Chit Chat Stocks - BONUS Interview - Unraveling the Tether Mystery With Bennett Tomlin

Episode Date: November 17, 2021

Bennett Tomlin answers every question we could think of about Tether. Tether is a stable coin. The token is on the blockchain and it is designed to match the price of the US dollar. Although we would not consider ourselves experts on Tether Bennett knows his stuff. Listen in as Bennett dives into what Tether is and the utility of its existence. Enjoy the show! We will conduct Bonus Interviews periodically whenever Brett and Ryan are eager to speak with a certain guest but know that the discussion wouldn't fit our traditional show format. Want more of Bennett Tomlin? Find him on Twitter here: https://twitter.com/BennettTomlin?s=20 Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Rather watch us on video? Subscribe to our YouTube channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ Contact us: [e-mail] Timestamps Tether | (3:28) How big is Tether? | (28:12) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. Today, we have a bonus interview with Bennett Tomlin on Tether. But before we get to the introduction of that, we want to talk about 7investing and the special promotion we are running with them through the end of 2021. You can get $50 off the annual subscription with code CHITCHAT. No capitalizations. You can see that in the show notes if you're confused at all with that. It's a special promotion that they have. They're not running normally. It ends at the end of 2021. So if you want to get $50 off your annual subscription, into the 7investing service, get 7 stock research reports each month,

plus plenty of other stuff. They do video reports along with it. It's a fantastic, fantastic service for researching and finding new ideas. If we have a new idea among ourselves, one of the first places we go to and see is if on 7investing, someone on the analyst team is covering it

because I know it's a great way to get up to speed and have a soundboard to talk to someone else. All right, Ryan, do you want to talk about Tether? Well, yeah, I don't know much about Tether, but Bennett does. And so this is an interview, kind of unique. It's not about a particular stock, but it is about a particular asset slash company. Oh, well, they don't think it's an asset, but we'll get into that. You know, the Tether doesn't think it's an asset. Right. Well, it's a little bit confusing, but Bennett knows this really, really well. And it's really fascinating to hear him kind of talk about the implications of it. Were there any highlights for you? highlights the connections to i think it connected a few of the dots i know like about like maybe half of the story some of the dots got connected to how it relates to the cryptocurrencies in

general and buying the other ones how it relates to the different exchanges how the companies are interrelated a little bit of background of the history of the people i mean you get a lot of stuff i'm gonna have to listen to this one again i may have to listen to it twice because there's so much information and there's so many dots to connect but when you do you're like this is insanity so hopefully um that uh that gives a good uh intro here but here we go here's the interview welcome to chit chat money on this show host ryan henderson and brett schaefer interview industry experts and riff on the world of investing as a quick reminder to chat money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital and

Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now please enjoy this episode. All right, today we have a bonus interview and we are welcomed by Bennett Tomlin. I'm getting that name right. I'm assuming saying that right. Yep. And we're going to be talking about Tether, a financial asset that's not maybe a lot of, some people may be aware of this. It's not like a typical stock or company that we're covering. It's kind of an asset that was invented out of thin air about a few years ago. We should preface this with, I intentionally, even though I've never looked at it before, I intentionally avoided

looking at it prior to this interview, because I want to try to be in the shoes of the listener. And Bennett's sort of an expert on it. Brett kind of knows a little bit about it. I probably know about 1% of what Bennett knows. You've been an expert on this. You've been coming around for years, I think. And we'll get into what Tether is. But first, just an introduction. How did you get into, you know, how'd you find Tether, all that good stuff? Yeah. So my senior year of college, which would have been 2017, 2018, I got re-interested in crypto. The idea of these anti-state censorship resistant technologies was appealing to me. And so I started researching them and researching the markets in which they traded.

And I kept bumping up against this odd little coin called Tether. And then being on crypto Twitter, I eventually came across Bitfinext, who is this pseudonymous account on Twitter who has for years been pursuing Bitfinex and Tether for their activities. So I started reading a bunch of his writings. And then early in 2018, which is, this is the point where I really kind of fell fully down the rabbit hole, Bitfinex posted on Medium, a post with a bunch of clips from Whale Pool Team Speaks that Bitfinex and Tether executives had been a part of. And in them, you hear them admitting to just kind of absurd things that really kind of convinced me that there was likely a problem here. Like you hear them describing how they have to play cat and

mouse games with banks. And at one point they discuss how they considered allowing wash trading and just a whole bunch of these pieces that really made it seem like these people were ill-intentioned. And so from that point, I really started researching Tether and Bitfinex more deeply and Bitfinext started getting harassed on Twitter by a bunch of bots and sock puppets and stuff. And so I started publishing more of my writings because I thought it was important that people still discuss these entities and what they were doing. And I've kept writing about them now for the last like three and a half years. So for the layman, can you explain what Tether is? Yeah, so Tether is a stablecoin, which is just a token on the blockchain that's meant to represent a finite amount of currency. So each Tether is supposed to be worth $1. And specifically when they started, the promise was that Tethers would only be issued in response to Tether, the corporation, receiving dollars.

