangled up with one another, and distilling three distinct paths — Sound Money, Web3, and Open Finance as authentically independent journeys. It’s good; check it out.

The Crypto idea maze | Jon Choi

And finally, this is too cool not to include: an interactive map of population density and change that visualizes them better than anything I’ve seen yet. Caution: you may spend an unreasonably long time browsing around, and it may impact your productivity.

Human Terrain | Matt Daniels

Elsewhere in the world:

Modern China is so crazy, it needs a new literary genre: “The Ultra Unreal” | Ning Ken (translated by Thomas Moran) | New England Lit Review

The story of Amsterdam, told through its trash | Sophie Haigney, NYT

How Google won over Waterloo | Catherine McIntyre, The Logic

Harvard researchers say they may have solved the mystery to Beijing’s air pollution: formaldehyde | Martin Finucane, Boston Globe

Redemption City is the anti-Lagos: what happens when Pentecostal churches become urban planners | The Economist

Worthwhile interviews:

Interview with Chad Syverson on the American productivity puzzle | Aaron Steelman, Richmond Federal Reserve

Tyler Cowen interviews Ben Thompson | Conversations with Tyler

Eric Idle on his memoir and on Monty Python’s 50th anniversary | Bullseye with Jesse Thorn

AI guru Andrew Ng on the job market of tomorrow | Sara Castellanos, WSJ

I also recently did a podcast with Erik Torenberg from Village, and it was really fun. I certainly won’t win any awards for being concise in this one — it’s quite rambly, be warned — but I had a great time making it and we got to cover some pretty challenging topics. Enjoy:

Alex Danco podcast with Erik Torenberg | Village Venture Stories

Other reading from around the Internet:

The State of the American Heartland in 2018 | Metropolitan Policy Program at Brookings

What a massive database of retracted papers reveals about science publishing’s “death penalty” | Jeffrey Brainard & Jia You, Science

The human gut microbiome’s emerging relationship with early-onset Type 1 diabetes | Vatanen et al., Nature

TikTok is cringe-y and that’s fine | Taylor Lorenz

Uber’s secret restaurant empire | Kate Krader, Bloomberg

Soundcloud’s new artist contract is a raw deal for musicians | Dani Deahl & Nilay Patel, The Verge

And just for fun:

SB Nation’s Forest of Fright: ten Halloween stories from the sports world | SB Nation


In this week’s news and notes from the Social Capital family, Relativity Space has been continuing to blaze a new path into space (quite literally) and recently scored a major coup: hiring Tobias Duschl, formerly Tesla’s global director for business operations.

Relativity hires senior Tesla manager Tobias Duschl to help automate rocket production | Eric Berger, Ars Technica

Duschl’s operating expertise will be key as Relativity turns its first major corner: from being a startup in development to a full-fledged launch company. Their Terran 1 rocket is due to begin testing in two years, with commercial launches starting the following year. Relativity’s targeted $10 million price for a dedicated launch, or as low as $8,000 / kg into low earth orbit, breaks open a huge number of new markets for spacecraft and payloads. It also requires a paradigm shift in manufacturing towards completely automated rocket assembly, which Duschl admits is an ambitious goal: as he put it to Ars Technica, “When I first heard about Relativity, I thought this was crazy. It’s just incredibly ambitious.” His experience at Tesla, who is continuing through their own challenges and growth through an automation period, will be invaluable in Relativity’s own transition.

It’s not the first time that Relativity Space has recruited a high-level employee from the SpaceX / Tesla family, which isn’t surprising considering the founders’ origin stories. A few months ago, Relativity brought on board Tim Buzza, who had been employee number five at SpaceX and, in founder Tim Ellis’s words, “literally knows everything there is to know about rockets.” That’s high praise from Ellis and his co-founder Jordan Noone, who in addition to being widely respected in the space industry as bona fide pioneers, are routinely recognized for the sheer breadth of their knowledge and their ambition — like this recent profile in Entrepreneur Magazine’s 50 Most Daring Entrepreneurs of 2018 list (just after Elon).

As Relativity expands, they’re continuing to hire for a number of roles, both in Los Angeles and at Stennis Space Center in Mississippi. If you or anyone you know are looking for a challenge beyond belief, get in touch.

Have a great week and happy Halloween,

Alex & the team from Social Capital