- By Amy Castor and David Gerard
Tether has long played financial shell games to keep its dollar stablecoin USDT up and running. It’s also been happy to ignore money laundering laws for most of its existence.
But we think Tether’s day of reckoning is on the horizon due to USDT’s latest use case: sanctions evasion.
How sanctions work
The international financial sanctions system, led by the US and Europe, aims to cut off cash flows to serious bad actors — terrorists, enemy countries, major criminals, and so on.
As Congressman Juan Vargas told Mark Zuckerberg of Facebook in the Libra hearings: “The dollar is very important to us as a tool of American power and also a tool of American values. So we would much prefer to put sanctions on a country than send our soldiers there.”
The US regards the power of the dollar and the sanctions system as part of the national defense. Sanctions are taken very seriously.
The Office of Foreign Assets Control at the US Treasury keeps a list of sanctioned individuals, countries, and companies. [OFAC]
Doing business with an OFAC-sanctioned entity is a strict liability offense that can result in massive fines. That hasn’t stopped Tether.
Use case for Tether: North Korea, Hamas, Russia
Tether’s sanction violations started hitting the papers two years ago.
In August 2022, the US sanctioned Tornado Cash — the favorite crypto mixer of North Korea’s Lazarus Group for laundering stolen ETH to help the country get hard currency. OFAC posted a list of sanctioned Ethereum blockchain addresses for the Tornado Cash smart contract.
Tether flat-out ignored the sanctions. The company posted that it “does not operate in the United States or onboard U.S. persons as customers,” so is not obliged to comply with US sanctions. [Tether, archive]
(This theory doesn’t quite hold, as we detail later.)
The Palestinian Islamic Jihad received $93 million in crypto between August 2021 and June 2023, according to Elliptic. Wallets connected to Hamas received $41 million over a similar period, almost all in USDT, according to Israeli blockchain firm Bitok. [WSJ, archive]
Chainalysis found that stablecoins like Tether were used in the vast majority of crypto-based scam transactions and sanctions evasion in 2023. [Wired, archive; Chainalysis]
TRM Labs concurred, saying that Tether was the most used stablecoin in illicit crypto flows in 2023. Tether on the Tron blockchain in particular had “cemented its position as the currency of choice for use by terrorist financing entities.” [TRM; Bloomberg, archive]
In April 2024, Reuters reported that PDVSA, Venezuela’s state-run oil company, was steering users to USDT and asking for half of each payment upfront in tethers to avoid having their money frozen in foreign bank accounts. US President Biden lifted sanctions in October — but said he would be reimposing them as Venezuelan President Nicolas Maduro had failed to uphold his commitment to free and fair elections. [Reuters, archive; CoinDesk]
Also in April, the Wall Street Journal reported that tethers had become “indispensable” to fund the Russian invasion of Ukraine. Russian middlemen used USDT to skirt US sanctions and procure parts for drones and other equipment. [WSJ, archive]
Bloomberg reported that the US and the UK were investigating $20 billion in tethers that passed through Garantax, a Russian-based crypto exchange that both the US and the UK have sanctioned. [Bloomberg, archive]
Russians were using tethers to skirt sanctions quite soon after the invasion of Ukraine in February 2022. You would buy tethers in Russia with rubles and sell them in London for pounds. [CoinDesk]
The Counter ISIS Finance Group is a group of countries aiming to cut off funding to the Islamic State of Iraq and Syria. Most of ISIS’s funding is in cash — but the US Treasury fact sheet on the CIFG’s January 2024 meeting has a whole section on their fondness for tethers, particularly in Western Africa. [Press release; fact sheet, PDF]
Liberty Reserve
Liberty Reserve was a digital currency service run out of Costa Rica, active from 2006 to 2013. It issued dollar-backed liabilities called “LR.” These were just entries in a ledger at Liberty Reserve — everything was centralized. But otherwise, LR worked very like a stablecoin.
Customers purchased LR through middlemen — such as Gerry Cotten and Michael Patryn, who ran Midas Gold before starting the now-collapsed Quadriga crypto exchange. These “exchangers” bought LR in bulk directly from Liberty Reserve and sold them to secondary users. This helped obscure the money trails.
LR and its ilk ushered in a new era of cyber money laundering. Gone were the days of crossing borders with suitcases full of cash. You could simply set up an LR account and send dollar equivalents digitally!
Liberty Reserve was a bustling laundromat for seven years — until the DOJ seized its website and arrested its merry band of founders in Spain and New York. The US charged them under the Patriot Act with money laundering and running an unlicensed money transmitter. Liberty Reserve’s founder, Arthur Budovsky, is currently serving a twenty-year sentence. [DoJ; DoJ]
Liberty Reserve Junior
Tether is Liberty Reserve but on the blockchain.
Tether has large clients who purchase USDT in bulk — or maybe borrow it, the tethers being created out of thin air with the loan being the “backing reserve.”
Secondary users buy the tethers on offshore crypto exchanges, such as Bitfinex, Binance, and Huobi.
Tether disclaims any responsibility for what these secondary users do with their tethers — even as Tether has complete control over all USDT and can freeze or destroy individual tethers at any time.
Tether is an improvement over Liberty Reserve because it runs on a blockchain — 15 different blockchains, in fact, with Tron being its main blockchain.
