Tether And The Great Crypto Ice Age

Gennaro Hacker Noon profile picture


Gennaro is the founding father of FourWeekMBA, a number one supply on enterprise mannequin innovation.

Where will we begin?

This story is so intricate that we have to take a step again.

It was 2009 when Satoshi Nakamoto… Sorry, not telling you this once more.

So let’s begin by 2021.

In a Tim Ferris Show interview to Ethereum’s co-founder, hosted by Naval Ravikant, as they mentioned the way forward for crypto, Vitalik Buterin highlighted one thing which may have opened a Pandora’s field “I feel the Bitcoin ecosystem does have its personal […] ticking time bomb demons too, like Tether is one instance.”

What’s Tether, why is it a ticking bomb? And what makes Vitalik Buterin assume it is a “Bitcoin solely” concern?

Instead, some have already labeled it because the Lehman Brothers of crypto, with the potential to ship crypto to a glacial age, which may forestall its additional adoption for a decade (in the perfect case situation) or simply make the entire crypto universe collapse on itself perpetually (what Nassim Nicholas Taleb has warned many occasions because the “absorbing barrier” or some extent of no return!).

In Lehman Brothers’ case, the paradox of centralization is that it will definitely prevented a systemic collapse. Indeed, central gamers just like the Fed and the federal government bailed out the system (with the bailout of AIG first, after which with the Troubled Asset Relief Program which pumped again $700 billion in liquidity into the system).

In the crypto area, with out a last-resort authority accountable for stopping systemic dangers, as all the things goes awry, can this simply mark the top of all of it?

I consider it’s important to reply these questions, to ensure we proceed to see the blockchain and crypto ecosystem develop and actually change into the Web 3.0 all of us dream of. And but, to make this occur we have to make readability on the short-term existential threats current proper now.

And past all of the scammy tasks, buzz, and cultism occurring in crypto, Tether is probably the most harmful one, as a result of it is offered because the “actual factor” doubtlessly masqueraded as the best Ponzi Schemes of all occasions.

So let’s make some readability right here.

A Quick Glance At Tether’s History

As Bitcoin had gained traction over the 2010s, the thought of enabling different tokens to be constructed on high of Bitcoin’s protocol took off (certainly, this was additionally the unique concept of Ethereum in 2014).

This gave rise to the Mastercoin mission. The imaginative and prescient was to resolve two of crucial limitations to Bitcoin mass adoption: Insecurity and instability (as highlighted on this Coindesk piece).

Mastercoin, subsequently, has been credited by some as ‘inventing the ICO’ area. Mastercoin can be rebranded as Omni by 2015.

The rebranded Omni Protocol would function the inspiration for Tether, which acquired constructed on high of this protocol (Tether was additionally an ERC20 token – constructed on high of Ethereum’s blockchain protocol). At the identical time, Tether initially was referred to as “Realcoin” and solely afterward (by 2014) renamed Tether.

As defined on its web site, these days “Tether tokens exist as digital tokens constructed on bitcoin (Omni and Liquid Protocol), Ethereum, EOS, Tron, Algorand, SLP and OMG blockchains.”

And as additional defined “Tether Platform currencies are 100% backed by Tether’s reserves. Tether tokens are redeemable and exchangeable pursuant to Tether Limited’s phrases of service. The conversion fee is 1 Tether USD₮ token (USD₮) equals 1 USD.”

Tether had for the reason that begin a transparent mission, that of facilitating the exchanges throughout digital currencies, by offering what’s referred to as a stablecoin. A stablecoin itself is a digital forex pegged to an underlying asset. In Tether’s case that’s the US greenback.

Thus, by pegging the Tether to the greenback, whoever is changing its cryptocurrencies again to a stablecoin has the benefit of with the ability to commerce again throughout varied digital property. They would give you the chance to take action with out having to incur wild value swings, that are intrinsic to the crypto world.

In brief, stablecoins have change into the liquidity suppliers, particularly for central exchanges.

As liquidity suppliers, these are nearly as good as these exchanges settle for them as liquidity reserves.

There are dozens of stablecoins and but the highest three (Tether, USD Coin and Binance USD) nearly attain 100 billion market cap as of the time of this writing.

And probably the most fascinating half is that these stablecoins for higher or for worse have change into so fashionable that at this level there is not actually a conversion between Bitcoin and USD, quite the conference between Bitcoin to USDT (brief for Tether) has change into extensively adopted.

This implication is crucial as a result of it implies that Bitcoin liquidity doesn’t exist in fiat forex (to say you possibly can’t actually convert all the present Bitcoins again to {dollars} – not less than not these which can be going by central exchanges). This once more poses a severe systemic threat, as within the short-term, if an excellent chunk of USDT can be exchanged again for {dollars}, it is likely to be straightforward to think about a large liquidity drought.

In truth, whereas some would possibly say, “you realize Tether is simply over $60 billion in market cap when Bitcoin is over $600 billion” (on the time of this writing). But this reasoning would not make any sense. Because if a disaster of liquidity occurs this is able to drag down the value of Bitcoin (and all the opposite cryptocurrencies) to the purpose that we do not know what would occur subsequent.

