Tether and the systemic risk for cryptocurrencies

Like many others, I have long been concerned about the long-term viability of cryptocurrencies like Bitcoin and Ether. When the price of Bitcoin surged over $ 19,000 in late 2017 for no apparent reason other than “irrational enthusiasm,” many worried that it was a speculative bubble. In fact, Bitcoin has fallen over 50% from its peak. However, a recent article in Medium states, “Is the price of Bitcoin based on anything at all?” increases the possibility that things could get much, much worse. According to the article, a cryptocurrency called Tether, unfamiliar to most people outside of the cryptocurrency community, may be responsible for much of the appreciation in a number of cryptocurrencies, including Bitcoin and Ether. In short, Tether is a cryptocurrency that is pegged to the US dollar, which makes it an ideal medium for exchanging one type of cryptocurrency for another.

However, questions have been around for a long time in the cryptocurrency community about how Tether really works. According to the company, “every tether is always secured 1: 1 by the traditional currency held in our reserves. 1 USD ₮ therefore always corresponds to 1 USD. “However, it is unclear where Tether gets the dollars from to support its currency. In theory, nobody should invest in tether. By definition, it is impossible to generate any return. Ten thousand dollars invested in Tether a year ago would be worth ten thousand dollars today. A recent audit of the company released by law firm Freeh, Sporkin & Sullivan LLP (FSS) confirmed that as of June 1, 2018, there are approximately $ 2.5 billion remaining in two bank accounts held by Tether. Where did all the money come from? Why does Tether use a law firm instead of an accounting firm to review its holdings? In the “audit”, the law firm expressly declares that it “is not an auditing company and has not carried out the above-mentioned reviews and confirmations using generally accepted accounting principles”. FSS also states that the document “should not be construed as the result of an examination” and that its work is “not for the purpose of providing security”. This contradicts Tether’s own assertion on its home page that “our reserves … are subject to frequent professional audits.” Hence, there is considerable doubt that Tether actually has the reserves it claims to have.

Assuming, at the time of this writing, Tether has actually earned $ 2.8 billion (plus EUR 40 million that was not audited as part of the “audit”) (see https://wallet.tether.to/transparency for) the current numbers) there are a few options:

  1. The exchanges hold reserves of Tether to create markets for the many cryptocurrencies they trade in on a daily basis. This is supported by Tether’s “Rich List,” whose largest owners include exchanges such as Binance, Huobi, Bittrex and Bitfinex (which share a CEO and CFO with Tether). However, exchanges are the number one target for hackers, and some have already been drawn in, with huge losses to their customers.
  2. Criminal corporations use Tether as a place to park their funds out of the reach of national regulators and law enforcement agencies. Or, less threateningly, by ordinary people who distrust their national banking systems and are looking for a safe haven that is not subject to the volatility that characterizes most cryptocurrencies.
  3. Investors in Bitcoin and other cryptocurrencies are investing money in Tether to increase the prices of their other cryptocurrencies. Since it is often a little difficult and expensive to convert cryptocurrencies to or from fiat currencies, tether is often used to swap one cryptocurrency for another (in fact, it is currently the number one cryptocurrency by volume Bittrex). If Tether makes it easier to acquire other cryptocurrencies, it will help stabilize the price. Of course, such market manipulation would normally be illegal, but when you are dealing with unregulated markets it is an open question how regulators or law enforcement agencies could put an end to it.

Neither of these options is particularly reassuring. If Tether collapses, be it due to law enforcement, loss of confidence, or the discovery that it does not have the reserves it claims, it could lead to a huge drop in the price of leading cryptocurrencies. According to Coindesk, Bitcoin was around $ 1,000 in early 2017, around the end of 2013 during the last speculative “boom” (how strange that now seems), whereupon it lost about three-quarters of its value before beginning its accelerated rise. Could it be that $ 1,000 or less is Bitcoin’s natural “bottom”? How much of the increase in value is due to increasing usage, how much is due to speculation and how much is due to tether? Nobody seems to know. The fact that Coindesk restricts itself to using “technical analysis” to predict the likely movement of Bitcoin prices rather than market fundamentals such as Bitcoin supply and demand shows to what extent the market is driven almost entirely by psychology. Cryptocurrencies have value because buyers believe they do; If that belief is lost, the results can be disastrous, as we saw in the 2007-2008 financial crisis.

All of this serves to illustrate a key problem with the whole idea of ​​a currency that is not pegged to central banks. Regardless of the complaints one might have about central banks’ ability to manipulate the value of fiat currency, at least one country has tax collection agencies and institutions that trust its currency will not suffer catastrophic devaluation (yes, I know In some countries I have speculated that people in weak currency countries and financial institutions could be a source of funding for tether. This is certainly a primary use case for Bitcoin in such countries. US national debt could be US $ 21 trillion Dollars are up and down, but no one seriously doubts that US Treasuries are a safe investment, which is why interest rates have stayed flat this year despite two rate hikes.

That’s why we at Mercator tend to focus on the possibilities of blockchains or distributed ledgers. While cryptocurrency has fascinating potential, especially in global markets where traditional money transfer systems are expensive or inefficient, there are simply too many risks right now to make them safe places to invest or act as a useful medium of exchange with the exception of the above Countries with weak financial systems). We need to achieve some kind of hybrid model that combines digital currencies with strong governing bodies so that we can rely on them in day-to-day use.

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