Legal representatives for Bitfinex and Tether confirm the widely held suspicion that USDT is not one-to-one backed by US dollars. Court documents confirm tethers are only 74 percent backed, and those holding tokens are “subject to the risk of default, insolvency, inability to collect, and illiquidity.”
In February of 2019, Tether updated the content on its website to specify that USDT reserves “may include other assets and receivables from loans made by Tether to third parties, which may include affiliated entities.”
Updates to the language around Tether’s claims of “one-to-one” backing with dollars had been changing since early 2018, with growing suggestions that USDT is not fully backed.
The updated terms-of-service in February again reaffirmed that tethers are no longer one-to-one backed. The disclosures went as far as to say:
“…assets backing digital assets such as Tether Tokens, including loan receivables owed to Tether, are subject to the risk of default, insolvency, inability to collect, and illiquidity.”
Other clauses in the terms-of-service suggested that token holders are assuming non-trival amounts of risk by holding USDT
“Tether assumes no liability or responsibility… for any and all other commercial losses directly or indirectly arising out of… loss of value of Tokens or reserve backing… failure or insolvency of any bank… or form the theft of such assets, or from freezes, seizures, or other legal processes asserted by a Government.”
As of Apr. 30th, 2019, Tether had cash and cash equivalents of $2.1 billion, representing 74 percent fiat backing of outstanding USDT, according to Bitfinex’s legal counsel Stuart Hoegner.
Meanwhile, in response to the New York Attorney General’s Apr. 25th preliminary injunction, which suggested Tether ought to hold $1 in cash fiat for every USDT, Tether’s legal representative Zoe Phillips responded:
“These allegations are wrong on multiple levels.”
These statements confirm that USDT is not fully backed by cash reserves. As such, token holders should acknowledge they are assuming risk, with limited upside, by holding tethers.
Summary of the Scandal
On Apr. 25th, New York Attorney General Letitia James (“NY AG”) issued a preliminary injunction against iFinex, the company that owns Bitfinex and Tether, preventing Bitfinex from accessing a $900 million line-of-credit provided by Tether Ltd indefinitely.
“Bitfinex has already taken at least $700 million from Tether’s reserves. Those transactions—which also have not been disclosed to investors—treat Tether’s cash reserves as Bitfinex’s corporate slush fund, and are being used to hide Bitfinex’s massive, undisclosed losses and inability to handle customer withdrawals.”
According to court documents from Bitfinex’s legal representation, the company needed the $900 line-of-credit to cover the loss of access to $850 million from payment processor Crypto Capital. Bitfinex had entrusted Crypto Capital with increasingly large sums of cash due to the exchange’s difficulties in securing a traditional banking relationship.
However, attorneys from Bitfinex and Tether claim that funds from Crypto Capital were seized by at least one government, hindering access to the funds. Losing access to these funds jeopardized the exchange’s ability to honor customer withdrawals, leading Bitfinex to tap Tether’s reserves, through a loan, to cover these withdrawals.
Bitfinex’s general counsel Stuart Hoegner stated:
“Freezing Bitfinex’s access to the credit line is highly disruptive and will only serve to reduce liquidity on hand to satisfy the needs of Bitfinex’s customers and impede the normal operations of Bitfinex’s business.”
Defending Against the Allegations
In response to the accusations, Tether and Bitfinex claim the statute leveraged by the NY AG to issue the preliminary injunction, the Martin Act, does not apply to the facts and circumstances around Bitfinex’s line-of-credit.
The Martin Act is is a New York antifraud act enacted in 1921 that grants the Attorney General of New York expansive law enforcement powers to conduct investigations of securities fraud and bring civil or criminal actions against alleged violators.
However, the Martin Act uses the precedent of “proper disclosure” around the risks associated with the sale of securities and commodities. So long as there is disclosure, Phillips asserts, then there is no case for fraud—”members of the public can decide for themselves whether to buy or sell [USDT].”
As noted earlier, there is a bounty of information disclosing that USDT was not backed one-to-one by fiat. As a result, it seems that Bitfinex is claiming that Tether does not necessarily need to keep its reserve of fiat held in Tether Ltd and that Bitfinex should have access to the loan that was provided.
As noted by Hoegner, even if Bitfinex fully draws on the remaining $200 million left in its line-of-credit from Tether, then USDT would still have 68 percent backing.
Among a number of other arguments, the legal representatives for Bitfinex and Tether claim that fractional reserves are not a novel concept. Commercial banks in the US operate with a 10 percent reserve requirement, meaning banks only need to keep cash on hand representing 10 percent of the bank’s liabilities. Hoegner wrote:
“Tether’s cash [reserve percentage] is far more than that, and the company has never lacked the funds to process a redemption.”