Decoder: What Is Tether? Will It Bring Bitcoin Down?
08.30.2018

Late August has been quite good for crypto markets—bitcoin is up nearly 17 percent since mid-month lows, and as they tend to, many other digital assets have followed along. But observers have been troubled that that rise has been accompanied by an influx of more than $500 million of Tether, a so-called “stablecoin” designed to be worth one U.S. dollar consistently over time.

That’s about as boring as things get in cryptocurrency. The problem is that many doubt Tether’s claims about what’s backing up that value, and even argue that Tether is being used to intentionally manipulate the cryptocurrency market. The boring stablecoin, then, is shrouded deeply in mystery—and if its critics gain enough traction, that mystery could quickly reveal a dark, destructive horror.

What is Tether?

Tether is, in theory, relatively simple. Tether, a private company, issues digital Tether Tokens (USDT) to anyone who gives them U.S. dollars. Technologically, Tether tokens are secured on either the bitcoin blockchain, via the Omni second-layer protocol, or on the Ethereum blockchain, as ERC-20 tokens.

Why Do We Need a “Stablecoin?”

There are several competing cryptocurrency “stablecoins,” including Havven, Dai, and Basecoin, using several different models to maintain a steady market value. A truly stable digital token would offer many of the advantages of other cryptocurrencies, such as low transmission costs and global reach, without the infamous volatility of most crypto assets.

That could make them a kind of backbone for bank-free global payments and finance. In places like Venezuela, cryptocurrency offers an escape route from value-destroying monetary policy, but a stablecoin could be an even better alternative to the bolivar than bitcoin has been. Stablecoins could become even more important components of long-lived blockchain smart contracts, providing a reliable link between conventional finance and the crypto world. To take a simple example: if someone built a blockchain mechanism to sell copies of a band’s album, denominating the sale in a stablecoin would keep the album’s price from constantly gyrating.

Right now, Tether is in demand for a less transformative reason: It allows crypto traders to quickly and safely move in and out of speculative positions. Not all crypto exchanges have banking relationships that allow direct dollar trades, so Tether is essentially a faster-moving, more digitally-liquid dollar replacement on platforms like Binance and Poloniex, or even on decentralized platforms like ShapeShift.

What’s the Matter With Tether?

Oh, where to begin. Tether has an army of critics, who fundamentally claim that one, Tether doesn’t actually have bank deposits backing the Tether tokens on the market, and two, that Tether is essentially “printing” Tether tokens as a way to pump up the value of the rest of the cryptocurrency market.

Those critics have a lot of evidence, but the biggest red flag is that Tether has never submitted to a full audit of its bank holdings. In July, Tether published a letter from the law firm Freeh, Sporkin & Sullivan attesting that, in the course of an investigation of its bank accounts, the firm found the $2.5 billion in Tether then in circulation was fully backed by bank balances. But, as that letter itself makes clear, this wasn’t a formal audit, which has to be conducted by an accredited accounting firm. For Tether’s critics, it was just another case of misdirection.

Meanwhile, deeper analyses, including one by finance researchers at the University of Texas, have claimed that the issuance of large amounts of Tether—usually directly to exchanges including Bitfinex—is triggered not by investors buying it with dollars, but by its creators “printing” it, usually when prices of cryptocurrencies are declining. Once it’s being used on exchanges, Tether increases aggregate demand for all cryptocurrency, in much the same way that fiat currency printed by a central bank can buoy an economy.

In other words, Tether looks an awful lot like it’s being generated specifically to manipulate the price of cryptocurrencies like bitcoin. The motive behind this, Tether critics allege, is that Tether is a sister company to Bitfinex, an exchange that generates massive revenue through trading fees. A depressed market could cause buyers and traders to sour on the entire crypto sector, and those sweet fees would dry up.

Perhaps scariest of all, actually redeeming a Tether for a dollar is very difficult. Tether’s own USDT cash-out portal has been closed for months, ever since, according to the company, hackers stole $30 million worth of USDT. It stopped redemptions to keep the thieves from escaping with their ill-gotten gains, it said. But nobody else can cash out, either, and there’s no clear timeline for reopening the service.

What Would a Tether Failure Look Like?

At this point, Tether’s critics have had little impact on the market, and $2.7 billion worth of Tether is sloshing around exchanges at a firm value of one Tether to the dollar. The crypto market, in short, seems to be living in blissful denial of a howling void at its center. But there may come a tipping point where a critical mass of traders, exchange operators, and other players lose their faith that a Tether is actually worth a dollar.

Tether would then face intense pressure to reopen its Tether-dollar redemption service, much as bank customers demand to close their accounts if their bank seems troubled. If Tether holders can’t cash out, the market value of USDT would start to slump, with holders scrambling for the exits in something likely to resemble a bank run. The last holders out the door could wind up with “one dollar” tokens actually worth fractions of a penny.

The knock-on effects of that sort of run could be far worse than the $2.7 billion lost by holders of worthless Tether. Because Tether at once is a haven and a transaction mediator for active traders in other tokens, its collapse would likely slow those markets’ practical functioning, trigger blindside margin calls for exposed investors, and generate a broader wave of uncertainty and fear. That fallout would quite likely impact the price of even stalwart tokens like bitcoin and Ethereum.

Or maybe that will never happen, because Tether truly is fully backed. Maybe Tether will finally submit to a real audit, and put to rest one of the biggest unknowns in the crypto-sphere. After all, anything is possible.