As accountants, we know the importance of internal controls, but I see over-confidence that this is the answer to the problems facing cryptocurrency companies.
We have seen countless historical fraud cases where closely related and related parties control property, creating an environment for controls to be circumvented. Internal controls are not helpful unless basic accounting is addressed first.
In this article, I want to address the recent change in the definition of tether, what they hold in terms of reserves, the assets that support the stablecoin. Accountants I’ve heard about only seem to think of cash equivalents like US Treasuries or Certificates of Deposit (CDs). Additionally, commentators point out the need for Tether to increase its transparency and that the market is satisfied as it continues to trade at or near its $ 1 fixing.
A bit of a tether background
Tether is the oldest and most widely traded stablecoin in the cryptocurrency space. It currently has a market cap of over $ 2 billion. If you’re unfamiliar with Tether’s history, Amy Castor provides an in-depth look here, and Frances Coppola describes Tether’s change in transparency and potential fractions lending issues in Forbes. In addition, I have covered the various levels of security and their current state in the cryptocurrency market here in the past.
Tether had originally commissioned auditors in the second half of 2017 and then withdrew, citing the “excruciatingly detailed” procedures in order not to provide a prompt statement. Very few accountants seem to find this strange, and I believe they are being misled into believing that this engagement would require specialized, highly technical blockchain skills.
With mediocre Excel skills, I did the bookkeeping for the wallet addresses included in the original order, which wasn’t difficult. What I suspect Tether didn’t expect were any third party confirmations required for an audit.
Talking Tethers “Transparency”
As a former auditor, I don’t believe in bank letters or a media company that checks a sample of bank statements. The point of a fiat-backed stablecoin is for the company to hold a customer’s fiat currency in reserve when he / she is ready to redeem. In the absence of an audit, we have no idea where the funds, restrictions, or encumbrances are coming from.
The change: According to web archives, on February 26, 2019, Tether changed the definition of its “reserves” as follows:
I think we can all agree that traditional currencies and cash equivalents could be fiat and other liquid products. Despite the current guidelines on how to classify cryptocurrency as an intangible asset, it is likely that it could also be viewed as a cash equivalent.
The source is controversial as it does not say that these could have come from customers. This can be a problem because if they come from another party, that other party can make advance claims against a customer.
Other assets and receivables from loans from Tether
Tether has a simple balance sheet and business model and offers a digital IOU. Aside from borrowing some of its traditional cash (presumably customer deposits or interest on short-term investments), the other option is to hold a receivable from Tethers.
The problem with lending customer deposits is that the funds may not be available when the customer wants to redeem. I believe they covered this in their terms from a legal standpoint, but nonetheless this should be a concern for customers.
It is conceivable that Tether will extend the terms to an exchange, venture capital company, or other customer. For example, they may agree to provide USDT 200 million to an exchange and bear a claim for all or part of the balance.
The concern here should be that Tether is now indicating that bill requests can be used as support. If the exchange goes down with the note, it is likely that Tether can reclaim the USDT. I also believe legally that this is addressed in their terms and conditions. Conceptually, accountants should question that USDT is ultimately the only asset available.
Connected tether units
Most now know that Tether and Bitfinex are joint owners. However, these can also be known or unknown affiliated companies of the company.
In addition, Tether announced a partnership with Tron. This partnership appears to be strengthening the Tether exchanges as well, as Tron is offering Omni USDT holders a 20% incentive to convert to Tron USDT on the Huobi and OKEx exchanges.
Although not included in that definition, there are several other notes on Tether’s balance sheet that are ignored. Tether has the ability to quarantine compromised tokens. This will take them out of circulation without affecting your cash.
The current amount reported in the Transparency Report is $ 30,950,010. If you look at the blockchain, you can find an additional 8,099,980 unrecorded, frozen USDT. This is useful in order to reduce the circulating supply and increase equity. It is nearly USDT 9 million that does not need to be redeemed.
We currently view share buybacks as a common practice in the stock markets. This is the management practice that ideally uses the profits to buy back shares, ultimately reducing the outstanding shares and reinvesting them in the company.
In October 2018, it appears that Tether may have contracted delivery by purchasing USDT at a discount of around 0.96. The question would be, when using customer deposits, the reserves to buy them back.
Problems with tether
Also, what I find worrying about some of the comments is that this change took place on February 26, 2019. This change went unnoticed for over two weeks until a group of critics on Twitter discovered it on March 13, 2019. This should raise questions about whether users are concerned or trying to redeem them at all. Failure to redeem should lead to additional questions from market participants who use USDT as they are responsible for maintaining the bond.
Even if no one you advise on cryptocurrency is using USDT or USDT exchanges, I feel it is irresponsible not to consider the potential accounting implications and possible systemic risks. For those only familiar with domestic fiat exchanges, here’s an up-to-date look at how much USDT is being used. (Source Coinlib.io)
We have to be skeptical when evaluating new technologies
Cryptocurrencies: What Accountants Need to Know