Why is Tether, who has been criticized, still standing still?

In the current cryptocurrency field, perhaps no other cryptocurrency asset will be more susceptible to censorship and improper accusation than Tether. The startups behind the stable currency have been accused of manipulating the market, and their business dealings and accounting practices have raised many concerns. Critics believe that Tether lacks transparency and may be involved in criminal activities, and that the stable currency is not supported by its claimed financial reserves.

The allegations made by the New York Attorney General (NYAG) to the company and its owner, iFinex (iFinex is the parent company of Tether and cryptocurrency trading Bitfinex), prove to some extent the correctness of the above allegations. Previous news has reported that Bitfinex recently repaid a $100 million loan from Tether, a situation that could further exacerbate this situation. At the same time, several other stable currencies have emerged in the past 18 months and seem to have a stronger momentum. Despite this, Tether is still the dominant stable currency. So, given that many people think it poses a problem for the entire industry, why can Tether continue to stand still?

Many problems with Tether

There are many kinds of stable coins in the cryptocurrency market, each of which has its own trade-offs and competes with each other based on several variables. The most important variables are liquidity, volatility, security, credibility, transparency, legitimacy, anti-censorship and privacy. According to various sources and experts, Tether lacks some of these variables.

01. Audit history

The main allegation against Tether is that the stable currency does not have enough dollar reserves to support its USDT tokens issued on the market. Critics believe that Tether is only operating on a partial reserve basis, that is, it only has a portion of the funds needed to support the stable currency to anchor the dollar in a 1:1 ratio. This allegation has been partially confirmed: in mid-March this year, Tether disclosed itself: “Every Tether is backed by our 100% reserve, including traditional currency and cash equivalents, and sometimes other assets and accounts receivable. These assets and receivables may come from loans that Tether issues to third parties, which may include affiliated entities.” The problem is that the true extent of the Tether guarantee can only be revealed by an audit of a reputable third party entity.

However, Tether's history in auditing is not glorious. In January 2018, due to community concerns, Friedman ended its audit of Tether, and Tether subsequently responded by saying that “in view of Friedman’s extremely detailed audit process for a relatively simple Tether balance sheet, it’s clear that Auditing is impossible within a reasonable time frame.” These rather opaque explanations did not alleviate concerns.

Prior to this, Friedman had confirmed that Tether did have the required dollar reserves, although the company did not disclose where the funds were stored and made it clear that there was no guarantee that the funds were not used for other purposes.

02. Dependence on the banking system

The relationship between Tether and the bank makes the issue surrounding auditing more complicated. Tether relies on traditional banking systems to store its reserve assets. Due to the 1:1 anchoring of the US dollar, Tether should use the full reserve banking system, ie no collateral should be borrowed. Since the birth of the partial reserve system, few banks now implement a full reserve system. Therefore, only a limited number of banks in Tether are able to provide the services they need. In addition, most banks are cautious about offering businesses that are relevant to the cryptocurrency sector and that have many controversies.

Tether has a tortuous history with its many partner banks. Since Tether's relationship with Puerto Rico's Noble Bank ended in October 2018, the company has changed its banking partners several times. The company's defenders claim that disclosure of their bank information will subject the bank to strict scrutiny and investigation by the regulatory body and may result in the termination of its partnership.

This is indeed a convincing argument, because Tether seems to be caught in a dilemma . The failure to disclose the status of its bank information has heightened concerns; and if it is open and transparent, Tether faces the loss of bank support and the security and stability of the stable currency.

03. Lack of transparency

Due to the overall lack of transparency in Tether's business, the company's capital reserves and banking relationships have received a lot of attention. It has long been speculated that Tether and iFinex are the same company. The information revealed in the November 2017 Paradise Papers document confirms this. The document states that the chief financial officer and chief security officer of the Bitfinex exchange are also senior partners of Tether.

According to Bitfinex and Tether's website, Tether's CEO JL van der Velde, CFO Giancarlo Devasini and General Counsel Stuart Hoegner are currently in the same position at Bitfinex. Although it is clear that both companies are controlled by the same senior management, it is not clear which company has priority in decision-making. New York Attorney General (NYAG)'s allegations against iFinex, as well as earnings estimates for Bitfinex and Tether, mean iFinex is at the top of the hierarchy, and Tether and Bitfinex are most likely to be subsidiaries of iFinex. These disclosures, not public information, make people wonder why the leadership of iFinex wants to cover up this information.