they would always have enough dollars in their bank account to back every single tether in circulation and then when you no longer needed the tether and want your dollar back if you were a verified customer client of tether you would send them the tethers back get your dollars and go on your merry way so and who is giving okay who is giving the dollars to tether and what's the point of getting a quote-unquote tether coin if i want to call it like that so um a lot of people well a decent a couple dozen entities are verified clients of tether who have received tethers the vast majority of them are market makers liquidity providers over-the-counter trading desks and prop trading desks in the crypto space with the lion's share of that being made up

by Alameda Research and Cumberland Global, who account for just about two thirds of total Tether issuance. The reason Tether is valuable in the ecosystem is several fold. One, when Tether came onto the scene in 2014, it was difficult for cryptocurrency exchanges to maintain banking, especially if they wanted to touch the US dollar. Maintaining consistent US correspondent banking was challenging, especially for offshore exchanges. And so for many of them, it was appealing to be able to effectively outsource a lot of that responsibility to tether the corporation. And so if you were in exchange, like say Binance, you didn't need to necessarily find consistent banking because you could rely on the fact that people could bring in

and take out tethers to basically proxy the dollar activity you should be doing, or to proxy the banking activity you would otherwise be doing. And so this helped Tether grow to a whole bunch of different exchanges who wanted to allow people to trade against the dollar without having to deal with U.S. banking regulations. The other part is once that started to happen, Tether became increasingly valuable to these major market players because it was an easier way for them to arbitrage differences between exchanges

Because Tether could be moved quickly on the blockchain and didn't require a lot of the same process that wires into and out of exchanges might have taken. They could move their assets more quickly between different desks, exchanges, whatever, and take advantage of temporary market inefficiencies, arbitrage opportunities, and the like. Besides that, Tether is also used as a tool for Chinese capital flight. um there's some businesses in the chinese mainland that accept tethers and it is occasionally implicated in money laundering we'll see like federal cases where money launderers are using tethers all right and maybe to try to simplify it so listeners understand what is happening um say you're an institution you're able to exchange your dollars with tether they they give you Tether, are they called Tether tokens or is it just called Tether and it's

an institution called Tether? I get confused with that. Generally it's capital T Tether is the corporation and lowercase T Tethers are the token. Okay. So you get lowercase T Tethers and then you get those and what are you, you're using that to buy cryptocurrencies and explain that. Is it basically just using that to buy cryptocurrencies? Yeah. That's the primary use case for tether is to purchase other cryptocurrencies okay so i think i understand how it's supposed to brian do you have any other clarifications kind of so it just gives them an easier in and out of other currencies what what would be the hassle with trying to buy cryptocurrencies with dollars for a lot of the crypto a lot of the cryptocurrency exchanges

the places where you would be trying to buy cryptocurrencies couldn't get access to us bank accounts and so because of that couldn't really offer easy withdrawal and deposit of dollars okay and then you mentioned bitfinex i don't want to clear up the names here before we get into more of the details so there's bitfinex which is an exchange correct yeah so bitfinex is an exchange with the same executive leadership as tether the stablecoin okay and then one last clarification bitfinex is an account that so that's a little bit confusing they're an account that's trying to report on Bitfinex and Tether, correct? Yes, that is correct.

All right. All right. I wanted to clear that up because it's a bit confusing. And now we can kind of get into the meat of it and what you've been investigating over the last few years. How do you think Tether actually works? What kind of problems or potential problems have you been seeing? I don't know.

I guess, do we want to start at the beginning or kind of maybe a few years ago? I know there's a lot of stuff there. Yeah, there's a lot of problems in Tether's history. So I'm trying to think of which ones are going to be the most clear-cut examples. Let's start with the most important promise of Tether that it started out with, that every single Tether would be backed by a dollar in the bank account. It seems that was very rarely the case, that Tether had a dollar in the bank account for

every Tether in circulation. So that would be the first problem. The second problem was that Tether promised to be regularly audited in order to show that they had a dollar for every tether in circulation. And so far, tether has not been audited. The other things come down to tethers activities. So tether, at least occasionally, and perhaps more often does unsecured lending of tethers, where they will send unbacked tethers out to a certain entity, market makers, traders, whatever, on the expectation they'll be getting funds in the near future. Is this known, like do the parties on the other side know it's unsecured lending or do they

think it's secure? So there's a little bit of ambiguity there. It seems that, well, the CFTC settlement suggested that the entities did know that they were doing unsecured lending because they were getting their tethers from Tether before their wires to Tether would clear. And so those entities knew they were getting those basically extended on unsecured credit. There's circumstantial evidence and suggestion that Tether may do that on a larger scale and more frequently, but still then I think their counterparties are probably aware that they're getting an unsecured loan effectively. And so how do they issue the Tethers without, Now, so the idea is that whoever the party is gives them a dollar for every tether.

