Opinion: Tether is likely backed by Bitcoin U$ equivalents, not by cash US Dollars [June 2018]

A lot of the controversy surrounding the Tether cryptocurrency seems to focus on whether it is fully backed by US Dollar funds or not. Several relevant questions have been posed in this respect, such as why investors would keep U$ 2.5 billion (as of May 2018) in cash deposited as reserves for Tether, with little or no return, when there are much better and safer investments available? A $2.5 billion fund manager would be a guest of honor at any bank in New York or London and they’d surely be offered top notch exclusive, investment opportunities. Why, then, keep all this cash locked up somewhere just to back a cryptocurrency? Our theory is that this simply isn’t the case.

We believe that Tether is backed by Bitcoin value converted to U$ by the current exchange rate, not by actual US Dollars, and in this article we’ll present evidence to back up this hypothesis.

Our Thesis: The Value of Tether is Backed by Bitcoin cold wallets not US Dollar deposits

Our theory is based on the asumption that Bitfinex is behind Tether. If this is indeed the case, then our thesis is that the Bitcoin funds under Bitfinex’s control regulate the value of Tether against the US Dollar. The logical reasoning for this is that the price of Tether is not directly derived from US Dollar as it may seem at first sight (and as is assumed by most cryptocurrency investors), but instead it is based on the current dollar price of Bitcoins which is then converted to US Dollars.

There is one level of indirection between the US Dollar and Tether and it is Bitcoin. This indirection may seem harmless, but in our opinion it is the key to the entire Tether cash reserves debacle.

Similarly to what we argued in our article about fake market cap, there is no direct and high volume trade between Tether and actual US Dollars. Traders are not buying and selling billions of U$ in USDT. There aren’t billions of U$ cash being traded for Tether anywhere in the world at this time – only Bitcoin is actively traded against the US Dollar in significant amounts at the time of this writing (June 2018), which continues to justify our argument that US Dollar market cap can only accurately be computed for Bitcoin and cryptos which are directly traded for US Dollar in significant amounts. All other USD valuations are mere estimates and shouldn’t be computed as US Dollar market caps but only as Satoshi units. This applies to complementary cryptocurrencies such as Tether, which brings us to the point of this article.

The Bitfinex Connection

Although the Bitfinex/Tether connection may seem obvious and is taken for granted by most cryptocurrency investors, in order to develop a correct thesis we’d like to try and establish this fact beyond reasonable doubt before proceeding with our argumentation. If you are already 100% convinced that Bitfinex is behind Tether then you may safely skip this section. For the thesis presented here to make any sense, it is necessary that a multi billion dollar Bitcoin fund exist and it must be under the same management as Tether. If it can be proven that Bitfinex is indeed behind Tether, then we can argue in favor of our thesis that Tether is backed by Bitcoin.

What evidence do we have that Bitfinex and Tether are associated?

1. US Financial Regulators believe so, or they wouldn ‘t subpoena both together
2. Financial media calls Bitfinex and Tether “sister companies”
3. Reddit sleuths have found strong human resources coincidences between Tether and Bitfinex
4. High Volume of Tether trade as been detected from Bitfinex wallets

A document revealed in December 2017, supposedly from Bitfinex’s internaly quarterly updated directed at its stakeholders, calls Tether “a party related to Bitfinex”:

So, in summary, for any of this hypothesis to make sense, we need to part on the principle that a large Bitcoin reserve exists and it is closely related to Tether. And the only possibility we see is that Bitfinex is the financier behind Tether. Whether this is so will likely be revealed by regulators, or perhaps the Tether executives themselves, in due time. For now what we got are simply very strong indications.

For the rest of this article we will assume that Bitfinex is behind Tether. If you believe this is false then our whole argument collapses.

How We Currently Believe Tether gets Pegged Against the Dollar

The current consensus is that there is an immense US Dollar stash that backs Tether’s U$ 1 constant value. Whenever the US Dollar gains value against other cryptocurrencies, Tether would lose value against USD and therefore its regulation system must purchase Tethers out of the market in order to drain the supply. This purchase would be made in US Dollars, much like how central banks regulate the value of currency, they inject one currency into the market while reducing the float of another currency.

When the market moves in the opposite direction and Tether tends to gain against the US Dollar, more Tethers would be sold to the market for USD, draining USD from the float and increasing the value of the US Dollar currency.

