Richard Yan of The Blockchain Debate podcast held a debate between The Block’s Larry Cermak and Bennett Tomlin, a data scientist and blogger with an interest in fraud. Patrick McKenzie, a Tokyo-based entrepreneur, who wrote one of the best articles describing Tether to date, joined as a co-host. 

The motion on the debate was, “Is Tether acting in good faith?” Tomlin argued that no, they are not. While Cermak argued for the motion, giving Tether a generous benefit of the doubt.

Cermak is a bit of a puzzle to nocoiners these days. He has recently taken to defending Tether, stating that he believes the BVI-registered stablecoin issuer, which has so far issued $24 billion in tethers, is fully backed. In the past, he took a hard stance against Tether and its sister company, crypto exchange Bitfinex, causing them quite a bit of trouble. In October 2018, for instance, he disclosed in a tweet that Bitfinex was banking with HSBC under a shell. Soon after, the feds froze that bank account. The shell, as it turned out, was registered to Arizona businessman Reginald Fowler, who was indicted the following year on bank fraud charges.

Cermak has also admitted to owning crypto and making money in DeFi markets. He recently bragged on Twitter about gifting his fiancee $1,000 in crypto to gamble in the futures markets. Tomlin, who is working on a book on Tether, told me he does not currently own any meaningful amount of crypto. (At one point, he owned about $500 worth of bitcoin and ether.) “I want to stay as unbiased as possible,” he said.

Tomlin does a good job presenting facts in the debate. He clearly has read through all of the related court documents, and knows what’s in them. Whereas, Cermak tends to rely on “somebody told me this” type of information. His sources appear to be Tether frontman Paolo Ardoino and large Tether customers, such as OTC desks, exchanges, and high-frequency trading firms, who stand to make big profits in the crypto space.

What follows is the transcript with my annotations. I’ve removed filler words (such as uh, basically, you know, right, so, etc.). Brackets indicate words I’ve inserted for clarity. I’ve added links where appropriate and edited out most of the intro. Overall, there’s lots of good info in here, and I recommend reading the full transcript. 

Richard: Bennett, please go ahead and tell us how Tether has been acting in bad faith all this time since they started in 2014.

Bennett: The easiest way to go about this is to look at a specific example that will show many of the patterns that have persisted over this period. Bitfinex gave over $1 billion to payment processor Crypto Capital Corp without a contract or an agreement. This payment processor was not a registered money servicing business or a licensed money transmitter. This payment processor lied to the banks about what the accounts would be used for. And when the principal for this payment processor was arrested, he had in his possession, counterfeit U.S. currency and fake bond certificates. 

(The “principal” Tomlin is referring to is Reginald Fowler, who allegedly served as Crypto Capital’s money mule, setting up bank accounts under shell companies and moving money for Bitfinex. It is worth mentioning here that Tether and Bitfinex have the same operators: CSO Phil Potter, CEO Jan Ludovicus van der Velde, and CFO Giancarlo Devasini, who are barely heard from these days. Nocoiners refer to them as the triad.)

When this payment processor stopped responding to Giancarlo and Bitfinex’s requests to withdraw funds and the DigFinex executives believed that these funds were potentially lost, Bitfinex publicly insisted that withdrawals were working fine and there were no problems.

(DigFinex is the parent company of Bitfinex and Tether. Here is an org chart for reference. The “lost” funds included $850 million, some of it tied up in a network of 60 bank accounts set up by Fowler and some of it seized by the Polish Ministry of Justice from Crypto Capital’s Polish subsidiary, Crypto Sp. z. oo.)

However, privately, in order to combat this effective insolvency of Bitfinex, the executives of Bitfinex and Tether orchestrated a swap of multiple hundreds of millions of dollars from Tether’s bank accounts to Bitfinex in exchange for a ledger notation saying that tether now possessed the inaccessible funds at Crypto Capital, effectively making Tether insolvent.

This fact was not disclosed and Tether’s homepage and terms and conditions at this point still claimed every tether was fully backed by the equivalent currency, despite this effective insolvency. These are not the actions of good actors in the cryptocurrency space.

(The NY attorney general has been investigating Tether and Bitfinex since late 2018 for violating the Martin Act. Most of the details of what Tomlin is referring to can be found in a court filing.)

Richard: Thanks Bennett. That was very thorough. And I would say you’re probably one of our first guests that have actually prepared a statement and read from it as if this was a hearing or something. But anyway, thank you, Bennett. I definitely don’t think you are in the minority there when you accuse Tether of being in bad faith. So I’d love to hear what Larry has to say next. Larry, please go ahead with your opening statement.

Larry: First of all, Bennett’s statement was great. There’s a lot of merit to it. That being said, Tether has seen tremendous growth this year. It’s important in several different products. It’s incredibly important for the current market structure. Basically all the futures are collateralized by Tether. Now the majority of volume is coming from tether pairs, and we’ve seen legitimate growth from Tether this year. Some people argued that growth is pumped by Tether itself, where you can see similar growth in USDC and competing stablecoins. 

(USDC is a US regulated stablecoin that has also seen a lot of growth, but that growth is dwarfed by Tether, which since March 2020, when BTC plunged to below $5,000, has issued 20 billion tethers.)

There is, at least in my experience, overwhelming evidence that there is money going into Tether and there’s money being redeemed by several different parties. These parties are usually OTC desks, market-makers, and exchanges. The reason why there isn’t much public evidence of this is because these parties tend to be more on a private end and they don’t have much of a reason to actually tell people that they’re redeeming for hundreds of millions of dollars.

I do think that Tether used to act questionably and Bennett highlighted that really well. I do think that they’ve changed significantly in the past year and a half. I’ve been watching Tether for the past four years now. And the behavior has changed a lot. 

They are much more transparent publicly. They are much more transparent in their goals, how they operate. And I do think that right now, my belief is that they are fully backed. And my belief is that they are not acting in bad faith. Quite the opposite. I think they are super important to the crypto space. And I agreed that it’s important to consider the possibility that Tether might at some point stop existing. But I don’t think it’s fair to say that they’ve been acting in bad faith, especially in the last couple of years.

(Tether has not been transparent at all. In a recent podcast, Tether frontmen Poalo Ardoino and Stuart Hoegner refused to say what assets were backing tethers. However, one thing they were clear on—it wasn’t all cash.)

Patrick: If I can jump in here. Assuming, arguendo, that Tether is fully backed, Tether has said a few definitions over the years as to what constitutes backing. Under which definition do we believe that they are fully backed? What is the collateral? Where is it?

Larry: That’s a good question. I think that they are fully backed when it comes to dollars on bank accounts. Tether has the mandate to invest in super low-risk yielding opportunities. So as far as I know, the vast majority is in US dollars on their bank accounts and they don’t just have one, it’s possible. Some of it is in some bonds or really low-yield investment vehicles. I don’t believe that any of that backing is in cryptocurrencies or some kind of other more risky vehicle.

(In his recent podcast, Hoegner counted Tether’s remaining $550 million loan to Bitfinex as an asset backing Tether. In an April 2019 affidavit, Hoegner said the 2.1 billion tethers in circulation at the time were only 74% backed. Tether/Bitfinex have never said anywhere publicly that they’ve invested in bonds. Also, Tether’s terms of service says tethers are backed by “traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties, which may include affiliated entities.”)

Richard: And when we say bank accounts, are those bank accounts at Deltec Bank in the Bahamas or are those bank accounts at Deltec Bank somewhere else? Are there banks that the world doesn’t know [about]?

