- Are popular crypto stablecoins the next subprime CDOs, or even outright Ponzi schemes?
- The settlement agreement between Tether and the New York Attorney General’s Office, court transcripts, skimpy disclosures, and independent analysis by Bloomberg of Tether’s financials paint a troubling picture.
- Two stablecoins, Tether and USCoin, now have around $100 billion total in market cap and may not be backed by adequate collateral, or in Tether’s case, much collateral at all.
- Tether is particularly sketchy. I believe there are some obvious red flags worth noting about the coin.
- The craziest one? Tether supposedly owns 5 percent of the world’s commercial paper, but no one can seem to find anyone who has done business with them.
In the run-up to the 2008 Global Financial Crisis, lightly regulated nonbank financial companies created “innovative” products like subprime CDOs that offered false promises of high, safe yields to their investors. When the economy turned into recession, many of these products lost all of their investors’ money. Even worse, the 2000s boom allowed fraudsters like Bernie Madoff and Allen Stanford to build up massive schemes, only to be detected when the economy turned down and their investors hit them with redemptions. In fact, so much fraud was uncovered in 2008 that the IRS even changed the rules in early 2009 to ease the burden on defrauded investors by letting them write off Ponzi scheme losses as theft, rather than capital losses. Memories are short in the world of finance, and today we have new “innovations” that may or may not be what they appear on the surface. And today, nonbank lenders are again offering risky products with high yields and plenty of red flags. The most glaring example of this is the ballooning market capitalization of Tether (USDT-USD).
Tether Market Cap (log-scale)
Tether essentially is supposed to work like a money-market fund. Like money market funds, its value is pegged at $1.00. Unlike money market funds which pay less than 1% interest, Tether pays interest at rates of 6-12% at popular crypto brokerages.
As such, Tether is vacuuming up money like there’s no tomorrow– its market cap has ballooned 1500% since 2020 from $4 billion to nearly $70 billion. Another popular stablecoin–the USCoin (USDC-USD) now has a market cap of over $32 billion. Before bank regulation started to be taken seriously in the US during the Great Depression with the creation of the FDIC in 1933, stuff like this happened all the time. Without regulation, anyone can start a “bank” or something that functions like one, lure cash from depositors by offering high levels of interest, make a lot of money making risky loans and investments, and then close up shop when the economy turns down. Charles Ponzi did it one better in the 1920s by not bothering to invest the money at all and just paying off old investors with new investors’ money, and now his name is forever associated with the term Ponzi scheme. Stablecoin founders like to tout that they’re using new technology, but the main ideas aren’t any different from those that preceded the panic of 1837, the panic of 1873, the panic of 1907, the panic of 1929, or 2008.
NYU professor Nouriel Roubini has called tether a “criminal enterprise,” and “the mother of all scams.” Jim Cramer called tether the “black hole or crypto.” Ethereum co-founder Vitalik Buterin has said tether is a “time bomb.” Another recent analysis Tether compared it to the collapse of much of Iceland’s offshore banking industry during the 2008 crisis. With nearly $70 billion in liabilities and questionable collateral backing it, in my view, Tether certainly is one of–if not the sketchiest investment out there right now.
Red Flag #1– Questionable Reserves
Tether lists its reserves as nearly half in commercial paper. By this measure, Tether would own nearly 5% of all the commercial paper in the world. But when Bloomberg called around to all the major trading desks in New York and London, none of them said they’d ever done business with Tether! This is a huge red flag! Remember that their liabilities are pretty easy to figure out, for a bank, liabilities equal the amount deposited with them, plus anything else they borrow. To paraphrase Charlie Munger’s dictum, Tether’s liabilities are 100 percent there– it’s the assets you have to worry about.
From Matt Levine at Bloomberg:
Tether now says that its reserves consist mostly of commercial paper, which apparently makes it one of the largest commercial paper holders in the world. There is a fun game among financial journalists and other interested observers who try to find anyone who has actually traded commercial paper with Tether, or any of its actual holdings. The game is hard! As far as I know, no one has ever won it, or even scored a point; I have never seen anyone publicly identify a security that Tether holds or a counterparty that has traded commercial paper with it.
How can Tether supposedly own 5% of the world’s commercial paper and have no banks ever do business with them? Tether also refuses to disclose what commercial paper it owns, for “privacy reasons.” However, what makes the global commercial paper market work is reputation, it’s not some secret. Either all of the commercial paper is somehow in emerging market countries and with other crypto companies (bad) or doesn’t exist (worse). Tether claims they trade through intermediaries, but their main custodian is a tiny bank in the Bahamas, which would have to use a major bank/broker-dealer to exchange all the commercial paper themselves. Harry Markopolos famously used similar logic to prove Madoff was running a Ponzi scheme, and the similarities between the two cases here are hard to ignore.