04. Legality

All of the suspicions and allegations surrounding Tether were almost unauthorized until recently the New York Attorney General (NYAG) announced allegations of the project, including the Bitfinex exchange's misappropriation of Tether's cash reserves to cover the rumored $850 million funding gap. The allegations, as well as the USDT stable currency, are only supported by the reserves of only 74%. The judge who presided over the case claimed that Tether acknowledged that the anchor assets of 1:1 were no longer maintained, which essentially undermined the overall effectiveness of the stable currency. In addition, it is disclosed that this 74% reserve includes assets other than the US dollar and even a small amount of Bitcoin (BTC). Since Tether is intended as a tool to hedge the volatility of encrypted assets, the use of bitcoin as a reserve asset undermines the role of Tether's mortgage assets.

And iFinex seems to be trying to fix these problems. Just last week, Bitfinex announced that it had repaid a $100 million loan to Tether in advance. Despite the recent announcement of the news, the NYAG case has confirmed many of the views of critics over the past few years. Juan Villaverde, founder of Weiss Ratings, said:

“This case confirms all our doubts about USDT over time. That is to say, the stable currency is not 100% supported by the US dollar and other legal currencies. It also confirms that these reserve funds are being loaned to third parties for profit. Even some of the reserve funds are sometimes used to buy crypto assets such as Bitcoin. All of this seems obvious to us, but we have no solid evidence before. Now NYAG has made all of their practices public. ”

05. Waiting to accept the sanctions?

Tether's system is almost entirely central. The company is subject to government action, as is its currency reserve – as long as these currency reserves are in the bank, they are subject to the government. In addition, the company has shown us that it can reverse transactions and enforce hard forks.

Of course, these criticisms apply equally to most other centralized stable currencies. Given Tether's current legal problems, coupled with concerns about its solvency and credibility, Tether has become a bigger target for law enforcement than other centralized stable currency competitors.

Conversely, decentralized stable currencies (such as DAI and Reserve) can take advantage of Tether's centralized weaknesses to provide a more powerful alternative to the true anti-censorship of crypto assets. In an interview, Nevin Freeman, co-founder of the stable currency project Reserve, highlighted the current problem of centralized stabilization coins:

“Currently, centralized stable currencies like USDT, USDC, TUSD, etc. cater to people’s stability needs for cryptocurrencies… When centralized credits begin to be more restricted or fully closed, decentralized stable coins will It has become much more important. Libra is another example supported by centralized assets. The project will be great as long as the government allows it, but if the government decides to close it, they can do it."

The response from governments to Facebook's Libra Stabilization Coefficient proves this threat. Libra and Tether are not particularly different. Facebook's current size and strength seem to be the most important factor in its goal of becoming a government. These recent responses underscore that it is the relatively small size of “Tether” that protects it from a full-scale conflict with regulators.

Competitive advantage of other stable currencies

Compared to many of the deficiencies of Tether, many other stable currency competitors have multiple advantages.

01. Transparency

Almost all competing stable coins can boast that they are more transparent than Tether. USD Coin (USDC), True USD (TUSD), Paxos Standard (PAX) and other stable currency projects have clear management records and contact information. For example, USDC involves major traditional institutions such as Goldman Sachs, which communicate frequently with users and complaints from users. Get a response, work in a highly professional way, and more.

02. Appropriate reserve support

This transparency extends very importantly to the financial guarantees and support of these competitive stable currencies. Taking the USDC as an example, the stable currency is often audited with the reputable Grant Thornton LLP. And PAX CEO Chad Cascarilla also said that stable coins such as PAX further separate the user's funds from the company to ensure greater transparency and security:

“PAX provides users with a simple guarantee: their money is always there, always safe. We allow users to easily create or almost instantly redeem PAX at no charge, no matter how much. We It is a regulated trust company. PAX's US dollar reserves have been kept in separate accounts of multiple FDIC insurance US registered banks, and these mortgage funds are quite safe."