Larry: Absolutely. As far as I know. The last time I talked to Paolo was maybe a month ago when we were working on a stablecoin report. I asked him this question as well. He did say that the majority of funds are at Deltec and there are also some other banks that they’re working with, but only for smaller amounts. I assume that’s mostly just to make the redemptions and the transfers easier for customers. But I do think that the majority of the funds is at Deltec in The Bahamas.

Bennett: If I can ask a question, because I’ve been curious about that too, just as an outside observer, as to where the funds might be held.

The Central Bank of the Bahamas publishes a quarterly statistical digest that looks at the total assets that all the banks in the Bahamas are holding. And if you look at it, with the most recent one being released in November, you do not see any increase in assets held at Bahamian banks over the last year. Either there must be comparable outflows from somewhere else to match any inflows from tether, or there’s some reason Deltec Bank would not be counted among those statistics. Do you have any insight into why that would be?

Larry: I don’t. I really don’t know. I’ve looked into those documents as well. I’m not sure if it even encompasses all the money that is in the Bahamian banking system. I’m not sure why that is honestly.

Basically the reason why I believe that Tether is fully backed is not just because I talked to Paolo and they feed me this marketing stuff. It’s because I talked to a lot of different actors in the crypto space, those being massive OTC desks, large traders, exchanges directly, and basically anyone who deals with Tether directly, and they have redeemed tens of millions of dollars. I mean, I’ve seen proof of that.

I trust these people, and I’ve talked to so many of them at this point that it’s beyond reasonable doubt that Tether is operating as it should when it comes to redeeming money. The frequent argument that I hear from people on the other side is, why isn’t the supply decreasing at all? Basically, why is it only going up?

The simple answer is that the demand is just so much higher, and they don’t do these redemptions every week or something. They have a system, where if more money is coming in then is coming out, they obviously don’t reduce the supply. And this happens in fairly long periods of time. So that’s why it’s not happening. 

And if what you guys are conferring is that if Tether was not back fully or only had a really small amount of the backing, they would not be able to serve these redemptions. And basically without any issues, these things are happening quickly. And to the point where a lot of these large traders or institutional customers have started their own bank accounts in Deltec, just so they can make the process more efficient. 

(Paolo and Stu confirmed in their podcast that several of their customers also bank at Deltec. Yet, we have no idea what type of arrangement Tether has with its large customers, whether Tether is in fact loaning USDT to them and counting those loans as backing, or what the deal is.)

And so that’s the basis for my argument that Tether is backed. And then also just talking to Paolo and having conversations with people that are close to the business. At this point, I would be shocked to find out that it was less than 98% or 99% backed.

Bennett: I have a couple of things I want to add to that. The initial document released in the New York attorney general investigation said, at that point, the largest redemption was $24.2 million. So Do you think that Tether’s documents that they were handing over before the ex-parte order were incomplete, that the average size of the redemption has gone up significantly in the intervening two years? What would explain that dynamic? 

Larry: Oh, absolutely. I think it has gone up way significantly in the last two years, to the point where now a hundred-plus million dollar redemptions are completely normal. 

That’s because the space has just grown quite a lot. Like I said, the dynamic with Tether has changed significantly. Bitcoin used to be the main reserve currency when it comes to crypto, both for futures and derivatives. Now it’s tether and the same is happening for the pairs. It used to be all bitcoin, now it is tether. 

So Tether is much more important now. The supply is much higher and these parties are using it unquestionably because if they want to get access to futures, and these features are extremely liquid, they do have to have access to tethers. So these redemptions are definitely increasing in size. There’s no doubt about that. 

Also, one thing I would like to point out is that you have to understand that Tether obviously doesn’t want any of their information to be public. And that is not only because they are covering something shady, which could be the case, but it’s also because they just don’t want their own business information to be out there for everyone like you and me. So that’s my basic response to that. I do think that the redemptions are now significantly larger. That still means that they’re not acting in bad faith.

Bennett: There’s one other point I wanted to make there before we move on. You said that you were confident tethers were fully backed because they’ve been able to service these large redemptions. But you also said that there are more deposits actively coming then going out, which would mean to service these redemptions, until there’s a whole group of them, they could in theory, service them with a small amount in reserve and the incoming deposits, correct?

Larry: Yes. It’s hard to estimate how much they would need to have to justify this condition. So I agree with you. Again, I guess the main question here is: What do you think they’re doing with the money? Do you think they’re just taking it for themselves or what do you think they’re doing with it?

Bennett: We know from the New York attorney general investigation, that Tether executives do receive large, aperiodic payments from comingled client and corporate funds out of the Tether account. That was discussed when they were arguing for the initial injunction against them, with the limits on related party transactions. So I do think there is the possibility that money has been exfiltrated by Tether executives.

Their lawyers also argued that their mandate is not just to invest in easy yield or things like that, but that Tether has the ability per Tether themselves to keep zero in reserves and invest anywhere they see fit, including—and the lawyer made very clear that they had done this—in bitcoin and crypto assets. So it is conceivable to me that a meaningful portion of their backing is currently invested in extraordinarily volatile assets.

Larry: I think that’s definitely not true. And again, I’ve had conversations with Tether executives and talked to different people. And as far as I can tell, that’s not true. They’re not investing in bitcoin and volatile assets. They are investing in low-yielding opportunities. 

(It is interesting Cermak would say this, considering he literally wrote an article for The Block in March 2019 with the headline “Tether admits in court to investing some of its reserves in bitcoin.”)

And to your point that some of the money used to go out to some of the executives. I do agree that’s a terrible look. I think it can mostly be explained by the fact that they just had so much trouble banking themselves that they used their personal bank accounts, which is a terrible practice, I agree. I don’t necessarily think that they’re acting in bad faith, but they acted in a careless way. I don’t think at this point that they’re just taking money out of it for their own personal gain. And that’s mainly because Tether now has more than $20 billion [worth of tethers] in supply.

Even if you say that they’re yielding about maybe 0.05% or around 0.01%, that’s a lot of money and the business is really treating them well in that regard. They’ve grown significantly this year and they’re generating a lot of money from it. And that’s while Bitfinex itself, as an exchange, has struggled this year. 

Now it’s picking up again. Early this year and late last year, the volumes really dropped significantly. And that again is another argument against people that think that Bitfinex is just faking value. They’re just creating a lot of Tether, and then the volumes are going up. 

That’s definitely not the case. And the clear evidence against that is because in 2017 and 2016, Bitfinex was one of the most important exchanges when it comes to spot. Now it’s not even in the top five and the volume has dropped significantly compared to other exchanges. So I don’t agree with that fully.

Patrick: It is extremely curious that their lawyers wouldn’t bring up that we only invest in low volatility as zero-custodial-risk assets when asked that in the course of investigation as to whether they were dissipating client funds and instead chose to tell the court that they had the right to invest it in absolutely anything they wanted, including cryptocurrencies. And we’re doing that. These seem difficult to square for me.

Larry: I was the one that read the document first. And I was the one that led the coverage on that first. So I know what the document said. It wasn’t as clear. It was a little bit more ambiguous. 

They’ve said they’ve previously invested on small amounts of cryptocurrencies. Again, I don’t believe that to be a significant amount. And if it was, I still believe that it was a very small amount of the total. And again, it’s hard to explain some of these things because that’s just by talking to people and understanding how Tether works in the background. 

But you keep coming back to the point that they basically can do anything, and that the lawyers don’t want to disclose what they don’t want to tell people. And that to me makes a lot of sense, right? Tether can do almost anything. It’s in their best interest not to disclose the information because they feel like the US people and the United States overall, they don’t have any jurisdiction. Tether claims to not function there. So I would say that kind of explains that.