How do they, did they just create a whole bunch of tethers without any dollars? I'm confused how they started that. It's kind of like they tried to be their own Federal Reserve or U.S. Treasury, correct? Or am I getting that analogy a bit wrong? That's a common analogy people try to use, and I don't think it's quite right. I think tether is more of just like a wildcat bank. They're not being careful with their reserves. They're often inadequately reserved, and they're participating in this kind of business of taking deposits and making loans without the appropriate charters or things they should have in order to do that. Yeah, so there's frequently been periods where Tether issued Tethers without receiving cash, and this is another one of their problems.

For the entire history of Tether's terms of service, they basically said Tethers would only be issued in response to us receiving currency. But that was regularly untrue. In 2015, they advertised on their site that they would do no KYC, no your customer checks on you if you gave them Bitcoin and they'd give you Tether. Since then, we've learned that they have done secured lending agreements with crypto lending platforms like Celsius and Nexo, where they'll put up Bitcoin as part of a secured lending agreement in an exchange received Tether. And so there are a variety of entities who have received Tether without necessarily giving Tether the corresponding cash amount. Do you have another question, Ryan? Yeah, so I guess there's a lot of ground to cover. But what exactly is – so if the counterparties know that maybe it isn't backed by the dollars, what's the harm? what rule are they breaking they shouldn't be lending if they don't have the reserves

well i mean there's a couple things that could be breaking first would be uh whether or not they're engaging in the regulated activities of like a bank for example taking deposits and making loans are generally very uh controlled activities especially if you have any nexus to the united states and tether does not have a bank charter and they're I think still even their MSB registration is to an entity that was since struck off. And so, yeah, so they're not. And then the other thing would be, and this is what Gary Genzer has been discussing recently, that he thinks many stable coins, especially those backed by securities like Tether,

may represent securities themselves as like being similar to like a share in a stable value fund. okay and you mentioned the tie to bitcoin what kind of and a lot i think a lot of people kind of get confused when they say like you're you're using bitcoin or they're securitizing with bitcoin or something like that um how does that work what is the relationship between backing say a tether or i don't know what i get confused myself like what's the relationship between tether and bitcoin How are they tied at the hip? Is the price of Bitcoin really impactful or potentially impactful on Tether's liquidity or vice versa? And I guess this kind of gets into the meat of it too. I guess I have one more question. There was a time when the peg of Tether, am I getting that term right?

Fell off. I think that was the spring. Can you kind of dig into that and how that relates to Bitcoin and stuff? Sure. So there's a few different things at play there. Tether's reserves include Bitcoin in at least two ways. They directly hold Bitcoin as part of their reserves, and that's classified on their asset breakdowns, their attestations as digital assets. So that's a couple billion dollars of digital assets they hold directly to back Tether. The other way that Tether ends up backed by Bitcoin is through these secured lending agreements they have with platforms like Celsius and Nexo. The way these work is that Celsius and Nexo will take, for example, let's say $1.5 billion worth of Bitcoin, give it to

Tether as collateral and in exchange receive like $1 billion worth of Tethers from Celsius would receive like $1 billion worth of Tethers from Tether. Then eventually Celsius would pay that back with interest and their collateral will be released. And so tether reserves are exposed to Bitcoin in two ways. First and foremost, just directly the Bitcoin they hold. That dropping in value potentially affects the assets they have on hand and whether or not they have enough assets to back their tethers. The other part kind of feeds into the rehypothecation of assets and the inbuilt leverage that has become part of tethers operations. So Celsius, for example, the way it works is a Celsius user would, for example, deposit their Bitcoin into Celsius in

order to get a loan in Tether. Celsius takes these Bitcoins that get deposited by their customers and give them to Tether in order to get the Tethers, which are then given to these customers. Oh, no way. That's crazy. Yeah. And then they use these Tethers, obviously, to go out and do the main thing you can do with Tethers is buy more cryptocurrencies. Then if they want, they can take those cryptocurrencies, go back to Celsius, put them up as collateral. And so this is kind of where you get into the inbuilt leverage that's inherent in how Tether operates now, which is not the way they were supposed to operate. This is not what they promised back in 2014. And so because of that,

