Cryptocurrency startup Tether Limited, as well as one of the world’s largest exchanges, Bitfinex, were reportedly issued subpoenas by U.S federal regulators on December 6th, 2017. This news came to light after the company ended its relationship with Friedman LLP—an auditing firm it had employed to confirm its financial stability—on January 27th. What is this potential scandal about, and why is it sending cryptocurrency values plummeting?
What is Tether?
Tether is a cryptocurrency with a simple idea: each token issued is worth one US dollar (USDT) or one euro (EURT). To support this, the company that issues the tokens holds enough money to buy back every single token at any time. In a volatile market that banks and investors often shy away from, this provides an easy way for people to move their money in and out of cryptocurrency and gives them a stable way to store value without withdrawing their money into fiat currency.
The three layers of the project are:
1) A Litecoin-based blockchain
2) A set of rules called “the Omni Layer” that tells the blockchain when tokens are created, destroyed, or exchanged
3) A company that takes in and gives out the fiat currency
The third layer is seen by many as the weak link. Since there is no blockchain monitoring the company’s reserves of dollars and euros, only a third party checking their accounts can confirm whether they have enough to cover all of their tokens. This is where we run into the first problem.
Issue #1: Auditing
Tether Limited has historically kept its books very private, not even revealing the names of the banks where they keep their money. When their reserves were called into question in 2017, they hired Friedman LLP to audit their records. To their credit, the firm released a report in September showing a 443 million USD bank balance, which matched the number of tokens issued at the time.
However, Friedman emphasized that these numbers were not a full audit and that they would need a closer look at the records. On January 27th, though, the two companies split, with Tether Limited citing “excruciatingly detailed procedures” that would be impractical for them to comply with.
Issue #2: The Bitfinex connection
Bitfinex is one of the largest cryptocurrency exchanges in the world, so it is significant that there is almost 100% overlap between the two organizations. The cryptocurrency and the exchange share their CEO, CFO, chief strategy officer, chief compliance officer and general counsel.
The fear is that the two companies are colluding by making up money, buying cryptocurrencies, and selling them off for profit. If it turns out that people were paid in worthless USDT, billions of dollars in value could be wiped out instantly.
Issue #3: USDT tokens are flooding into the market
The total number of USDT tokens on the market has increased by 1/3 since December 6th. Indeed, January alone saw 850 million more tokens coming onto the market. This could simply be people locking in their profits as the market tips downwards, or it could be Tether doubling down on its fraud.
The evidence so far is completely circumstantial, but it is building. Prices have already started correcting as the cryptocurrency community starts to suspect that a scandal is imminent. Concrete proof is likely a long way off. The subpoenas’ exact nature is not publicly available, but the two companies are unlikely to comply right away. The likelihood of a self-imposed audit also seems remote.
The optimistic scenario is that the company may just be having trouble proving their legitimacy. They are a massive, fast-growing company in a sphere that has no set auditing procedure, after all. The worst-case scenario is that the company has been committing fraud and is set to run off with the money. The resulting price correction would be good in the sense that the market will accurately reflect supply and demand again, but it would wipe out a lot of profits.
Nonetheless, a sector as new as this one has plenty of room for growth. Cryptocurrencies may not be a get-rich-quick guarantee, but they are most likely part of the future.