Patrick: The jurisdictional point is an interesting one for me, because I’m not super familiar with banking regulations in the Bahamas, but if hypothetically Tether is holding large amounts of dollars at Deltec and not in the Bahamas, then the natural thing for me to assume is that they’re holding it in some sort of correspondent banking relationship elsewhere. And so it would matter a bit whether those jurisdictions would care whether the US believes that Tether is subject to a US court order.

So do we actually know what those jurisdictions are? Are they ones like, without loss of generality, Russia, which don’t care about us court orders? Or are they ones like Japan or the United Kingdom, which would happily enforce one?

Larry: I don’t think we know the details. Again, what do you think would have to happen for the money to be frozen by the US authorities?

Patrick:  A polite request to? 

(Banks don’t like dealing with crypto money, so if an onshore bank knew that it was holding Tether money, they would likely freeze the accounts. This is exactly what happened with CIBC and QuadrigaCX in Canada. And it’s why Wells Fargo cut Bitfinex off in early 2017. Bitfinex tried to sue Wells Fargo for it, but later dropped the suit.)

Larry:  Why do you think that would happen? There will have to be significant evidence of some sort of fraud or the money not being used in the right way. And we haven’t seen that yet.

(The NYAG is literally investigating Tether and Bitfinex for fraud at this moment. They have already uncovered evidence, in the form of Bitfinex hiding from its customers the fact that it lost access to $850 million in 2018, leaving the exchange insolvent.)

Bennett: I remember a case where an analyst published some evidence that Bitfinex was using global trade solutions at HSBC. And shortly after that, their accounts got shut down and they had to switch to new banking.

Bitfinex is now banking with HSBC through a private account of Global Trading Solutions. Very good fit if you ask me. It's also worth mentioning that all EUR, JPY and GBP deposits are paused but Bitfinex "expects the situation to normalize within a week". Banking issues? pic.twitter.com/1pxQ13NO0m

— Larry Carrot 🥕 (@lawmaster) October 6, 2018

Larry: Oh, absolutely. And I used to be in the same boat as you are. What I realized later is that they’re doing this because they are having so much trouble finding a bank. And that’s why when they find a banking relationship that works for them, they tend to stick to it. And Deltec seems to be the one that has stuck. 

I one hundred percent agree with you. It is really weird when you see they open a new bank account, and then all of a sudden, after everyone finds out, it gets shut down. And that’s because no bank really wants to associate themselves with Tether because they’re risking way more than they would be gaining out of it. That’s just a natural response. 

(Banks have to comply with strict KYC/AML rules. If they touch dirty money, they face huge fines, and crypto money is often dirty, so naturally, they don’t want to do business with Tether, for that reason.)

And also because Tether—and again, I don’t think this is necessarily a bad faith, it could come across as that—but when they start these bank accounts, it’s because they basically are forced to. I want to make sure that everyone who listens understands my position isn’t to defend Tether. They’ve made several major mistakes before, but I do think that they’re super important to the space. And I do think that they’re acting well now. But they were in a difficult position because no one would give them bank accounts. So at that point, you really have no other choice almost.

Patrick: That’s the answer to my question on what the United States government would likely take issue with. If one assumes, arguendo, that tether has not been entirely candid with what it said to prior banking relationships, and then gotten frozen out of their accounts. That record of being less than entirely candid might not just go away because they got a new bank that was willing to say, politely, have a broader risk tolerance, not that a lawyer couldn’t speculate, but that would be a thing that I would not want in my history if I wanted a stable US dollar banking in the future.

Larry: I think that the response to that from Tether would be that they have not really been involved with a lot of the US customers directly. And the US court system doesn’t really have much of a jurisdiction over what they’re doing. I want to be clear again, I do think that something like this is possible. And I’ve warned people about it. Tether at this point is massively important to the crypto space. And if something like a black Swan event were to happen, it’s important to be ready and to be prepared to do something about it, and make sure that you don’t get completely screwed over if something like this happens. I don’t think it’s likely at this point.

(Cermak is on one hand defending Tether, and on the other, he is telling traders “to be ready” in the event something catastrophic happens.)

Richard: Can we take the debate in a different direction? Let’s talk about the fact that institutions do business with Tether. What is the nature of the business relationship between these businesses and Tether? Why do they not do business with USDC on a similar scale, for example. And when they obtain their USDTs, given the fact that Tether had this history of not being fully backed to put it politely, what kind of discount, if any, do the hedge funds or OTC desks get when they get the tethers?

Larry: They get no discount whatsoever. And that was the one point I was going to bring up as well before. If you guys believe that they’re not fully backed and if you believe that they might be acting in bad faith, why do you think there is no discount? And why do you think there is no premium? The discount only happened twice, if I recall correctly. And it was always about 10% maximum, then went back quickly. 

So why do you think that there is no premium, there is no discount. Why do you think it’s trading at par? It’s actually less volatile than USDC, for example, or at least comparable.

Bennett: Generally, if you look at the USDT/USD markets, it trades pretty even at 1:1. And there hasn’t been a major premium since, say, the end of 2018, like comparing tether to spot exchanges. And just speaking more broadly, the OTC quotes I’ve been able to see for tether do generally have it priced right around a dollar. 

I don’t think there’s any major discount in the market for tether like that. And even accepting that tether is not fully backed, I don’t necessarily think there would be a discount, so long as you believe that it’s redeemable or that, at that moment, you’ve got more need for it than you would for the comparable dollar. And so I still think even a potentially fractional reserve tether could still trade one-to-one without that being evidence of it.

Larry: I don’t agree with that myself. I agree with Bennett saying that if it’s only like 85% backed, 90% backed, they would still trade at 1:1. It’s only trading at 1:1 because there’s a future expectation that it will be back 1:1 at some point in the future. Not just because you can redeem it.

These large traders, again, they’re not idiots. They have to hedge their risks. And if they do think that at some point in the future, there might be a background on tether and they won’t be able to redeem all their money, they’re not going to even deal with it. So I don’t agree that. 

Richard: And what about the earlier part of my question? Why don’t these OTC desks do business with USDC, which also has experienced dramatic growth?

Larry: To your earlier point, and then maybe then Bennett can jump in. The biggest reason is because Tether has been the first and it has by far the biggest network effects. 

I brought this up earlier already, but the majority of futures is now collateralized by tether. And that wasn’t the case early this year before BitMEX really started to be affected. And now effectively it’s not even important anymore. BitMEX was all collateralized by bitcoin. And it was by far the largest futures exchange, the most important one by far. 

(Four BitMEX operators were indicted in October for Bank Secrecy Act violations. One was arrested, three remain at large.)

It’s not anymore. Now you have Binance, you have Huobi, you have OKex, you have Deribit, most of them are collateralized by USDT. So that dynamic itself, that shift, has already happened. And those network effects are why these OTC desks and these large institutional players have to get exposure to Tether because the products that they’re available on only function in tether. There are no futures that are collateralized by USDC.

Really the only alternative you have is bitcoin, but then you’re not trading the most liquid futures. The same thing can be said about crypto exchanges. The role of Binance has also grown so much this year, and that’s actually another thing I’m a little bit concerned about. Tether and Binance are by far the two most important companies right now in the space. And if something happens to either of them, we are definitely in trouble. 

I want to make sure that people understand that. And those risks need to be understood and prepared for, if they do happen at some point, even if it’s a low chance of happening. To answer your question, it’s because the market structure just demands tethers. And it’s mostly because of the network effects.