Tether can theoretically get to a point where if the price of Bitcoin starts to crash quickly and Celsius can't provide additional collateral quick enough, they have to liquidate those stores of Bitcoin. But as they liquidate, they potentially trigger more liquidations and other secured lending agreements down the line for them. And if they're not able to do it quick enough, they end up under-reserved. And this is really what we're kind of getting at with the issue with Tether here, is that they're supposed to be acting as like a tokenized dollar on the blockchain. And often the analogies you hear for them is that they are similar to a money market fund, but the kind of things they're doing with their reserves and the kind of investments they're

making are atypical for a money market fund and seem more like a cryptocurrency hedge fund where they're making more of these bets and trying to find yield and stuff and in doing so taking on significant additional risk to their reserves okay i think maybe this could be a good comparison is it like i show up at a casino and i deposit money in the little circle in the middle and they give me chips and then the casino is lending against my chips while I go gamble. Is that similar or is that the wrong analogy? So I don't think that's a perfect analogy because of the way

the secured lending agreements are. I think that the correct way to describe it would be to just basically say that Tether acts as kind of this inbuilt way to rehypothecate Bitcoin and amplify the leverage inherent in this system because the asset of account, the dollar itself, is secured by the Bitcoin collateral that it is most often used to trade for. So that the Tether is most often used to trade for Bitcoin and Tether itself is secured by the value of Bitcoin. And so you can quickly get into a leverage unwind if that goes the wrong way okay okay that makes that makes total sense i think i think i'm like i'm like 90 there and understanding what there's the big thing that

came out recently is that tether is backed by the certain financial instruments that you mentioned like what information does the public have on that and i guess to reiterate how does it play into the tether story and how important is it to tether's viability so uh what we know about tether's reserves is what has been released in the recent more cayman attestations about tether they suggest tether is largely collateralized by international commercial paper um the expectation is that a lot of that is coming from China, but we don't know that. Tether hasn't directly said that. The other parts of the reserves are a very small portion of liquid cash. It was three cents on the dollar. I think it's still about that. Then they have some fiduciary deposits, the

secured lending agreements we've discussed already, and then a small portion in treasuries, digital assets, and gold. I think that one of the reasons this is perhaps important for Tether's viability is I think having this mixture of assets and this combination of things makes them more interesting to regulators and law enforcement who want to understand what's happening. And I do think having a lot of these potentially volatile assets backing what is supposed to be a stable asset, suggests that there is a meaningful risk in tether breaking peg. And you'll often hear this described as like the risks of a run on tether. But the dynamics of that end up a little bit strange because tether doesn't have to redeem. Like even for their clients who are verified

and through them, they can at any point say, no, we don't want to redeem that. Or they can say instead, we're going to redeem that for this amount of commercial paper that we got from over in China. And so the dynamics of a run on Tether look different than like a run on a money market fund or a bank. And really what you'd probably see is just the peg breaking in secondary markets and then the premium for Bitcoin traded against Tether exploding. The other issue with the Tether reserves is it leads to questions about how Tether is operating nowadays, because it seems strange that they would start with all of these entities, giving them liquid cash, and then end up with them having 0.02% assets over liabilities after investing it into all these things that should

be earning them significantly more yield than liquid cash. It suggests to me that tethers are not issued just in response to getting cash, and that tethers may be being issued, for example, in response to giving the commercial paper in terms of getting the other securities that back Tether. And yeah, and then the other part that I mentioned there offhand is that Tether maintains an extraordinarily small margin of assets over liabilities. They have just a couple million extra assets over the number of Tethers in circulation. And so any loss in value of any of the securities These are things that back Tether, very quickly lead to Tether being under-reserved. And the history of Tether is them not telling people when that happens.

Okay, so that's fine if you're a money market fund and really, really, really non-risky stuff. But if they're in this risky stuff, I mean, that poses some trouble. And they're not regulated like a money market fund. They're not registered as a fund in that way. They're not doing the appropriate disclosure. sure they're not. They're currently suing because they don't want people to disclose the name of their chief investment officer. Really? Can you go into more of that detail? As part of the freedom of information letter that was submitted to the New York Attorney General's

office after that case, Tether issued a counter suit to try to say which information they think should still be confidential. One of the things they included is that the name of their chief investment officer is like a business secret that should not be disclosed and i mean that's wow yeah and it's silvano di stefano everyone knows who it is he used to work at bmp the troubled bank in italy and was one of the signatories on the loan agreement between bitfinex and tether it's an open secret but like they have this culture this belief that they need to keep every detail their operations totally opaque and that's often because they've been taking advantage of that opacity in order to do these financial maneuverings that seem to primarily benefit them

