PaymentsJournal
SUBSCRIBE
  • Analysts Coverage
  • Truth In Data
  • Podcasts
  • Videos
  • Industry Opinions
  • News
  • Resources
No Result
View All Result
PaymentsJournal
  • Analysts Coverage
  • Truth In Data
  • Podcasts
  • Videos
  • Industry Opinions
  • News
  • Resources
No Result
View All Result
PaymentsJournal
No Result
View All Result

The Most Important Cryptocurrency You’ve Never Heard Of: Tether and the Systemic Risk to Cryptocurrencies

Aaron McPherson by Aaron McPherson
September 10, 2018
in Analyst Corner, Cryptocurrency, Featured Content
0
cryptocurrency

cryptocurrency

4
SHARES
0
VIEWS
Share on FacebookShare on TwitterShare on LinkedIn

Like many others, I have long been concerned about the long-term viability of cryptocurrencies such as Bitcoin and Ether.  When Bitcoin’s price surged above $19,000 at the end of 2017, with no discernible cause except “irrational enthusiasm,” many people worried that it was a speculative bubble.  And, indeed, Bitcoin has dropped over 50% from its peak.  However, a recent article in Medium, “Is the Price of Bitcoin Based on Anything at All?” raises the possibility that things could get much, much worse.  According to the article, a cryptocurrency called Tether that most people outside the cryptocurrency community are unaware of, may be responsible for much of the run up in value for a number of cryptocurrencies, including Bitcoin and Ether.  In brief, Tether is a cryptocurrency that is pegged to the U.S. dollar, making it an ideal medium for exchanging one type of cryptocurrency for another.

However, there have long been questions in the cryptocurrency community about how Tether really works.  According to the company, “Every tether is always backed 1-to-1, by traditional currency held in our reserves. So 1 USD₮ is always equivalent to 1 USD.”  However, it is unclear where Tether is getting the dollars to back its currency.  In theory, no one should be investing in Tether at all; by definition, it is impossible to gain any sort of return.  Ten thousand dollars invested in Tether a year ago would be worth ten thousand dollars today.  A recent audit published by the company by the law firm of Freeh, Sporkin & Sullivan LLP (FSS) confirmed that as of June 1, 2018, about $2.5 billion in U.S. dollars rests in two bank accounts held by Tether.  Where did all this money come from?  Also, why is Tether using a law firm rather than an accounting firm to audit its holdings?  In the “audit,” the law firm explicitly states that it “is not an accounting firm and did not perform the above review and confirmations using Generally Accepted Accounting Principles.”  FSS also states that the document “should not be construed as the results of an audit,” and that its work is “not for the purpose of providing assurance.”  This contradicts Tether’s own claim on its home page that “Our reserve holdings are … subject to frequent professional audits.”  Therefore, there is significant cause for doubt that Tether actually has the reserves it claims to have.

Assuming for the moment, that Tether actually did acquire $2.8 billion (plus €40 million, which was not examined in the “audit”), as of the time of this writing (see https://wallet.tether.to/transparency for the current numbers), there are a few possibilities:

  1. Exchanges hold reserves of Tether in order to make markets for the many cryptocurrencies they trade on a daily basis. This is supported by Tether’s “Rich List,” which has exchanges such as Binance, Huobi, Bittrex, and Bitfinex (which shares a CEO and CFO with Tether) as some of its largest holders.  However, exchanges are the most frequent target of hackers, and several have already been comprised, with huge losses for their customers.
  2. Criminal enterprises are using Tether as a place to park their funds outside of the reach of national regulators and law enforcement agencies. Or, less ominously, 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 putting money into Tether in order to boost the prices of their other cryptocurrencies. Since it is often somewhat difficult and expensive to convert cryptocurrencies into or from fiat currency, Tether is often used to trade one cryptocurrency for another (in fact, it is currently the number one cryptocurrency by volume Bittrex).  If Tether is making it easier to acquire other cryptocurrencies, then that helps stabilize the price.  Of course, market manipulation of this sort would normally be illegal, but when you are dealing with unregulated markets, it’s an open question how regulators or law enforcement agencies could put a stop to it.