Tether: The Currency of CEXs

What prompted within the first place this large adoption of stablecoins, and in primis of Tether?

I imply why do folks use stablecoins once they can merely commerce again in {dollars}? There are varied causes for this phenomenon. However, incentives from central alternate platforms have extensively pushed the adoption of stablecoins.

One of the options that made stablecoins an excellent factor to have is the decreased intermediation charges to commerce them.

A second, killing characteristic that made stablecoins the go-to digital forex for traders is the truth that some central exchanges solely settle for them within the first place. As highlighted within the paper “What Keeps Stablecoins Stable?” Crypto exchanges like Binance and Poloniex, already in 2019, solely accepted stablecoins as a medium of alternate.

This implies that “liquidity” throughout these exchanges is mediated by stablecoins (this implication is crucial as a result of it makes us redefine what liquidity means on these exchanges, and the way this may be pumped up simply).

This brings us again to a central concern for Tether. As the core assumption is that in case of a mass liquidation Tether would nonetheless be capable to redeem it and but preserve the peg with the greenback. Here the issue as an alternative is that not solely this peg wouldn’t be maintained.

But worse of all, in case of a flight to liquidity it’d create a large detrimental domino impact on the entire crypto ecosystem.

So how does liquidity work on central exchanges?

How Central Exchanges Liquidity Works

Running a Central Exchange has been – paradoxically – one of many first viable enterprise fashions on high of Bitcoin. That’s a paradox as a result of because the say goes “Not Your Keys, Not Your Coins” would suggest that you do not want anybody holding the important thing for you.

And but “we maintain your key” has been the principle enterprise mannequin for profitable exchanges like Coinbase. And many hard-earned classes have been discovered by the crypto group within the final decade as varied central exchanges went bust (the epitome of that has been Mt. Gox chapter again in 2014).

So why did this central alternate enterprise mannequin work? Well, as a result of it enabled a wider and wider variety of folks to affix in. They may be part of with out having to fret about wallets, storage, and extra intricacies that make the crypto world nonetheless very arduous to know.

You bounce on a platform like Coinbase, with an amazing UX, a gamified part (the Earn platform lets you begin incomes cryptocurrencies by answering just a few easy questions) and you’ve got the sensation to be already an professional.

With the motto of “you do not have to fret about your key” central exchanges exponentially grew the person base, and with the rising value of most cryptocurrencies, operating a central alternate has change into extremely worthwhile.

Perhaps, in Q1 2021, a platform like Coinbase recorded an nearly 10x enhance in revenues from over $179 million to $1.59 billion.

And the factor is, the entire central alternate enterprise mannequin is predicated on buying and selling quantity, as they generate profits largely through charges.

Central exchanges, subsequently, have labored wonders within the crypto markets by simply increasing the person base.

And they used a easy shortcut to resolve the liquidity downside: stablecoins.

Back to Tether!

Why Stablecoins Solve For Liquidity But Pose Other Serious Systemic Risks?

A 2018 article, entitled “Why Stablecoins Make No Sense” referred to as Tether a “naive stablecoin” because it was not launched as an impartial forex. Instead, that may be a type of banknote or an “I owe you” or a promise of fee, that tells you that in case you wish to alternate your USDT (Tether) again to {dollars} this will probably be simply backed.

There is an issue right here although, as what makes a banknote precious is how a lot you possibly can belief the bearer. And within the case of Tether, the bearer is a personal firm referred to as Bitfinex.

That can also be why 2021 has change into a key 12 months through which Decentralized Exchanges (DEX) had been wanted. And among the many most profitable ones, Uniswap solved for liquidity – as Decrypto highlighted – “by permitting the alternate to swap tokens with out counting on patrons and sellers creating that liquidity.” At this time additionally DEXs have some core points (like so-called “rug pulls” one of many hardest issues to resolve for a decentralized platform that is not managed by any central participant).

In brief, Central Exchanges solved for short-term liquidity (which is among the best plagues of crypto) by stablecoins however – particularly within the case of Tether – they create a plethora of different points. The most elementary one is that they solely “centralize the system” by requiring traders to having to belief the bearer, thus killing the entire premise of a blockchain-based system.

And issues solely worsen when the bearer is a personal firm, which lacks transparency.

So enter Bitfinex.

A Glance At Bitfinex

Bitfinex is one other central alternate that has change into extraordinarily fashionable (due to Tether) making it among the many high 5 central exchanges.

This is owned and operated by iFinex Inc., an organization primarily based in Hong Kong. While Tether is primarily issued by an organization referred to as Tether Limited, owned by the identical house owners of Bitfinex.

So the place does the issue stand right here?

Let’s see a few of the pink flags that made this bearer very arduous to belief.

*Assuming {that a} “blockchain financial system” can exist within the first place on these stablecoins backed by non-public corporations with no regulation by any means. So the paradox right here is that if we would like a system pushed by central exchanges and stablecoins regulation is a should!

The First Red Flag: False Claims On 1:1 Peg With USD

Already in 2018 Bitfinex was alleged of hiding $850 million in funds, masked as Tether reserves.