all right brian did you have any so from tether i guess i missed this part what's the point of tether how do they make money they get those dollars tether yeah so so yeah tether was supposed to make money in two ways uh fees on issuance and redemption a small few basis point fees that they would charge there and then whatever interest they could get on the cash um not necessarily a brilliant business model but that is what the promise business model was is that they'd make it on fees and a little bit of interest and the interest isn't like traditional like i don't know banks would go get interest in issuing loans or whatever it's this is more risky more speculative stuff what are they trying to get interest through well so the original

version is that tether would have just stored the pile of cash at their banking partners and so it'd be whatever interest the banks are willing to pay them in exchange for them parking the cash there which generally would have been pretty low it was part of the issue with the business models um now tether supposedly earns yield on a variety of these assets they should be earning yield on the treasuries on the commercial paper on the lending agreements on all of this and yet somehow the assets of reliabilities never increases so any money tether is making out of the yield right now they are immediately taking his dividends to shareholders or whatever and leaving just that same very small 0.02 percent margin of assets over liabilities to preserve for their customers

and do you think it well is it confirmed that they're paying out these dividends to shareholders or is there any like theory that it's potentially they're adding you know that they have like this commercial paper or allegedly they have this stuff and they're supposed to be earning say four or on some of the you know the higher risk um assets is there any potential that they may be fudging it or do they have any history of doing that i know you laugh a bit when i say that but um it is so there is i don't know that it's confirmed publicly that they have paid out dividends to shareholders the other explanation would be either they're not earning the yield they should be, which leads to questions about what they actually have in their reserves and why

it's not earning the expected yield. Or Tether itself is taking any additional profits and stuff that are generated from that and using it to immediately back new Tethers and then doing something with those Tethers. I think the most likely explanation is that a lot of those funds are going to the executives, but that is not necessarily proven. Right, right. We don't want make any acquisitions without the proof um all right let's hit an ad break then we have more connect our questions about how tether connects to the financial system how big is it bitfinex who works there and stuff like that all that good stuff this episode is brought to you by lakinta by windham here you are miles from home and ready

to start your vacation good thing you're staying at lakinta by windham they have free high-speed Wi-Fi to stream all your favorite movies. And in the morning, get fresh waffles with their free bright side breakfast. Or squeeze in a workout at their fitness center. Either way, you're ready to conquer the day. Tonight, La Quinta. Tomorrow, you triumph. Book your stay at LQ.com. This episode is brought to you by KPMG. As a business leader, how can you innovate, build trust, and move forward in a digital era? KPMG can help by bringing together the right talent and technologies, generating insights that spark opportunities. To explore their thinking, visit reed.kpmg.us slash opportunities. Okay, welcome back in. Next question I have,

and I think I know the answer to this, or this may be a little old now, but some people may be surprised to hear how big Tether is. How large is Tether, and what sort knock-on effects could it have if it ended up going away um i'm not sure exactly what their market cap is right now i know it's greater than 70 billion but i don't think they've hit 75 yet so somewhere in between 70 and 75 i think um which makes them larger than madoff's fund um not that that's a comparison i'm making or anything uh so the knock-on effects are a little bit tricky for me to say confidently, because we've never really seen it play out like this. But I think that Tether is one of the largest sources of liquidity in the cryptocurrency

marketplace. A very large number of trades occur against Tether. And so if Tether were to become effectively worthless or frozen, I think we would probably see a pretty meaningful liquidity shock that would probably have some effect on cryptocurrency prices. I don't know what the magnitude of that effect would be. I don't feel confident in estimating that just based on the little bit of information we have. But I think it's reasonable to expect there would be some kind of effect from that amount of liquidity suddenly withdrawing.

Yeah, I think that answers the question. Is Tether supposed to have a certain charter? or have they like applied for one i think yeah i think the big thing is ryan's kind of confused like did they just make this all up right well i'm just like how does it how does it keep how does it keep going oh well because no one stopped it yet um the it's uh it's a little bit unclear where stable coins are supposed to fit in terms of the regulatory landscape that's like why we saw the recent president's working group report on stable coins where they were taking a look at these assets. And their suggestion was basically that the Congress pass laws mandating that

stablecoin issuers become OCC chartered and FDIC insured banks. And I think especially in cases like Tether, where they're engaged in this type of lending activity and not just holding assets and trust, that seems even more justified. The other potential way that Tether perhaps should have registered would have been as a security. It looks a lot like a share in a stable value fund or a money market fund that's meant to maintain a certain value, especially at the point that Tether started backing itself with these various securities. As to the question as to why no one has stopped it yet, it's a little bit more challenging to answer. regulators and law enforcement can sometimes move somewhat slowly we recently saw tether