As well as DeFi shenanigans local to each chain, this also facilitates chain hopping — where you take a pile of tethers from multiple customers, mix them up, and move them to a new chain, making the funds harder to trace.
Tether routinely creates hundreds of thousands of tethers at a time on one chain, so they can “swap” them from another chain. Sometimes they actually burn the old tethers on the original chain! [Tether]
While Liberty Reserve was mainly used by fraudsters, hackers, and traffickers, it never grew to the scale that Tether has — and it never became popular as a tool for sanctions evasion, not just crime.
Why hasn’t Tether been shut down yet?
Shutting down Liberty Reserve was a huge job — it took a multi-year investigation spanning 17 countries. Tether is even more complex.
Tether is not very linked to the US. None of its principals are US citizens. The company is registered in the British Virgin Islands. The CEO, Paolo Ardoino, lives in El Salvador. Tether’s main bank is Deltec in the Bahamas. A major owner is based in Thailand.
Tether has a long and sketchy history, back to its launch in 2015. They operated under the radar for years. By 2017, federal enforcement agencies were too busy tackling the ICO boom to take notice. So Tether grew unchecked.
In 2018, the New York Attorney General charged Tether and its crypto exchange sibling Bitfinex with fraud when they tried to cover up $850 million in missing reserves. The companies settled in February 2021 for $18.5 million, a small slap on the wrist.
In the process of investigating Tether and Bitfinex, the NYAG accumulated quite a lot of dirt on the companies. You might think they would have passed this pile of evidence to the Feds with a bow on top — and they did try.
In his book Number Go Up, Zeke Faux writes how New York reached out to the SEC, the DOJ, and the CFTC about Tether in early 2021 — but the Feds just weren’t interested?! The CFTC did eventually act against Tether later in 2021.
It wasn’t until 2022 that the Feds finally started to pay attention — when they noticed Tether’s role in sanctions evasion.
A bigger hammer
Despite Tether’s claims to have no links to the US, the company has more than a little US exposure — they have substantial backing reserves held in the US in dollars, such as their Treasury notes at Cantor Fitzgerald. This makes them at least slightly subject to US law.
In any case, non-US entities who work around US sanctions risk being sanctioned themselves. This may be applied to individuals as well as companies. [OFAC, PDF]
An entity may be cut off from the US dollar system altogether — and from any entity elsewhere in the world that wants to keep its access to US dollars. This is a financial death penalty. It’s a big stick.
If Tether remains noncompliant, this could put their banking and reserve relations at risk. Having Tether as a client could become too risky even for Cantor.
By 2023, Tether had wised up a bit. They froze 32 wallets that were linked to terrorism and warfare in Ukraine and Israel in October 2023. In December, Tether froze 41 wallets tied to sanctions as a “precautionary” measure. [Tether; Tether]
By this time, the Feds were keeping a close eye on Tether.
Ardoino wrote public letters to US senators in November and December proclaiming Tether was now in “alignment” with OFAC, and they were fine with freezing secondary addresses. Also, Tether had “onboarded” the Secret Service onto their platform — though it’s not clear just what that meant — and they were working with the FBI and the DOJ. [Yahoo; Tether; Letter, PDF; Letter, PDF]
Seriously, stop it
While Tether was blocking addresses and trying to convince the world it was in full compliance, the US government was making its annoyance more explicit.
Treasury Secretary Wally Adeyemo gave a speech at the November 2023 Blockchain Association Summit. This was the earliest example we could find of the government using the words “national security” about cryptocurrency: [Treasury]
While some have heeded our calls and taken steps to prevent illicit activity, the lack of action by too many firms—both large and small—represents a clear and present risk to our national security.
Adeyemo doesn’t name Tether in the speech, but it’s clear who he’s talking about:
We cannot allow dollar-backed stable coin providers outside the United States to have the privilege of using our currency without the responsibility of putting in place procedures to prevent terrorists from abusing their platform.
He gave this speech just after the Binance settlement dropped.
Senators Elizabeth Warren (D-MA) and Roger Marshall (R-KS) sent a letter to the Treasury, the Department of Defense, and the White House in April 2024 saying that they were concerned about Russia, Iran, and North Korea using Tether to evade sanctions: [Letter, PDF; WSJ]
The national security threat posed by cryptocurrency requires a commensurate response by our country’s defense community. We seek information on the additional authorities you may need in order to neutralize this threat.
The US has decades-old laws in place for dealing with sanction violators. The Bank Secrecy Act, the Patriot Act, and the International Emergency Economic Powers Act give the US sweeping powers.
The government is also working on new stablecoin regulations — and any effective regulation on US dollar stablecoins would likely be fatal to Tether.
What happens next?
Binance already learned this lesson after supplying services to Iran. They had to settle fines of more than $4 billion for violating the BSA, money transmitter laws, and the IEEPA. Former Binance CEO Changpeng Zhao was sentenced to four months in prison. Binance is getting a monitor.
We expect something similar to happen to Tether — large fines, compliance requirements, and the possibility of jail time for Tether principals.
If the heat gets too much, Tether might try to unwind the entire fund and shut down. The tricky parts will be how to do this while keeping as much of the money as possible and how to realize and return the dollar value of what reserves actually exist in any tangible sense.
But most importantly, they have to not unduly upset any of the more demanding sort of Tether customer who knows where they live.
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Amy Castor 