So, in theory, there is a very fluid and direct US Dollar to Tether exchange which is very dynamic and acts 24×7 to maintain USD to USDT parity. We know the FED is the guardian of the US Dollar, we know the Japanese Central Bank is the guardian of the Yen and the European Central Bank is the guardian of the Euro.

But we’re still looking for the exchange where Tether is traded for US Dollar in order to maintain this parity.

How Tether Really Gets Pegged to the US Dollar

The reality is that Tether is not traded for US Dollars in any significant amounts. There is no cash USD for USDT central bank-like institution maintaining parity 24×7, that is a mere illusion irrationally perpetuated by the cryptocurrency markets. This is the fundamental point to understand that there is no significant fiat money reserve involved in the U$ 1 value of Tether.

So, how then is Tether pegged to U$1? Via Bitcoin, of course. CoinMarketCap does not list the Bitfinex Tether daily volume. But, fortunately for us, Bitfinex itself provides its BTC/USD volume data for 24 hours, 7 and 30 day periods:

BTC for USD it says. Nowhere in Bitfinex’s stats page is USDT mentioned at all. USD and USDT are treated as one and the same – this is important, so take note. We don’t know how much of the Bitfinex volume is in Tether and how much of it is in USD as it gets mixed inside Bitfinex. All that we see from the outside is a grand total reported to be USD (but it’s not USD, it’s mostly USDT).  Keep this in mind, please.

Now let’s take a look at how Bitcoin was used to peg the Tether value to U$ 1 during the month of May 2018.

Bitcoin price varied from approximately U$ 9251 to U$ 7494 during the month of May:

This represents a 23% drop and, if our thesis that Tether is backed by Bitcoin is correct, Tether would need to be inflated approximately 23% in order to compensate for the Bitcoin vs. US Dollar variation.

Via the OMNI explorer we can see all Tether’s being minted and being moved in and out, and that is where we can see all the movements made by the owner of the Tether contract on the OMNI ecosystem.

We see that the Tether smart contract owners have minted 250 million dollars in mid May 2018:

(Quick Digression: Talk about Quantitative Easing!)

So, just like that, U$ 250 million worth of Tether have sprung out of nowhere in the month of May 2018. As we’ve just seen, most crypto exchanges, starting with Bitfinex, treat this just like USD. There was no such emission of Tether in April and there has been no movement in June of 2018 at the time of this writing, again, all this can be verified here.

The 250 million USDT just minted account for 10% Tether inflation (250 million divided by 2507140814 total Tether supply). Where did the other 13% come from?

7% of it came from Bitcoin mining. Approximately 54000 Bitcoins were mined last month. At an average price of around U$ 8000, this equals U$ 430 million was injected into the Bitcoin circulating supply by miners during the past month, lowering its value by this amount therefore exempting Tether from having to devaluate itself by this much.

This means we had U$ 180 million more Tethers minted than Bitcoin value was mined during this period. This equals a 7% Tether inflation (over a total of U$ 2.5 billion).

So we’re still missing 6% of the Tether to Bitcoin variation. This 6%, which amounts to approximately U$ 21 million, includes actual US Dollar to Bitcoin direct exchange and other transactions of which we don’t have records. This leaves us with a 6% margin of error or uncertainty and is a financial volume that we cannot account for on this article (maybe our readers can figure this one out?!).

The important thing to note here is that the US Dollar variation in Bitcoin price during May 2018 was 94% driven by the amount of Tethers issued by the Tether contract owner.

Lastly, we need to present a Bitfinex account capable of backing U$ 2.5 billion in Tethers. And, here it is:

Bitfinex has U$ 1.3 billion worth of Bitcoin reserves (note: Bitcoin, not US Dollars).

This backs approximately 50% of all Tethers in circulation today. Which seems to indicate that Bitfinex backs (owns?) 50% of all Tethers and they back this up with Bitcoin, not US Dollar accounts.

Conclusion

If you’re looking for U$ 2.5 billion in cash backing Tether, then you’ve probably been looking in all the wrong places. You’ll find it in Bitcoin cold wallets, not banks.

Links

Tether Lawyer Admits Stablecoin Now 74% Backed by Cash and Equivalents

Tether’s U.S. Dollar Peg Is No Longer Credible

While Tether Withdraws Claim of USD Backing, Rival Stablecoins Provide Monthly Attestations

Press Release: BITFINEX AND TETHER DENOUNCE BASELESS LAWSUIT DESIGNED TO UNDERMINE THE CRYPTOCURRENCY COMMUNITY