settle with the cftc we know tether is under investigation by the scc we know tether executives have received target letters from the department of justice suggesting they'll be indicted shortly for bank fraud. And so I think it is plausible that some of the mechanisms that could lead to Tether being stopped are currently in action, but they are somewhat slow moving. And this happens a lot of time with corporate frauds and stuff. The regulators are hesitant to come in before the fraud is exposed, before the collapse has happened, because there's often a tendency for the regulators being blamed for the crash that occurs if they interrupt a fraud in process and so it's their preference generally to wait until after it's happened and they can just come in and clean up

right always the autopsy never the diagnosis is that exactly they're gonna be gray area right if they're like yeah and i think that was especially compounded since tether was so deeply associated with the cryptocurrency ecosystem and crypto was a new asset class right and tether especially was this new asset class when it came out in 2014 and tether didn't really see really huge adoption until like 2017 in that major bull run by that point um my pet theory is that trump's sec jay clayton and the like were they seemed loath to intervene in much of anything in the crypto yeah they didn't do much And so I think that the four year period there, there was a lot of fraudulent and scammy cryptocurrency projects that effectively benefited, survived, expanded, grew, thanks to the fact that there was no one really actively policing that.

And so I think that's why you saw Gary Gensler when he first came out in even his first couple speeches really try to emphasize that the regulatory scheme around cryptocurrencies was likely to change. Okay. And you mentioned a wildcat bank earlier. Why do you think Tether is comparable to a wildcat bank? The first and most obvious is that they're engaging in bank-like activities without having a bank charter, and they're taking deposits, they're lending. Besides that, the other part that I'm often trying to evoke with that analogy is that often wildcat banks were lying about the funds they had in reserve. For example, there was one case described by an auditor and an inspector up in Michigan where they went to check out one of the banks, claimed to have a certain amount of assets. And when they opened one of the chests, on the surface was a thin layer of the silver coins they were supposed to have.

But if you dug like more than an inch deep, the rest of the chest was filled with like nails and things like that, meant to give it a convincing weight, but not the assets they were meant to have. and so i think tether has done lots of things kind of like that where they present their assets in such a way that it seems at first glance they have what they're supposed to but as soon as you take a look at what they really have as soon as you dig more than an inch deep you realized it's a chest full of rusty nails okay or sorry right go ahead i wanted to get to kind of how this unravels like i guess do you want to say that for the end yeah we can save it go ahead what's your

Okay, who invented Tether? Who are the people that are behind this stuff? Yeah, so the initial co-founders were a group of people who had been working on the MasterCoin Foundation, later Omni, which was a second layer on top of Bitcoin that enabled tokens to be issued and stuff like this. The group led by Reeves, Craig Sellers, and Brock Pierce came up with an idea for a tokenized dollar on the blockchain. They started shopping around to a lot of the VCs out in California who allegedly had the reaction, this sounds very illegal. It sounds like you're ignoring all the regulations around banking and the things you should be doing. I don't think we should invest in this. And so they didn't. However, Phil Potter, the former chief strategy officer of Bitfinex, and Juan Carlos De Vecini, the chief financial officer of Bitfinex, apparently heard about this in some way and were able to purchase, partner, whatever, with the nascent at that point, RealCoin, which they rebranded as Tether.

This was in 2014. Shortly after this, most of the co-founders who were part of the original Tether, Reeves, Pierce, Quigley, Yantis, were no longer part of Tether. And Phil Potter, Juan Carlo De Vecini, JL Vandervelde, the CEO of Bitfinex, became like the executive team for Tether. Craig Sellers lasted a couple of years. I want to say he left in like 2016, but the rest were out much before that. Then, yeah, so then Tether was led by the same team as Bitfinex, the exchange, and several of those individuals have somewhat checkered paths. For example, Stuart Hognor, the general counsel for both Bitfinex and Tether was previously

the director of compliance at Excapa, which was the parent company for UltimateBet, which was the poker site that let some poker players see their other players cards gave them a god mode and so he was the director of compliance there uh juan carlo davicini had to like pay a big settlement or had to pay a settlement because he had been selling pirated microsoft software he had one of his ill-performing business warehouses burned down in a mysterious fire and then like phil potter got fired from one of the big new york banks after he did an interview in the New York times where he bragged about how much money he made. And so it was this motley group of characters who kind of took over from the original co-founders in like 2015 and started