Patrick: Are we seeing some fragmentation of the network where half of the network exists, or some percentage of the network exists in, let’s say the United States and tightly aligned countries and some percentage of the network exists everywhere else. Because it would seem to me, if you want futures exposure, you can get futures exposure at the Chicago Mercantile Exchange at the price of having to be credible to the CME and deal exclusively in regulated dollars. And what I hear you saying is that you would want futures exposure at an exchange that is more flexible with respect to how one funds that futures exposure. Does this portend well for those networks continuing?

Larry: The biggest reason why these funds and these clients are interested in trading on these venues is because they are more liquid. And that’s because, like you said, they’re a little bit more lenient when it comes to which clients they take. It’s hard for someone in China to trade on CME. It’s not hard if they want to trade on Binance or Huobi. 

And naturally, the products with the most liquidity, they end up attracting the most liquidity, and it compounds the debt. CME is not a perfect product. It’s cash settled. But for example, there are pretty high limits of how much you need to get exposure to. And a lot of these exchanges, like Binance or Huobi, they also have a ton of retail clients. And needless to say, some of these funds do want to trade against those people because they’re less sophisticated and it’s easier to market make and all that. CME right now is not a product that is really an alternative to something like Binance or Houbi because you don’t have the same possibilities.

Bennett: I agree almost completely with Larry’s last two answers. Tether’s got the largest market cap and the most adoption because it was the earliest and it is the most used [stablecoin]. It’s been integrated at the most exchanges, it’s used as collateral for the most things. And I do think there is an appeal for a lot of people that Tether is less willing to serve at the beck and call of US regulators. So you see adoption for tether out of China and out of Russia, but even for online gambling and stuff in the Chinese mainland. And the kind of people who would be interested in tether there would not be probably interested in USDC because they would expect there to be a larger risk of funds being frozen or inaccessible, in the sense that Circle would freeze the tokens or block the redemption more so than Tether would.

Larry: I absolutely agree with that. And USDT is viewed by some people, like Bennett said, as less friendly to US regulators and the US overall jurisdiction. The influence of the United States is viewed as much smaller than USDC or Paxos or Gemini dollar. 

Also, one thing I want to point out and I’m sure Bennett will agree as well. The first massive growth of tether initially, end of 2017. We have to remember the reason was that Chinese exchange has got cut off from the fiat systems. And a lot of that money ended up flowing into tether. First couple of billion, or the majority of the money early on, has come from the Chinese exchanges. What that means is that because of these early network effects, there are massive OTC markets in China that use USDT and China was super important early on in crypto, and it still is and those network effects are at this point super hard to destroy. 

And so I do think that when it comes to trading, unless there is some regulatory intervention, Tether will remain the stable candidate it’s used by far the most.

(China told all of its crypto exchanges to shut down in 2017. After that, the only way for traders to on-ramp from the yuan into the crypto world has been via OTC exchanges, which enable peer-to-peer trading by connecting buyers and sellers.)

Richard: Let’s take an audience question. So this is from Nevine Mishra [spelling ?], and this is a question for everyone here. What would be the ratio of bad transactions in Tether? So the bad here basically refers to money laundering, and Tether is basically on-ramp outside of the USD payment system. Just not sure if tether has necessarily instituted the mechanisms to do the proper KYC/AML and so forth. Even though recently they did put out a tweet affirming that they do so. So can you guys speak to basically the possibility and the extent to which these transactions are of the money-laundering nature facilitated by tether?

Larry: I tend to start and then maybe Bennett can answer after me. I do think because of the dynamics that we talked about, it’s by far the most used by trading, it’s also viewed as the most lenient when it comes to just allowing stuff to happen. 

It does end up being used for nefarious activities and activities that are illegal. But it is my belief that Tether’s KYC/AML system internally is as advanced as USDC, as advanced as Paxos. I do think that the compliance is on always the same level, if not the same model.

Their compliance team is great. You can find all the people associated with Tether and the ones that they work on compliance. Also, it’s important to realize that they have frozen a lot of money this year, and a lot of transactions. By far more than USDC, far more than Paxos, and far more than any regulated stablecoin.

(I am not aware of any evidence that points to Tether’s superior KYC/AML system. As noted in the Ardoino and Hoegner podcast, Tether says it does check the identities of its customers, but what about the thousands of other users that tether trickles down to? My theory is that Tether’s large customers are akin to Liberty Reserve exchangers, acquiring tethers in bulk and distributing them in smaller quantities to individuals who require anonymity in their payments.)

Richard: Can you elaborate on that point? The freezing.

Larry: Because it’s more likely to be associated with these activities. And when tether finds out about it, especially this year, they have been really ruthless. When they think something weird is going on, they block it. Some people do believe that they’re more lenient, but actually they do end up blocking a lot. If there is any suspicion that it’s involved in some money laundering activity, they freeze it immediately. 

That has happened a lot this year, and it’s not really happening with USDC and Paxos. The best thing about stablecoins on Ethereum is that all of this data is public. You guys can, after this podcast, go and find the number of blocked addresses on USDC and Paxos, and you’ll see it’s much, much lower than Tether. So the argument that they are less active, it’s like weird that way. But yeah.

Bennet: Larry, you mentioned something that’s one of my biggest frustrations with Tether, and that is that they are at their essence, a finance company that is supposed to be keeping track of all these records of tethers issued, assets in their bank accounts, and all of that. And on their transparency page, on their website, for years, they’ve listed for Omni, their quarantined USDT, the stuff that was frozen, either as part of the initial hard fork after the hack or later after the Omni devs added the freezing ability to Omni. And that number, the number of quarantined USDT they have in their transparency page does not match with what happens if you add up what you can find in the Omni blockchain. And that’s been true for years. So talking about ostensibly, a company where this type of record is the most important thing they keep, and it’s been publicly wrong for years. And it took me like 45 minutes of scanning the blockchain to figure that out and Tether hasn’t done that.

Larry: Again, I do think that Tether has been extremely negligent early on, and to some extent still is, in small ways. So I do agree with that. It is behavior that doesn’t come across. 

The contra agreement to that is that Tether simply doesn’t care about you and me. That’s the thing that Tether skeptics don’t realize. They just don’t care about what’s viewed publicly. They care about one thing, and that’s if they can find counterparties to actually trust them enough, to send them real money and then work with them to redeem their money as well. 

One thing that we didn’t touch on yet, and it’s really important for this to be known, is that Tether functions in a B2B way. It only works with large clients, like exchanges, like OTC desks, like traders, and it only redeems [tethers] with them. 

Whenever there is an argument on Twitter [where someone says] I tried to redeem tether with them directly, it is just not possible. And I agree that early on, [Tether] stated that it was possible—and that’s a major mistake—but they don’t function that way. They don’t care about Tether skeptics at this point. They only care if the tether peg actually remains the same, and they only care if they can find more clients to put in more money and earn more yield. That’s their point of view. And they don’t care about me and Bennett. Why would they?

Bennett: There’s a couple of things here I want to look at. One is yes, they’re B2B. And they really always have been, but that leads to the question of why they publish their stated minimum, which is only $100,000 to redeemed, and why they made such a big deal of reopening their verification platform, supposedly for clients to redeem tethers.

(In November 2018, Tether announced that customers could once again redeem tethers directly via Tether, but all accounts needed to have a minimum issue and redemption of $100,000. At one point, customers could redeem tethers via Bitfinex, but that is no longer possible.)

Also, Tether, themselves, are the ones who still proclaim on their website that they are the most transparent, that they will provide this look inside. And so I don’t think it’s unreasonable to hold them to their own statements.