None of these possibilities is particularly reassuring.  If Tether collapses, whether because of law enforcement action, loss of confidence, or the revelation that it does not actually have the reserves it claims, this could cause a huge drop in the price of leading cryptocurrencies.  According to Coindesk, at the beginning of 2017, Bitcoin was around $1,000, about where it was at the end of 2013 during the last speculative “boom” (how quaint that seems now), following which it lost about three-quarters of its value before beginning its accelerating rise.  Could it be that $1,000 or less is Bitcoin’s natural “floor”?  How much of the rise 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 is reduced to using “technical analysis” to predict the likely movement of Bitcoin prices, instead of market fundamentals such as bitcoin supply and demand, illustrates the degree to which the market is driven almost entirely by psychology.  Cryptocurrencies have value because buyers believe they do; when that faith is lost, the results can be catastrophic, as we saw in the 2007-2008 financial crisis.

All of this serves to illustrate one key problem with the whole idea of a currency untethered to central banks; whatever complaints one might have with the ability of central banks to manipulate the value of fiat currency, at least a country has tax collection authority and institutions to lend confidence that its currency will not suffer catastrophic devaluation (yes, I know this is not true of some countries, which is why I speculated that people in countries with weak currencies and financial institutions might be a source of funding for Tether; certainly that is a primary use case for Bitcoin in such countries).  The U.S. national debt might be $21 trillion and climbing, but no one seriously doubts that U.S. treasuries are a safe investment, which is why interest rates have stayed flat this year in spite of two increases in the Prime rate.

That is why at Mercator we tend to focus more on the possibilities of blockchains or distributed ledgers.  While cryptocurrency does have intriguing potential, particularly 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 to allow them to function as useful mediums of exchange (with the exception of the aforementioned countries with weak financial systems).  We are going to have to reach some sort of hybrid model, combining digital currencies with strong governance bodies, in order to rely on them for everyday use.

Tags: cryptocurrency
4
SHARES
0
VIEWS
Share on FacebookShare on TwitterShare on LinkedIn

    Analyst Coverage, Payments Data, and News Delivered Daily

    Sign up for the PaymentsJournal Newsletter to get exclusive insight and data from Mercator Advisory Group analysts and industry professionals.

    Must Reads

    digital payments

    Navigating the Future: Top Digital Payment Trends to Watch

    March 31, 2023
    scams

    As Scams Become Omnipresent, New Tools Can Help FIs Fight Back

    March 30, 2023
    item clearing

    As Check Volumes Decrease, Financial Institutions Need to Consider Alternative Clearing Options

    March 29, 2023
    payments friction

    Too Much Payments Friction Can Lead to Customer Chafing

    March 28, 2023
    online fraud

    Understanding the Cost of Online Fraud and How to Prevent It

    March 27, 2023
    live shopping, ebay

    Q&A: eBay Exec on Live Shopping and the Future of Payments

    March 24, 2023
    AI and Biometrics in Regulatory Compliance in Finance

    The Importance of AI and Biometrics in Regulatory Compliance in Finance

    March 23, 2023
    Everyone Benefits from the Real-Time Payment Networks  

    Everyone Benefits from the Real-Time Payment Networks  

    March 22, 2023

    Linkedin-in Twitter

    Advertise With Us | About Us | Terms of Use | Privacy Policy | Subscribe
    ©2023 PaymentsJournal.com

    • Analysts Coverage
    • Truth In Data
    • Podcasts
    • Videos
    Menu
    • Analysts Coverage
    • Truth In Data
    • Podcasts
    • Videos
    • Industry Opinions
    • Recent News
    • Resources
    Menu
    • Industry Opinions
    • Recent News
    • Resources
    • Analysts Coverage
    • Truth In Data
    • Podcasts
    • Industry Opinions
    • Faster Payments
    • News
    • Jobs
    • Events
    No Result
    View All Result