running Tether from that point out. Have any of them reached out to you about your research? So Stuart Hoganer at the general council of Bitfinex and Tether has called me a liar on twitter before but he hasn't really reached out i have dm'd with two former tether executives and i'm followed by a third on twitter um at least one of the former tether executives thinks that i am unfair in my descriptions of tether he feels that they are more honest than i give them credit for uh but yes i i have talked to some of them where i mean where do you find all this information i don't think they have just an ir page so i'm uh hours and hours of research uh digging through old corporate documents going through like archived versions of websites to see how it

was described at different points in time digging through site maps to try to find like extra pages and stuff looking through corporate registrations um the paradise papers were valuable that were published by the international consortium of investigative journalists because that was what finally definitively proved that tether and bitfinex had the same directors because they had at times tried to deny that fact um and then yeah just lots of digging through lots of documents so you mentioned Bitfinex there and I think some people may be confused how Bitfinex and Tether are connected um does is that meaningful to this story I don't think it is yeah largely because it ties into a lot of people's theories about what Tether may be doing and stuff like that

so Bitfinex itself was an exchange started in 2012 by a Ponzi schemer named Raphael Nicolay who had previously tried and failed to start an over-the-counter trading desk and took stolen code from a failed and hacked Bitcoin exchange and decided to use that stolen code to start his own Bitcoin exchange, which became Bitfinex. He operated that for a few months, and then Juan Carlo De Vecini enters and helps to start changing some of the things at Bitfinex, building certain things out.

And the reason Bitfinex became popular in its early days was twofold. One, they served as a meta-exchange. So you could either send your order to Bitfinex's own books. Through Bitfinex, you could send your order over to Mt. Gox, or you could send your order over to Bitstamp. So you could effectively trade on three exchanges using the interface of one. Besides that, Bitfinex was one of the first to have a pretty reliable way to lend out your coins. they had. So because of that, people liked to park their coins there because they could lend

them out, earn a certain amount back and get yield on their coins that way. So Bitfinex kept growing. The reason Tether is important to knowing that Bitfinex and Tether are important is because one, they lied about it and denied it. And two, because Bitfinex has used Tether's accounts to cover their own insolvency. So this is kind of a lot what the New York Attorney General case against Bitfinex and Tether was focused on, and it takes a bit to track the whole story here, but in March of 2017, Bitfinex and Tether were both cut off by Wells Fargo, their U.S. correspondent bank, and so no longer had consistent banking. At this point, they started relying a lot more on a shady Panamanian crypto or shady Panamanian payments processor called Crypto Capital Core.

Over the next couple of years, they would eventually end up giving over $1 billion of commingled client and corporate funds between both companies to Crypto Capital Core without ever signing an agreement or contract of any kind. in the summer of 2018 crypto capital core started having their accounts seized over in europe as part of a inquiry into money laundering for the colombian cartels then executives from crypto capital core started getting arrested starting with oz yosef or sorry starting with even moment Even Manuel Molina Lee, who was arrested in Greece and extradited to Poland, allegedly for money laundering for the Colombian cartels. Reggie Fowler, the former part owner of the Minnesota Vikings, was picked up in Arizona and sent over to New York, I believe, on wire fraud, bank fraud, like six total counts of fraud,

and was arrested with supplies for counterfeiting, fake bond certificates worth a billion dollars, and a bunch of other stuff like that. Oz Yosef was also picked up when they picked up. Yeah, I think Oz Yosef was also arrested. The one that might not have been arrested yet is Oz's sister, Ravid, who was also one of the principals

for Crypto Capital Corp. So Bitfinex and Tether trusted just over $1 billion worth of their funds to this payment processor that was likely money laundering for the cartels, was possibly counterfeiting, and was almost definitely committing wire fraud and bank fraud. At no point did Bitfinex and Tether sign a contract or agreement with Crypto Capital Corp. Because the funds were seized, Crypto Capital Corp. stopped responding to Bitfinex's request for withdrawals. So in the summer of 2018, in order to hide that fact and continue to service Bitfinex's customers,

Bitfinex took several hundred million dollars from Tether's account. Didn't disclose this. Neither of them disclosed this and they continued operating. They found some amount of assets between then and November 1st, 2018, which is when they announced that Tether was finally banking at Deltec Bank and Trust in the Bahamas. On November 2nd, 2018, shortly after Deltec had issued a letter saying Tether's portfolio cash value exceeded the number of Tethers in circulation, Bitfinex took $650 million out of Tether's account in order to again cover up their own insolvency and in effect

