Too Big to Fail? Tether Might Still Be Crypto's Ticking Time Bomb

Often, when a cryptocurrency tanks, holders of a rival coin will tease them with "SFYL" - sorry for your loss.

But the entire industry needs to keep an eye on Tether's USDT token, because if something were to happen to it, the result could be everyone's loss.

That's because the coin, also known as tether, has become a pivotal source of liquidity for the crypto markets. Without wanting to further spread fear, uncertainty and doubt (FUD) in a community that's had more than its share, a collapse of tether would be extremely bad for these markets, causing a ripple effect and, in the worst case, conceivably toppling exchanges.

To be sure, so far, tether has lived up to its description as a so-called stablecoin, whose value is pegged to the U.S. dollar. Trading data shows tether has generally hovered around $1, occasionally dipping as low as $0.80 or jumping as high as $1.10.

But the company's online critics have long alleged that Tether, which has close ties to the crypto exchange Bitfinex, has been issuing more USDT than it has dollars in the bank, in order to drive up the price of bitcoin.

That's a problem for investors because tether is rare among cryptocurrencies in that it carries counterparty risk - in other words, the possibility one party to a contract may not fulfill its end of the bargain. In Tether's case, the "obligation" is redeeming USDT tokens for dollars.

An audit by the firm Friedman LLP was supposed to prove that USDT was fully backed. But recently Tether abruptly announced that its its relationship with Friedman had ended. It remains unclear who dumped whom and why.

Now, with no audit forthcoming, the doubts are as pervasive as ever.

When contacted for this column, a spokesperson for Tether would say only, "Regarding the audit, we have no further comment."

Systemic risk
It would be one thing if the risk were confined to traders holding tether, which according to CoinMarketCap ranks among the top 20 cryptocurrencies, with a market cap of over $2 billion.

But Weiss Ratings, a decades-old investment research firm that recently began evaluating cryptocurrencies, is warning investors that Tether poses a risk to the whole ecosystem, explaining:

"Tether is the only 'cryptocurrency' with trading volume that regularly exceeds that of its market cap. This means the entire Tether supply changes hands regularly, sometimes more than once a day. ... This is important to know because it tells us that Tether is used for trading A LOT. It's one of the main sources of liquidity in the cryptomarkets."

Hence, Tether could be described as "systemically important," which is the polite term regulators use for "too big to fail." Don't count on a government bailout, though.

The Weiss report goes on:

"Liquidity is the lifeblood of a market. It's what makes prices stable and seamless trading possible. The consequences could be far-reaching. What happens if Tether does turn out to be shaky? ... What if this large source of liquidity suddenly evaporates?"

Aside from the mysterious severing of ties with the auditor, Tether's had a number of other problems.

In November of last year the company claimed that a hacker snatched nearly $31 million of the token from the company's own wallet. More recently, Bloomberg reported that the U.S. Commodity Futures Trading Commission (CFTC) sent subpoenas to both Bitfinex and Tether.

Another view
There is a more charitable and nuanced interpretation of this situation, however, than the one offered by Jordan Belfort, the Wolf of Wall Street - who in a recent interview with The Street called Tether a "massive fraud." (Takes one to know one?)

To understand the alternative explanation, you have to remember how tether, which was created in 2014, ascended to its current prominence.

In April last year Bitfinex had its wire services suspended by Wells Fargo. In order to continue trading, tether became a substitute for wire transfers for Bitfinex and possibly other exchanges that had a hard time getting or keeping bank accounts.

According to Bitmex research, Tether itself may have the same problem, and this would help explain why it's been so cagey about its finances:

"We suspect that Tether may have struggled to find appropriate banking relationships. ... We believe this is likely to be the primary reason for the apparent lack of transparency, rather than a lack of USD reserves. The transparency that some Tether stakeholders seem to expect may not be possible in the financial sector when the underlying activity is not clearly authorized or regulated by the authorities."