Larry: I totally agree. And I do think that it makes almost no sense why they would do that. I think initially, it was for people to trust them. Because early on, you have to remember, all this was new and you had a couple of tens of millions in it. It was hard to trust it. And they had to gain the trust somehow. I do think they made some of these statements up because they just wanted people to trust it more, so the peg would actually hold.

One thing that’s important for fiat-backed stablecoins. It’s really the only thing that’s important is trust in that stablecoin itself, because when the trust breaks, it’s very hard to get it back. I think they just were super careless, super negligent, made several of these mistakes before, where they claimed that something was true and that they couldn’t follow up on it. Another example we didn’t bring up yet is they used to claim that they are a hundred percent audited and there was never any audit. There was barely any proper attestation. And I do think that was in some way acting in bad faith—pretending to do something just to gain early trust so it would work at a larger scale. 

Bennett: The curious thing to me is that when they were banking in the Taiwanese banks, they had an accounting firm who did give them a monthly attestation that is in large form similar to what Grant Thornton gives to Circle. And then they stopped that. And a couple years later we got the Friedman report. And then a little bit after that, we got the Freeh report and then the Deltec letter and then nothing. So at one point they were able to get monthly attestations saying that the balance in their accounts was greater than the number of tethers issued. And then they stopped.

Larry: Yeah, that’s a really good question. And when I talked to Paolo and if someone at Bitfinex is listening to this, I one hundred percent agree. Attestations should be the bare minimum of what they publish, especially because it’s fairly easy to do and it’s reasonable, cheap. Everyone else does it. 

I think the reason why they don’t do it goes back to the point that they just don’t have to. It just functions well enough without that the attestations and people at this point trust it enough that they just feel like it’s not even worth their time, right? 

Tether is still a relatively lean team, similar to Bitfinex. And they just probably feel, who cares? Unless the peg starts breaking, we’re not going to release any attestations. And there’s precedent to this before. I’m sure you recall, Bennett, but whenever there was some sort of a break to the peg, historically, pretty much like clockwork, like a week or two afterwards, they started doing some sort of a relationship that confirmed some of these reserves, and they work with Bloomberg as well. So my view on this is that they only do the bare minimum because they just don’t feel like they have to. They feel like at this point, they’re trusted enough that they just don’t have to go to these lengths and spend the money. But if someone, again, if someone at Bitfinex is listening right now, I think this would be the bare minimum. They make enough money right now to justify it and it’s really a no brainer.

Patrick: Do you feel that their reticence with regards to attestations might be related to their reticence with regards to disclosing banking relationships? If I recall back in the day on the UI for requesting a wire from them, they put in red text that they didn’t want you to disclose the wiring information to or from them because it would put the entire cryptocurrency economy at risk. I think I read that in a tweet of yours, if I’m not mistaken. Are we allowed to take them at their word? Is that the reason why they don’t want to disclose this?

Larry: I don’t agree with this approach as well. Their argument is that they have these banking relationships that at least back then used to work in a way that had to be in almost a shady way. And they believed that was the case. 

I don’t think that’s the case anymore, by the way. I do think that all the banking partners that they have now are aware of the relationship. And I do think that at this point, they’re functioning in a much more legit way that they were before. Back then that’s why I was a Tether skeptic as well because they had literally, no one was associated with each other. No one really was able to answer these questions that I had. That has changed. So I’ve changed my mind on a lot of these things because of their approach and because of the information I’ve been provided by other third parties. But I was in the same boat as well.

Richard: We’re seeing a lot more institutional interest in Bitcoin, but the counter narrative to Bitcoin right now is just that it’s heavily manipulated with tether possibly being the biggest manipulator. What do you think is the level of due diligence these institutional investors have performed on this particular matter?

Larry: The first thing I would like to address is that this is like one of the laziest arguments that people make on Twitter, that Tether is manipulating the markets, that they’re creating tethers to pump the price of Bitcoin. There have been several papers debunking the system. And it’s apparent from data that they’re not doing this.

I track data on a daily basis. I track pretty much all the indicators that are there and every indicator this year has been going up. Everything like spot inflows, [just talking to?] exchanges that support fiat. There’s no evidence whatsoever that Tether is creating USDT to pump the price of Bitcoin. 

You can do some fairly simple data analysis by how the market reacts based on when the tethers are created. Really, the simplest explanation to why some people are confused is because when new money comes into Tether, they have to create USDT and that money ends up going into some sort of a cryptocurrency because otherwise they wouldn’t even put it in tether. 

They conflate the relationship of training tethers to market going up. It’s just a natural reaction when you put more money in the system, the price will go up. I would like to just make sure that people actually study this relationship more closely because that’s one of the latest arguments. And I think that Bennett agrees on this point.  

Bennett: I largely do. Generally when people are talking about tether manipulating the market, they’re referring to the paper from University of Texas that was published in 2018, “Is Bitcoin Untethered?” And that paper has some methodological issues, specifically, if I remember right with periodicity, meaning that to get the results they get, it’s very dependent on which periods you look at and how you analyze the flows with respect to that.

I don’t necessarily think that’s we’re seeing. The common conspiracy theory is: unbacked tethers are printed, and they’re used to buy bitcoin. The bitcoin is then inflated, sold. Money goes back into each Tether’s bank account [while they’re backed?]. The market I think is too liquid for that to really effectively work.

Tether can’t move the market enough to get back enough to make that effective. However, there is still again, we get back to the question of backing and what’s really behind the tethers. Because if there’s a general belief in the marketplace that there are 23 billion real dollars behind this tether purchase, seeing this bitcoin and whatever, if that is not fully backed, if that amount of dollars did not actually enter the ecosystem, I think that could fairly be called manipulation.

Now as to the size of that effect. I don’t necessarily think it’s a large effect. I don’t think tether is responsible for any of the bull runs in bitcoin or anything like that. But I do think that tether could have still slightly inflated the price if they were not fully backed.

(I asked Tomlin later what he meant in saying that tethers aren’t responsible for bitcoin bull runs. “It’s just a highly leveraged frenzy,” he said. “Bubbles are always caused by some amount of organic interest. Bitcoin is exacerbated by being a relatively, or historically at least, thin market that now is loaded with leverage.”

I disagree. I think large tether issuances have a huge impact on the market. Unlike in 2017, I believe the bitcoin price, which recently went as high as $41,000, is mainly pushed up by tethers in this bubble. Price plays a huge part in fueling the frenzy. Read my story, “Are pixie fairies behind Bitcoin’s latest bubble?”)

Larry: To some extent, I agree with that. One thing I would like to add is a fun consequence of the paper being published from manipulation is that, I don’t know if you guys will notice, but now Tether basically like they don’t disclose whenever they create new tethers exactly. They basically give it like a week in advance or something. So they prevent people from actually conflating these two things that’s happening at once.

Richard: You mean they authorize first, right? So they basically mint and then they say they authorize it, but it hasn’t been deployed. And then they distribute them to various places.

Bennett: I feel like you could still do much the same analysis. Instead of tracking the issuing address, you could just check movements from the treasury. 

Larry: You probably could, but it’s just like a funny consequence. 

Richard: Going back to that paper Is “Bitcoin Really Untethered” by John Griffin and Amin Shams that Bennett was referring to, what did you say specifically was the issue with their methodology? And also about other papers that have been debunking this? 

I actually have the papers here, but I am not sure where the debunking part is. One of them is called “The Impact of Tether Grants on Bitcoin,” by Wang Chun Wei. And then the other one is, “What keeps Stablecoins Stable,” by Richard Lyons and Ganesh Viswanath-Natraj.