Red Flag #2– Ongoing Criminal Investigations
Bloomberg reported this summer that senior executives at Tether were being targeted by a federal criminal investigation for bank fraud and money laundering. A journalist named Jacob Silverman recently tweeted that his FOIA request for documents related to Tether was denied due to a possible ongoing law enforcement investigation. Other people connected to Tether, and Tether’s payment processing firm, Crypto Capital, have been arrested for laundering money for international criminal organizations as well, and as part of the NY indictment, it was discovered that Tether did not have a formal contract with them, even though they handled hundreds of millions of dollars of their funds. Additionally, the president of this payment processing firm got arrested in Poland for laundering money for Columbian drug cartels. Tether and their affiliated exchange Bitfinex are ostensibly victims here because they lost $850 million to accused money launderers, but it’s not clear why they were doing business with international criminal organizations in the first place, especially when the premise of Tether is that it’s as good as cash. Another question is how these losses were dealt with on Tether’s books, the attestation lists their assets as slightly more than their liabilities, which seems unlikely if they’re investing the money the way they claim to be.
The narrative of some fringe crypto people that their currency is disrupting geopolitics and that’s why they’re getting negative attention from Western governments is just not true– when people get in trouble in the crypto world, it’s generally for old-fashioned stuff like stealing money.
Red Flag #3–Unusually High Interest Rates.
Most holders of Tether are earning interest for doing so at cryptocurrency brokerages. In itself, high rates of interest do not necessarily mean that an investment is not legitimate, but you need to understand as an investor why you’re earning the interest. Typically, high rates of return mean you have risk, which is okay if the risk is sufficiently compensated.
Holders of Tether are getting unusually high interest rates of 6-12% from cryptocurrency brokerages. Additionally, as Bloomberg reported this week in its most recent piece, many of these brokerages are directly or indirectly affiliated with Tether. This is a potential conflict of interest and another red flag. The main fear here is that Tether is simply using new depositors’ money to pay redemptions, as is eloquently argued here by Matt Ranger, an economics blogger. Another fear, which may pertain to USCoin as well, is that some more legitimate attempts at stablecoins earn the money to pay these high rates of interest by making sketchy investments, like loans to Chinese and Latin American companies that carry high rates of interest but probably will never see the principal returned. It’s not unusual for venture capital firms to back new companies and for them to heavily use promotions to acquire customers, but when financial services companies do this, you want to see that they’re regulated and audited, which brings us to our next red flag.
Red Flag #4- Lack of Auditing
Tether is not audited and in my opinion, wouldn’t pass one if they were. They tried to get an audit by Freidman LLP, a New York City law firm, but the audit was never completed and ended with Freidman dumping Tether as a client.
Tether soon after was investigated by the New York Attorney General’s Office for fraud, and they settled charges related to misleading New York residents this year about the reserves backing the coin. The New York AG would do more if they had jurisdiction, but Tether is an offshore web with links to China, the Caribbean, and Latin America. Tether to this day has not undergone an audit, which would prove that the reserves Tether holds are real and not simply borrowed from a third party when redemptions come in. Instead, they have an “attestation” from a small accounting firm in the Cayman Islands, while constantly promising they’ll someday get a real audit. For some light reading, the transcripts from the New York case are public record–you can read them here. Bitcoin (BTC-USD), for example, shows every BTC on the blockchain, eliminating the need for this type of audit. That’s also why Bitcoin is so volatile–no one is promising you they have a dollar in a bank account somewhere to back your BTC.
Red Flag #5- Commingling of Funds
The above New York settlement found that Tether had all of the depositors’ money in its lawyer’s personal bank account at one point in 2017. In 2018, they commingled reserves from Bitfinex (a crypto brokerage associated with Tether) with tether funds. Tether does not appear to have sufficient internal controls to stop this from happening more in the future, and with the amount of money they’re handling increasing exponentially, nothing good can happen from this. Commingling of funds is not something that entities that control billions of dollars should ever do.
To get both sides of the story, we reached out to Tether for comment and they directed us to their response to Bloomberg’s piece this week.
The Bloomberg BusinessWeek piece published today is a one-act play the industry has seen many times before, taking snippets of old news from various places and dubious sources, and making it fit a pre-packaged and pre-determined narrative. Crypto—and Tether in particular—are fostering a revolution in financial inclusion, transforming a model that doesn’t work in a modern world. This article does nothing more than attempt to perpetuate a false and aging story arc about Tether based on innuendo and misinformation, shared by disgruntled individuals with no involvement with or direct knowledge of the business’s operations. It’s another tired attempt to undermine a market leader whose track record of innovation, liquidity, and success speaks for itself.
You can read their full response here.
I read Bloomberg’s piece, and the reporting strikes me as credible and soundly fact-checked, and corroborates with other independent reporting done by other news outlets, bloggers, and activists. In my opinion, the Tether saga will most likely end when enough customers request withdrawals and there will simply be no money to pay them. With the market cap ballooning and the weight of the evidence suggesting that the collateral is either sketchy or nonexistent, Tether indeed appears to be a time bomb. I wouldn’t expect Tether to last more than 1-2 more years before it collapses under its own weight. With this in mind, I would promptly redeem my investment in Tether for cash if I had one. I would also be very cautious with other stablecoins, due to the possibility of counterparty risk.
Tether likely does not pose a direct risk to your retirement portfolio, the S&P 500, or the global financial system, but if Tether were to suddenly collapse, the stock market will probably be down at least 2% on the day as traders sell first and ask questions later. No one knows when this thing will implode, but Tether appears highly unsustainable. I’d advise my readers to stay clear.
This post from Logan Kane