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After an $850 Million Controversy, What Everyone Should Know About Bitfinex, Tether,
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After an $850 Million Controversy, What Everyone Should Know About Bitfinex, Tether, and Stablecoins

There is a legitimate case to be made that Tether is one of the few systemically significant companies in the entire cryptosphere. Its (partially) dollar-backed stablecoin USDT has a market capitalization of $2.8 billion, and it is a key source of liquidity for exchanges and traders around the world. For instance, according to the research site CryptoCompare, about 80% of all bitcoin trading is done in USDT.

It is for this reason that makes what has transpired over the last seven days so important.

On April 25th, the New York Attorney General’s office said the team behind crypto exchange Bitfinex, who shares a parent company with Tether (iFinex), used funds (collateral) from Tether to cover up $850 million in (alleged) losses. While this is not the same as a hack, which have become more prominent and lucrative in recent years, if this money is lost the effect would be the same but on a much greater scale.

Much has been written about the details of the story, and readers looking for that background should consult this explainer video from Coindesk. Here are the highlights:
  • Bitfinex is using a payment processor called Crypto Capital to handle withdrawals and other transactions for the exchange. $850 million in Bitfinex’s funds are tied up in Crypto Capital.

  • Crypto Capital was not processing withdrawals, so customers were experiencing delays in retrieving their funds. According to Crypto Capital, they could not send the funds because they had been seized by regulators in the US, UK, Poland, and Portugal.

  • At this point because the two companies shared ownership, they negotiated a transfer of $625 million from Tether’s bank account to Bitfinex’s. Subsequently Bitfinex transferred $625 million from its (lost/seized?) account at Crypto Capital to Tether’s. Details are unclear about how this happened, but it appears to have just been a simple accounting transaction.

  • Because Bitfinex is claiming that the funds were merely seized, not lost, they are theoretically recoverable. However, it is difficult to verify this information or determine an accurate timeline for recovery.
Anybody currently or considering investing in crypto assets needs to understand a few key items regarding USDT, stablecoins, and the industry's overall outlook.


1. USDT is a Stablecoin and Acts Differently Than Traditional Crypto Assets

USDT was designed to maintain a consistent price peg with the U.S. dollar because each USDT in circulation was backed 1:1 by a dollar or cash equivalent in reserve (more on this later). The value of this approach is that USDT’s value is no longer subject to the supply and demand market fluctuations of the volatile crypto market, which can be extreme. As an example, Bitcoin reached as high as $20 thousand at the end of 2017, but dropped to around $3 thousand in recent months. Today, it is hovering slightly over $5 thousand. Because, USDTs are designed to move in lockstep with price movements of the U.S. dollar, they can mimic the core properties of money, namely being a stable store of value, unit of account, and medium of exchange.


2. Tether is Far from the Only Stablecoin

Despite these legitimate concerns about Tether’s operations, the value proposition of its business model is strong. 
Sensing opportunity, several other more reputable players have moved into the space offering stablecoins with similar functionality to USDT. However, the companies behind these coins are disclosing their banking relationships and submitting their reserves to quarterly audits. These include Gemini (Gemini Dollar), Paxos (PAX Standard), Circle (USD Coin), among others.

Furthermore, not all stablecoins are backed by fiat. Some, such as Dai, try to achieve price parity with the dollar using crypto-based collateral such as ether (used in the Ethereum blockchain). This approach appeals to the more ideologically-driven crypto users who believe strongly in the decentralizing features of blockchain technology and are fearful that fiat reserves kept at a custody bank are subject to forfeiture or seizure.


3. USDT Has Long Been Shrouded in Controversy

Even before this most recent controversy, USDT has long-faced accusations of being under-capitalized. This is important because if there are not sufficient reserves to back up each USDT in circulation, there could be a run on the asset and its price would plummet. The reason why this is even a question is because up until very recently (November 2018) Tether refused to disclosed their banking relationships (Deltec Bank in the Bahamas). Without knowing this information, it is impossible to audit or verify the company’ fiat reserves. In announcing its relationship with Deltec Bank the company published a letter from the Bahamian institution demonstrating that the company had approximately $1.8 billion in reserves as of October 31st 2018. This amount would have covered every Tether in circulation at the time.

However, the questions did not end even after this information was disclosed, because the company refused to submit itself to a formal audit from a reputable firm. This matters because it is possible to move funds around to achieve a certain balance on a given day, as this recent Bitfinex controversy demonstrates, but a formal audit looks deeper at the cash inflows and outflows over time, including the company’s underlying processes and controls.

There is even more to the story, because this week the company’s lawyer disclosed in an affidavit on that USDT is actually only 74% backed by fiat equivalents. Specifically, he noted that the company holds about $2.1 billion in cash and short-term securities against USDT’s $2.8 billion market cap. We do not know what the other reserves are comprised of, but it is possible that some of it are funds transferred to its Crypto Capital account from Bitfinex’s.


4. Despite the Controversy Tether is Keeping its ‘Teflon’ Nature, for Now

Industry observers have long predicted the demise of Tether. This belief was rooted in the fact that there is nothing functionally unique about Tether when compared other fiat-backed stablecoins, and eventually its price would fall compared to its brethren due to its opaque operational practices. This happened briefly when the most recent news came out, as the USDT price dropped to $.98. However, it has recovered since, and as of this writing is $1.00 on CoinMarketCap.

This is even more surprising given the fact that when the story initially broke last Friday, it caused the price of Bitcoin to drop from $5500 to $5100, and but it still has not yet recovered.

Additionally, despite the controversies and rise of new entrants, USDT remains the dominant stablecoin by a large measure, with a market cap ($2.8 billion) of almost $1.2 billion higher than its closest competitor, the PAX Standard ($1.65 billion).

This may defy belief to some users, but it is not surprising to experienced observers. USDT has rebounded from other negative stories before largely due to the fact that traders have not had latency or slippage moving in and out of positions and there has been enough evidence produced over the last 12 months to suggest that even if Tether was not 100% collateralized, it was not far off.


5. This is Both a Legal and Ethical Debate

This story came to light because the New York Attorney General’s Office said that the re-allocation of funds was not disclosed publicly to investors. The NY AG is not trying to shut down the company, but rather stop any further transfers between Bitfinex and Tether. It remains to be seen what will happen in this case.

That said, the more interesting question here is not the relationship between Bitfinex and Tether, of which many people have looked at askance for years at this point. The bigger debate is what we should make of Tether’s official acknowledgement that it is not fully collateralized with cash and cash equivalents. This suggests that the company is now operating a “fractional banking” model akin to traditional institutions. While this is not necessarily a bad thing, it can be a cause for concern considering the mysterious nature of Tether’s operations to date.


source https://www.forbes.com/sites/stevenehrli...4ae047492f
by Steven Ehrlich
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