The first paper, “The Impact of Tether Grants on Bitcoin,” conducts an independent study as to whether Tether prints prior to bitcoin pumps. If there’s any kind of statistical relationship and basically says, there’s none. But it doesn’t directly debunk “Is Bitcoin Really Untethered.” So when Bennett says there’s some kind of methodology problem, I’m not familiar as to what exactly the issue is there.

Bennett: It’s been a while since I looked at that paper in specific. But if I remember, and they even mentioned this in one of the appendixes for the paper. If you change the way the period is measured or something like that, you see the impact from the tether flows decreases significantly. 

The other thing we do need to talk about is what Larry said is you expect when tethers enter the market, when legitimate money enters the market, that generally the prices of things are going to go up because there’s more money coming in. And so I’ve looked at a bunch of data around tether and I can push it and tweak it and get statistically significant results that are potentially interesting. But in order to get them, you have to pick magic numbers. So you’re picking a certain period, a certain cutoff, a certain something in order to make sure that your data looks the way it does. And the paper has some of those kinds of things in it.

Richard: As you’re saying the statistical finding isn’t sufficiently robust. If you pick a particular window in construction of your variable, you get a favorable result. And if you just move that a little bit, you no longer have a favorable result. Is that what you were saying?

Bennett: Yeah. If I remember even with the change in the periodicity, it was still directionally correct, but the impact became much smaller. And just looking at it, as a skeptic and as someone who tries to observe this market, it was not convincing enough to me and I was predisposed to be convinced by it.

Richard: The other interesting thing that’s been happening lately is that some of the Tether executives seem to have become a little bit more open in terms of appearing on podcasts and having conversations with the public. First of all, do you agree with that assessment that they’re being a little bit more open these days and second of all, if so, why do you think they’re doing that?

Larry: It’s one hundred percent by design and that’s one thing, like I mentioned before, that led me to trust into Tether more than I did before. They are public for one simple reason. And that’s to make sure that people stop spreading conspiracies. It’s for marketing purposes. When  you have a person that can go directly against some of these claims early on, it’s much more effective than letting someone like Bitfinex’ed just go with these theories that sometimes don’t have any merit. Sometimes they do. Sometimes they don’t. 

But they’re doing it because they want people to think of Tether as more legitimate than it has the rep for right now. Paolo keeps claiming that Tether is as regulated as other stablecoins. It’s a marketing move and it’s a good move as well.

(To be clear, the Tether/Bitfinex triad haven’t been seen at all in a long while. Paolo Ardoino, Tether’s CTO, took on the role of Tether frontman starting around November 2019. He constantly tweets reassurances that Tether is fully backed, regulated and is following KYC/AML protocols.)

– tether is backed
– working towards increased transparency in 2021, stay tuned!
– strong KYC/AML
– weekend purchases explained
– after 15th Jan, business as usual

And much more. Hopefully we can a round 2 soon to cover missing topics. https://t.co/YMzxWV3McU

— Paolo Ardoino (@paoloardoino) January 10, 2021

Bennett: I am not necessarily convinced that they are more public. If you go back in time to earlier Bitfinex and Tether history, like I’ve saved the entire post history of Raphael Nicolle, the founder of Bitfinex on Bitcoin Talk. I’ve got the same for Giancarlo Devasini, and “myself” [a pseudonym for] one of the early consultants for Bitfinex, and Phil Potter would frequently show up, not on podcasts and stuff like this, but if you’re looking back to 2016, 2017 on the Whalepool teamspeaks and in other places like that, where they were still trying to reach out to crypto traders and stuff like that. 

And I agree with Larry, it definitely is a marketing move, but it’s also interesting to me that not all the executives have been more public, like Paolo. He’s probably the most public face of both. And  Stuart, Hoegner, the general counsel for both Bitfinex and Tether, is probably the one you hear from next often. You will almost never hear from [J.L. van der Velde], the CEO of both Bitfinex and Tether, who originally came over from Perpetual Action Group Asia, or you’ll occasionally hear from Giancarlo now, but you hear from him a lot less even than you used to. I don’t necessarily buy that they’re more public or more open about this stuff now than they were historically. 

Richard: The weird thing is, if you are going to spend the time to go on all these podcasts and try to assuage the public about your legitimacy, why not just spend the money and do the report? Obviously, we have just been through this point and it sounds like both of you actually agree that some attestation should be in order.

Larry: Like I mentioned briefly before, Bitfinex hasn’t been doing so well in the past two years and they attribute that to marketing as well. Because they haven’t done much of marketing before and volumes went down significantly. Liquidity went down. So I don’t think it’s just about Tether, it’s about Bitfinex as well. And it’s about overall just having a face that you can connect to Bitfinex and Tether that is more public facing. 

Richard: Let’s take another audience question. This is from someone called EastMother: Does a stablecoin issuer, such as Tether, have fiduciary duties towards the people to whom issuances are made and, or the secondary market token holders, any opinion on us.

Bennett: This was a matter of debate of law in the New York attorney general case when Bitfinex was trying to appeal it. They basically claimed even in the initial transcript that they had no responsibility to secondary market participants, meaning tether holders who were not directly contracted with Tether Holdings Ltd. 

I think it’s reasonable to say that Tether, if they don’t have a legal responsibility, at the very least as a moral responsibility, that if they are issuing this asset that they say will maintain this value, that the asset does that, whether or not there’s a legal obligation fiduciary obligation towards any secondary market holders. I’m not qualified to answer.

Larry: I totally agree with Bennett there. I don’t think that legally they do. I do think that ethically that they do, but also one thing to realize that we haven’t touched on it much yet, but the collapse of Tether, if it were to happen at some point, and if we are assuming that they’re acting fraudulently, it would be terrible for their business and Bitfinex and Tether as well. They’re pretty profitable. 

So that argument to me never made too much sense. Yeah, you can probably make more money more quickly if you just rug pull and take all the money now, but you’re sitting on a business that’s generating millions dollars in revenue. You have Coinbase going public this year and likely trading at more than $40 billion and all these exchanges are going to be worth gold soon. So you would have to be shooting yourself in the leg, if you were doing this. Like why not just run the business for 10 years and probably end up making even more money? It seems ridiculous to me that some people think that this would be a legitimate strategy.

Richard: Back to the fiduciary duty part. So there have been recent regulations put forth by the US government. And one of them is the [proposed] STABLE Act, which basically says, if you are a stablecoin operator, you need to be regulated like a bank. And the second one is more of a rumor in that stablecoins might be classified as security and as such an SEC would have jurisdiction over them. Neither of them actually is law, but if they were to become law, what would be the implication on tether and then second order effect on the crypto market?

Larry: The first thing, I believe that stablecoins will never be considered securities. I don’t think that will ever happen, but I am not a lawyer, so I can’t say that for sure, but I think that’s extremely unlikely. The STABLE Act, I think, is a little bit more realistic, and it would definitely affect in a lot of ways, because if you do have to have a banking charter, if you do have to have to essentially be a bank to operate stablecoins in US dollars, that would put Tether in a really difficult spot. And it would be interesting to see if they would continue operating.

Richard: That would conflict with an earlier point in that the Tether folks basically think that the US doesn’t have jurisdiction over them. If so, then the STABLE Act or whatever the SEC wants to do, as long as they claim Americans aren’t touching this stuff, then it’s fine.

Larry: That’s a really good question. Maybe Bennett has some views here. I’m not an expert on this, and I’m not sure if they would continue operating if they were directly against one of these laws. I think they might, but not so sure, honestly.

Bennett: This is a tricky question. So I don’t think currency backed stablecoins, like a one-to-one backed, or pegged coin will be considered a security anytime soon. Now, there were more complicated algorithmic models like Basis before they were shut down. I thought there was the potential for parts of that model to end up being considered a security, but that necessarily an acute worry with something like Tether.