03. No trust

Given the fragility of the centralized architecture in the cryptocurrency ecosystem, as the countless exchange attacks show, Tether's centralization framework presents greater risks. The intensiveness of Tether and the Bitfinex exchange exacerbates this risk. As mentioned above, Bitfinex is happy to use Tether's reserves to make up for its losses. Most other stable coins have the same problem, and there are currently only a few decentralized stable coins.

However, decentralized stable coins can be the perfect solution in the market, provided they are scalable and provide the necessary liquidity and high level of user experience. As described by Juan Villaverde, founder of Weiss Ratings, the benefits of these decentralized stable currency projects are irresistible: “Especially DAI does not have counterparty risk because it is based on algorithms rather than centralized hosting.”

Tether's resilience

Despite the myriad of problems with Tether and the obvious advantages of competitors, the stable currency still dominates the stable currency market. According to the latest data from stablecoinswar.com, current Tether accounts for 98.3% of all stable currency transactions, while its market capitalization accounts for 81.42% of the total market value of all stable currencies. Only TUSD, USDC and PAX are their true competitors. Why is this so?

01. Network effect

In addition to compound interest, there may be no more powerful forces in economics than network effects. A network effect is when the value of a product or service increases as the number of people who use it grows. All cryptocurrency assets are affected by network effects, and stable currency is no exception.

Once a large number of users start using an asset, the usage increases exponentially or non-linearly. This is exactly what Tether has experienced. Since Tether was released in 2014, its usage has not started until 2017. The project benefited from the growing cryptocurrency bull market and total lack of competition, which made Tether the only choice for most traders who wanted stable prices at the time.

In fact, all of Tether's competitors emerged in 2018, when Tether had already gained a foothold in the market. At this point, it is likely that huge forces will be needed to overthrow Tether's dominance, such as the confiscation of funds by government agencies or serious loopholes in Tether's Omini protocol layer.

In general, the growing network effect has improved Tether's liquidity and reduced its volatility, which in turn makes traders more willing to invest in it. This effect then self-sustains, increasing the initial network effect. That's why despite Tether's many shortcomings, it continues to dominate the stable currency market.

02. Blockchain Agnosticism

Currently, Tether is using blockchain platforms other than Bitcoin to enhance its current momentum. Until recently, almost all Tethers were running on the Bitcoin blockchain through the Omni protocol layer. Aware of the potential for bullish congestion in Bitcoin (as happened in December 2017), the project is introducing support for Ethereum, EOS, Tron and Lightning Networks.

By transitioning to blockchain agnosticism, Tether can consolidate its strengths and prevent bitcoin congestion from hampering its success. Such a move is likely to be due to the increasing pressure exerted by other competitors. While Tether may not be ready to provide the level of transparency that some people are pursuing, it hopes that this enhanced interoperability will make up for this.

03. Impact on liquidity and volatility

Tether's leadership and network effects have given it tremendous liquidity. Large traders and institutions rely on high liquidity to increase or decrease positions without delays. Therefore, Tether is still the most attractive stable currency for players who are large, do not require regulatory compliance, or don't worry about other issues with Tether. It turns out that the advantage of the first mover is priceless, as Juan Villaverde said:

“The reason for this asset (Tether) is so successful is because it is the first stable currency. It is not as good as its competitors in other respects, but it still maintains a solid lead compared to all other stable currencies. status."

04. Demand in East Asia

The use of Tether is heavily biased towards demand in East Asia. In fact, competitors like USDC, TUSD and PAX have gained great appeal in the US and other Western markets, but compared to Tether's popularity in the East, the adoption of these competitors is dwarfed. Encrypted currency trader Alex Kruger said: "Tether continues to dominate the stable currency market due to demand from Asia."

According to a recent study by cryptocurrency research firm Diar, Chinese exchanges account for more than 60% of USDT transactions. As of now, the USDT transactions on these exchanges have accounted for $10 billion so far, while the US exchanges account for only $450 million. The remaining 36% of the volume is mainly from Binance and Bitfinex, both of which are primarily for East Asian customers. Diar emphasizes that these numbers are accurate and not a false transaction volume.