As the NY Attorney General acknowledged

Bitfinex and Tether recklessly and unlawfully covered-up large monetary losses to maintain their scheme going and defend their backside strains,”

 Attorney General James continued:

Tether’s claims that its digital forex was absolutely backed by U.S. {dollars} always was a lie. These corporations obscured the true threat traders confronted and had been operated by unlicensed and unregulated people and entities dealing within the darkest corners of the monetary system. This decision makes clear that these buying and selling digital currencies in New York state who assume they’ll keep away from our legal guidelines can’t and won’t. Last week, we sued to close down Coinseed for its fraudulent conduct. This week, we’re taking motion to finish Bitfinex and Tether’s unlawful actions in New York. These authorized actions ship a transparent message that we’ll stand as much as company greed whether or not it comes out of a standard financial institution, a digital forex buying and selling platform, or another kind of monetary establishment.

And it concluded:

Today’s settlement requires Bitfinex and Tether to discontinue any buying and selling exercise with New Yorkers. In addition, these corporations should submit common stories to the OAG to make sure compliance with this prohibition.

This case posed already some severe considerations about Tether as a stablecoin, and we had been in a time the place this complete factor may have been prevented, as the size was nonetheless restricted to lower than a billion-dollar quantity.

An article from NY Times, again in 2018, additionally claimed that again in 2017 the Bitcoin value was manipulated by Tether.

Again, even solely the suspect that this is likely to be true is a severe concern for all of the crypto area.

The Second Red Flag: The Commercial Paper Mammoth

For the primary time, in March 2021, Tether, which now grew to become a mammoth, launched for the primary time:


Source: Tether

While Tether claimed a money reserve of three.87%, it additionally claimed a large business paper reserve which propelled it as a world big, because the Financial Times seen.

Therefore, probably the most worrying a part of this report was the business paper backing, representing by massive crucial backing for Tether.

As Coindesk has famous, business paper is “a type of company debt that may be simply transformed to money – or not, relying on the issuer and market situations.”

As Coindesk additional famous, “Tether declined to determine the debtors of the loans or the collateral backing them.”

Thus, so far as we all know, there are much more doubts and inquiries to be answered to this breakdown.

The Third Red Flag: The Tether Printing Machine

In a thread between Nassim Nicholas Taleb and Paul Santos over Twitter, Paul Santos highlighted two crucial factors:

1. Price motion of BTC is dictated by Tether buying and selling pair: BTC/USDT, not BTC/USD. Look on the quantity charts. Tether is BTC, even in case you by no means commerce for Tether.
2. Exchanges are fiat illiquid. They all shut down on the similar time when their is a market crash to cease USD outflows.

And Taleb replied, “If appropriate it’s successfully printing Tether.”

If this seems to be true, it implies that, identical to central banks, Tether is printing forex to pump short-term liquidity within the system (and assist hypothesis), however behind it has a personal firm, of which we all know little to nothing, if not the breakdown they lately offered!

Imagine if the entire monetary system was primarily based on an individual that instructed you “I promise I will pay you again” however confirmed you a pockets with loads of rest room paper?

Key takeaways

  • Central exchanges have change into the first enabler of the crypto-economy by increasing the person base of traders, with the motto of “you do not have to fret about your key.” As cryptocurrencies are nonetheless thought of very dangerous by most banks, none or just a few typical banks wish to do enterprise with these exchanges. This led to a magic trick to resolve the short-term liquidity concern these central exchanges face: stablecoins.
  • In essence, stablecoins are the crypto model of banknotes the place the belief is within the bearer to maintain a secure peg between the digital forex and an underlying asset like as an instance the greenback. And the recognition of those stablecoins depends upon the willingness of the central alternate to simply accept them.
  • Stablecoins turned out to be extraordinarily profitable in 2021 as a result of they enabled traders to stop larger middleman charges. It gave them the power to simply convert them into different digital currencies at any time. It additionally created a large systemic threat. In brief, an excellent chunk of the Bitcoin liquidity maybe is tied to the Bitcoin/Tether peg. In brief, if you wish to convert a Bitcoin again to USD, it’s a must to undergo USDT (Tether) first. And if Tether shouldn’t be backed by actual USD there isn’t any liquidity in any respect.
  • Worse of all, if a flight to liquidity would possibly occur this would possibly make the entire crypto area bancrupt. And with out central authority doubtlessly saving the system what’s going to occur?

What questions do we have to reply at this time, shortly?

  • What’s actually behind Tether?
  • In case of a collapse of Tether what measures exist to stop the entire system from collapsing?
  • How can this be prevented sooner or later?

Answering these questions now makes the distinction from having a crypto ecosystem destroyed or not less than its long-term means to drive change intact.

Disclaimer: The opinions on this article belong to the creator alone. Nothing on this article constitutes funding recommendation. Please conduct your personal thorough analysis earlier than making any funding selections.

Gennaro Hacker Noon profile picture
by Gennaro @gcuofano. Gennaro is the founding father of FourWeekMBA, a number one supply on enterprise mannequin innovation. FourWeekMBA


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