Richard: Why is that though? With stablecoins, there’s no expectation to profit from the effort of others. So that particular component of Howey Test wouldn’t work.

Bennett: When I mentioned before was a multi token system involving Basis bonds and a couple of other pieces all working together in order to allegedly maintain a pegged value, which ended up accruing a larger number of Basis coins, the stablecoins, to the holders of the Basis bond.

Larry: Basically what Bennett is trying to say that it’s a multitoken system where one of these tokens is very similar to security.

Bennett: It’s a functioning part of the stablecoin system. And I could even see the argument being made that Maker is a security, but I can’t necessarily see the argument Dai [is a security.]

Larry: Right. I absolutely agree.

Bennett: As for the STABLE Act, this is always where I get conflicted with tether because they try to act as though they’re not regulated by US regulators, but in early 2016, Bitfinex was willing to sign a settlement with the CFTC and collaborate with regulators in those respects. 

My guess is a more restrictive, stablecoin law, like the STABLE Act would be somewhat similar to a regulatory shutdown of Tether with the difference being, they would probably be able to spin it down more gracefully, so there’d be a lot less collateral harm to the market and to holders. 

But I would agree with Larry and say that with a regulation like that, it is unlikely to me that Tether would continue to offer a dollar-backed stable coin. They initially tried to diversify with the Euro tether, which was never popular. They kept trying again and they’ve got the Tether Gold and the Chinese yen tether and all that. My guess is that is part of the reason they have those other coins.

Patrick: One of the other risks for any regulatory regime is that there’s a sort of regulatory contagion where regardless of whether a Bitfinex or Tether—which are alter egos of each other—regardless of whether they are subject to US law or jurisdiction, some people who would like to be involved in the cryptocurrency ecosystem are subject to US law, or jurisdiction, and they might not be able to interact with US counterparties, which interact with tether because of the risk of, basically the tether cooties, attaching to those counterparties. 

And potentially I know people in the cryptocurrency ecosystem don’t think this is likely because it’s so technically easy to mix funds via distributed finance, et cetera, et cetera, but potentially that sort of contagion risk could cause… If your regulated stablecoin is fungible for a non-regulated stablecoin via any mechanism you can reasonably foresee, then you have to solve that problem for the government, basically.

Bennett: This proves Tether’s claim that they’re not subject to US regulation that they’re separate from all that doesn’t hold up. They are a dollar-backed stablecoin. And fundamentally, if you’re working in dollars, the long arm of the United States government will extend to you. And I mean, that’s part of the fundamental risk of Tether is that at some point that long regulatory arm of the United States government, whether it be the CFTC, the Department of Justice or a state government, like the New York attorney general, will find something that justifies them seizing a large amount of tether’s funds and leaves them deeply insolvent.

Larry: I do agree that’s a significant risk that’s worth considering. I think that Bennett’s totally right. I do think that if the US government and the US system wanted, they can take out Tether, probably fairly easily. But one thing that I don’t necessarily agree with, maybe Bennet has more information on this, but I don’t believe that they claim they’re less affected by US regulation and the United States itself. I think that’s what people assume, but I’m not sure that actually claims this. 

Bennett: This is where you get into their public statements in press releases, blog posts and things Phil Potter says in a Whalepool teamspeak because you’ll see the Bitfinex executives try to make arguments like that, that they’re not subject to certain US regulations because of where they’re domiciled. And you saw Giancarlo making these back on Bitcointalk a couple of years into Bitfinex’s existence and stuff like that. So there are public statements by DigFinex executives making those kinds of claims. But the press releases, the blog posts, marketing materials on the website will generally be carefully worded to give them the impression that they’re compliant with all relevant US regulations.

Larry: And are you aware of any of these statements being made more recently versus early on in Tether’s functioning?

Patrick: The litigation with the NYAG at oral argument, they were asked point blank, who is your regulator? And they said, we are not regulated.

Larry: This is a really nuanced topic. We’ve been working on a stablecoin report for almost two months. And we talked to several different stablecoin providers, like USDC, Paxos, all of those. But when we asked them about this, what does it mean to be regulated as a stablecoin? And everyone has different answers. It’s like when you use the word regulated, it’s just so ambiguous. 

You have to think of several different ways of how you regulate it. One is, do you have AML and compliance teams? There are several other aspects. Where are you keeping your funds? Is someone monitoring that? Do you have the compliance manual? 

It’s just so many different things like that. And so Tether publicly claims that they are as regulated as a USDC. I think that’s questionable. They are registered with FinCEN, which means that they have to report when some activities out of the ordinary happen. 

But it’s probably not as stringent as when you are registered with the New York Department of Financial Services, like Paxos or Gemini Dollar. It is difficult to say what regulated means in this sense, because there are no clear rules. And because these things function globally and every jurisdiction has different rules and different regulations.

Richard: As far as the NYAG lawsuit goes, and I’ve asked this question in a previous podcast as well, but I’m curious to hear your thoughts. What do you think is the timeline for some kind of outcome and some kind of resolution. And what do you think would be the knock on impact on the Tether ecosystem?

Bennett: So the next due date for a document production is January 15th, which is coming up right around the corner. What will be included in that? If documents will be provided. [Here is the NYAG’s letter to the NY supreme court.]

Richard: Which documents are the prosecutors looking for?

Bennett: Financial records for Tether going back to 2017 showing KYC, AML history of redemptions and history of issuances. But I do not have that in front of me.

Larry: My question for you, Bennett, is do you think that the NYAG  has the right to ask for these documents while. Bitfinex has pretty publicly said that no customers can have access to Tether.

Bennet I am a New York resident. The Block was very recently able to register an account on Bitfinex and trade with the name “I am NY resident.”

Richard: I’m not familiar with what you were saying about The Block registering as a New York resident. Can you guys elaborate on this?

Larry: It was an article that we published a year and a half ago, or almost two years ago, where some user registered with a name that said, “I’m a New York resident.” And as part of registration, when you go through the registration process, there’s a box that says that you have to tick that says, I’m not a resident of New York, or I’m not a resident of the United States. 

And that user ticked that box, even though the name said, I’m a NY resident. And it was supposedly to test if the compliance would pick up on it. But the reason why I’m bringing it up is because sure, your customers definitely had exposures to Tether, but it is probably reasonable to say that Bitfinex is not interested in those customers, unless they are based outside of the US with their own subsidiary.

Bennet: That’s irrelevant for New York jurisdiction, Bitfinex being interested in them. Doesn’t matter to the New York attorney general. 

Larry: I agree.

Bennett: And going back, this is particularly striking because if you read the 2016 CFTC settlement that Bitfinex signed, they agreed to ensure that they would stop violating sections 4A and 4D of that act. And part of that was making sure they were at no point offering non-physically delivered futures to US citizens. 

And I think it’s pretty safe to say that they continued to do that for a while after early 2016. And I think if you look at what the New York attorney general has found, meaning that there are several professional firms that Tether has hired in New York, that there are tether traders in New York that you’ve got Giancarlo emailing the head of Galaxy Digital and telling him that he should meet up with Phil Potter because they’re both in New York. I think it becomes under the Martin Act, it would appear that New York has the jurisdiction to ask for these documents. I think the better question is, what happens if Bitfinex chooses to ignore the New York attorney general, and not produce the documents? I do not know how far their ability to enforce goes.