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Diar provides the trend of the volume of transactions on the Tether chain by region. Black represents the proportion of China's exchanges, red represents the proportion of US exchanges, and gray represents the proportion of global exchanges.

Considering that Tether is denominated in dollars, this dynamic is very peculiar. This may be due to Tether's lack of regulation and transparency, which makes it attractive to Asian investors and traders who want to avoid government regulation and sanctions. In addition, this situation is exacerbated by the high liquidity or the lack of viable and stable assets denominated in RMB, JPY or Korean won.

05. The impact of the Sino-US trade war

Tether may also benefit from the escalating Sino-US trade war in recent months. While the Trump administration raised tariffs, China’s economic situation was also affected. Key players in the cryptocurrency sector, such as Barry Silbert, founder of Digital Currency Group, and Naeem Aslam, chief market analyst, have previously said that the escalating trade war has led to the current encryption bull market.

Encrypted assets are one of the easiest ways to hedge risk and obtain capital from vulnerable and less liquid assets such as real estate. In addition, there is almost no stable currency linked to East Asian currencies.

06. Bringing systemic risks to the market

Due to the NYAG case, the current issue of Tether is better understood and officialized than ever before, but Tether continues to grow and play a key role in the market. This fact also highlights the risks that Tether may pose to the entire encryption community. The authors talked with experts to assess the risks they perceived from Tether. MT Greenspan, eToro senior market analyst, said: “My feeling is that each exchange has a contingency plan in place to deal with any Tether-related issues that may arise.” Villaverde generally agrees with this view and states:

“We believe that in the long run, USDT does not represent a systemic risk in the field of crypto assets. Let us not forget that the gains in Bitcoin accelerated around the end of April this year, when the market was worried about USDT as an asset class. Sustainability. The same thing happened in October last year, when Bitcoin soared more than 10% in one day because people were worried that Tether was not like it. The market has already expressed its position on this issue: it tells us even When the market is concerned about the sustainability of the USDT, its market liquidity is also sufficient to withstand the outflow of its capital."

Considering other costs, we seem to have reason to believe that major exchanges are working to mitigate most of the threats that Tether crashes can cause. This resilience may also depend in part on the offsetting effects of other competitive stable currencies.

Before the real time comes, we may not be able to know the true potential of USDC, TUSD, PAX and other stable currencies. However, it seems relatively simple for investors to exchange these major stable currency assets in US dollars. Despite the need for KYC and anti-money laundering tests, nothing prevents investors from adopting these stable currencies. In a crisis situation, if Tether theoretically collapses within a few days, the question will be whether these alternative stable currency projects have systems that can support the large amount of legal currency inflows that will occur. Paxos CEO Cascarilla said that PAX can easily deal with this problem:

“Since the launch of PAX in September 2018, we have accumulated liquidity and users can easily create and redeem PAX. Currently, there are more than $1 billion in PAX transactions per week, and nothing can limit us to 10 times this size. ""

Of course, it is equally possible that, as Villaverde believes, the collapse of Tether may only lead to a surge in bitcoin prices , ie USDT holders are more willing to trade bitcoin than to be less liquid than others. The stable currency is traded. He said: "No matter what happens in the short term, these funds will flow to Bitcoin and remain in the field of cryptocurrency."

Conclusion

There seems to be evidence that Tether's business has several major flaws, especially in terms of transparency, trust, legitimacy, and centralization. But the market clearly sees that Tether's benefits in terms of liquidity, price stability and availability outweigh the significant risks of its existence.

And Tether's history is long, and the resulting network effect continues to dominate the stable currency market. This uncontrolled network effect has recently been boosted by East Asian demand, providing the project with the high liquidity and low volatility that traders and investors aspire to.

At this stage, it seems that a huge force is needed to overthrow Tether's status. It remains to be seen that its competitors can withstand this capacity. However, in the short term, Bitcoin and other major cryptocurrency assets are equally likely to benefit from such a crisis. Perhaps the collapse of Tether will not bring systemic risks to the market, but will bring more bullish momentum to the market.

Author | Ben Whittle

Compile | Jhonny