Patrick: It’s worth mentioning that this possibly be a legal tactical move to ask for the document production. That question was put to them at oral argument and by the judge, if I recall, and they were given the opportunity to not deny that they were solely looking for Martin Act violations. So it’s possible that they’re using a statutory authority that they have to compel the production of documents, which would allow them to uncover evidence of other things that they could throw at Tether later.

Bennet: Which I think is actually an interesting thing for us to come back to because the New York attorney general launched their investigation into Tether before the really conflicted transaction — where they transferred the [$700 million] out of tether into Bitfinex in order to deal with the insolvency. So there was something before that that triggered a New York attorney general investigation, and Bitfinex and Tether were both producing documents and cooperating with the New York attorney general up until the time of this transaction. 

And that’s when then the Tisha James and [Assistant Attorney General] Brian Whitehurst had to go for the ex parte order. And then Bitfinex has been endlessly appealing and they are now out of appeals. You’re right, the Margin Act violation is not the only thing they’re potentially interested in, but they thought it gave them the best argument for document production.

Larry: I agree with that as well. I will say, some of these New York trading firms have subsidiaries in jurisdictions that allow them to get exposure to these instruments, even if they are officially based in New York. And similar can be said about what The Block published on the NY resident. Yeah, it is true compliance wise. I think it’s probably improved since then. That being said, someone basically had to take someone, who was  not the resident of New York. So technically you are still breaching the registration form.

Patrick: I know I’ve been intervening too much on one side of this debate. Bennett, what would you be satisfied with? Is there a way that tether could demonstrate their operating above board?

Bennett: If they were to start getting regular attestations by a qualified auditing firm, that would go a long way towards assuaging many of my fears. I still think that the history of tether has left them with enough detritus that they’ll never truly be compliant. And that eventually one of those albatrosses around their neck will pull them under water. But if I started seeing a true good faith effort like that to be publicly transparent and show that they are living up to their own promises, that would make me feel a lot better about them.

Richard: There’s an article from Decrypt last year about how a lot of us USDT on-ramp is done by Chinese nationals looking to move their wealth overseas because of the tight capital control there. Can you speak to the extent that this is true and whether you see this trend continuing?

Larry: From my experience and from the data that I’ve seen, I don’t think it’s as much of a problem as Decrypt made it out to be. Tether does have a lot of clientele in China and a lot of the money that was sitting on Chinese exchanges that then got cut off the fiat system. Some of it is now sitting in Tether. So there’s a very large Chinese ecosystem when it comes to tether. 

I don’t think it’s being used that much for fleeing capital controls. It definitely is to some extent, I don’t think it’s one of the biggest use cases of tether. Because there’s already a lot of money that was previously in these Chinese exchanges now with tether. But it’s important to say, the OTC markets for tether is the primary on-ramp for crypto in China right now. Basically running exchanges in China is illegal. You can argue whether that’s being enforced or not, but a lot of these exchanges like Huobi, Binance, and OKex, they have OTC P2P desks that allow people to convert their fiat to tether a Bitcoin directly. It is definitely being used. I don’t think it’s used at a massive scale. 

Richard: If I can summarize our debate so far, it seems that what Larry is saying is that tether has had these unprofessional practices, to put a charitably, in the past, where they also had constraints with banking access and so forth. But ultimately they crossed the line in various different ways in the past. But now the situation is slightly different. 

Number one is they’re a B2B business. They have enough institutional flow as it is. So they don’t really care so much for the retail opinion. Therefore, they don’t have to worry about attestation reports and so forth. And secondly, they have made up their mind, or at least taking comfort in the fact that they are outside the relevant jurisdiction that is pursuing legal action with them. That’s why they basically continue to operate the way they do. But ultimately, Larry’s arguing that they’re no longer acting in bad faith because they’re just doing enough to satisfy their existing clientele. Is that a fair summary of your position, Larry?

Larry: Yes. That’s a very good summary. Did a great job.

Richard: I think a big question on my mind is whether Tether is playing these games to pump the market with unpacked collateral. I know we’ve run around on this, but so far, I don’t think I’m thoroughly convinced that they’re not doing this. So if Larry, you could summarize in one or two sentences to convince somebody that this is not the case, what arguments would you use?

Larry: When new money comes into the system, you can expect the price to go up and evidence here is that when new tether is created and deployed, the price of Bitcoin goes up and even this relationship can be true while not manipulating the market. That’s really the only argument that I have.

Richard: The biggest hole I see in that argument is that there’s no proof that there’s money coming to the market. If there’s proof, which is probably what the attestation report can provide, then I think that whole logic will flow. But right now the problem is just that there’s no proof that money is coming in, right?

Bennett: That’s largely my problem is that we don’t have any public attestation, audit, or anything like that to suggest that the $23 billion in US dollars are actually there. And other oddities, like the fact that you don’t see those show up in the Bahamian central bank report and other things like that. Again, Tether making a better effort to be more public on that stuff would assuage lots of those fears.

Richard: I think the most favorable view with regard to this under collateralization problem is something like, even though there’s a lot of issuance of tether, right after a bearish movement in Bitcoin price and after the tether issuance, the Bitcoin price comes up. Even though that’s all true, that doesn’t mean there’s foul play. It could very well be that there’s authentic demand that is rushing into the market to take advantage of a temporary price dislocation. But the issue is that somehow still not sufficient to change people’s skepticism. 

Larry: It’s almost impossible to change their mind, honestly. [Their thinking is that] it’s beyond reasonable doubt that tether is manipulating the price. And if you believe this, your bias is too much to be objective. 

Richard: Let’s move on to the concluding remarks stage. Starting with Bennett, synthesize your thoughts and tell us how you feel after having this debate regarding your initial.

Bennett: I still believe tether has at many points in their history been a bad faith actor. You see this as early as 2015, when they’re lying about their ownership. You see this continuing through with the frivolous lawsuit against Wells Fargo. You see it continue with the interactions with Crypto Capital. You see it compounded by some of their opacity surrounding the tether hack and the forced hard fork of the Omni network. And just this continued pattern of behavior combined with just the public incompetence of failing to track their own assets on their public transparency page makes me believe that Tether does not at this point deserve the benefit of the doubt. And there is not sufficient evidence that they are making a good faith effort to be a good member of the crypto community and to be publicly transparent about both their functioning and their backing.

(Bennett has provided additional notes on his blog, as a follow up to this debate.)

Richard: Okay, great. Larry, go ahead with your closing remarks. 

Larry: I agree with Bennett that Tether has acted in, what someone, can call bad faith. I think I would call it bad faith early on, as well. I think they were forced to act in this way to basically survive and to find the product market fit early on, and then to grow that business early on.

I think some of it was necessary for the business to function. I don’t agree with a lot of these practices and I do think that they’ve made several mistakes. They’ve behaved in a negligent way. They behave unprofessionally. That being said, recently it has changed drastically. I don’t think they’re acting in bad faith anymore. I think they’re a really important actor in the crypto space. And I think that with all that I’ve said, and it might sound like I’m defending tether, but I still think that there is a chance that there is a regulatory intervention at some point, which would put the markets into chaos for some time.

And I do think it’s a possibility that even people like me that don’t think Tether is acting in bad faith should consider because the US government can do something about Tether and can if they really want to and let it set. And this one, it’s a reasonable possibility. I still think it’s fairly low chance that something happens, but whoever’s listening to this, it’s important to, consider this closely. And if it does happen, make sure that you’re prepared for that possibility. 

That being said again, I think this was a good debate and I agree with a lot of Bennet’s points, but I do not think that Tether is acting in bad faith now. And I don’t think it has been in the past year and a half. 

Richard: Okay, great. Thanks for joining the debate today, Bennett and Larry, and thanks for co-hosting Patrick.  

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