make Tether unbacked. This continued for several months with Bitfinex lying to the public, saying withdrawals were working fine, there's no problems, all of these people online are lying. And then in February of 2019, Tether updates their terms of service to say that now Tether doesn't need to be backed by cash. It can be backed by cash, receivables, and other assets. In March of 2019, Tether and Bitfinex enter into what they call an arm's length agreement for a revolving line of credit, in which Bitfinex puts up a whole bunch of shares of iFinex, one of the companies that operates the Bitfinex platform, and in exchange gets access to a revolving line of credit worth $900 million against Tether's

reserves. This was the loan agreement I mentioned previously that one of the signatories was Silvano DiStefano, Tether's chief investment officer we're not supposed to know about. It was signed for both Tether and Bitfinex by J.L. Vanderbilt and Juan Carlo Davisini. Same executive team makes it easy to get both teams to agree. um so then finally in april of 2019 leticia james and the new york attorney general filed for an ex parte order against bitfinex and tether alleging that they had engaged in these transactions i just described um and this is really finally when the public became aware that bitfinex and tether were engaging in these activities that's a it's an insane story that's

a comprehensive background though yeah i mean i think someone's listening to that that that is i mean there how many connections are there it's an it's insane how many little ties there are to these random companies and stuff and i'm really interested to see how tether plays out over the next few years so that brings us kind of to our wrap-up questions what scenarios do you think there are for tether moving forward could this become i mean what what's stopping it from becoming 700 billion and what will cause it to collapse let me ask another question is there is there a point for them where it's like fake it till you make it like can they basically get out of this and then on the flip side what does an unraveling look like so as i mentioned previously

i think there's not the same dynamics for a run on tether that you would see for like a run on a bank or something like that. There is, I think, some outside chance that we could see a major peg break if someone in the Game 3 situation here decided to defect because they were worried they weren't going to be able to get funds out of Tether. But largely, the couple dozen clients of Tether are incentivized to make sure Tether stays at or around a dollar because they use it as this tool to trade in all these cryptocurrency markets. So I think the most likely way that Tether would get shut down would be by either regulator or law enforcement action. I think the market doing it is relatively unlikely. What that would look like, I'm not super confident about.

The dynamics, I think we can say relatively confident as we'd see the price of Bitcoin and other cryptos denominated in Tether explode versus the price of Bitcoin denominated in dollars because any exchange where they don't halt trading, people are going to presumably be ditching their expected to be worthless tethers for anything they think might have worth, right? And so we might see Bitcoin trading at a million tethers on one exchange and $70,000 on like Coinbase, right? Because the tethers themselves will be becoming progressively less valuable. My expectation is that in this case where this liquidity is being withdrawn and the market looks like this, we would also probably see people on the fiat exchanges,

the one with access to banking, probably selling as well, just out of fear. And so I think the plausible outcome in a situation where Tether is suddenly shut down, seized, whatever, is that it would probably at least temporarily hurt cryptocurrency prices. The other part was, can Tether fake it till they make it? That's kind of an outstanding question. The president's working group recommendation is that Congress should pass a bill making it so basically these have to become banks. The two biggest bills that are currently out addressing that are the Stable Act and the other ones is the Digital Asset and Market Structure Investor Protection Act, I think. It's the one that supposedly came down from the Treasury that involves every stablecoin issuer

having to register with the treasury if one of those two bills pass i am skeptical that tether would be able to get an occ charter and get fdic insurance and become like a regulated american bank what would it require more reserves they gotta get the audit right they gotta get yeah they would need to become like a bank and follow all those regulations so yeah they would need Yeah, and both those bills basically involve the assets only really being able to be cash. And so it would be very challenging, I think, for Tether to do that. And I think it's unlikely that the U.S. Treasury would give Tether approval. And I think that even the Tether executives have certain fears about this.

Juan Carlo and Paulo recently on Twitter have been hyping up Tether Gold incessantly. And I think part of the reason for that might be they're worried that soon they'll no longer be able to offer the U.S. Tether product. However, there is a bit of a political gridlock in the Senate. I don't know if either of you have noticed that. That may make it difficult to pass new financial regulations. In that case, where none of the stablecoin issuers are in the near term future supposed to become banks, Then the recommendation in the report was that the SEC and the CFTC take their role in regulating these. And I think that's why Gary Gensler has been so careful in trying to compare these stable coins to stable value funds, because he wants to make sure that the SEC has jurisdiction over these things.

And we know that the SEC investigation into Tether just started a couple months ago. And so it's reasonable, I think, that we would likely see, if neither of these bills pass, the SEC start potentially bringing action against other stablecoins. The other piece of the puzzle is, of course, the Department of Justice. They started a probe into Bitcoin price manipulation back into 2018 with the help of Integra FEC. they've since expanded that investigation and it also includes the bank fraud target letters that the tether executives have supposedly received the tether executives being indicted for bank fraud i anticipate could also make it more difficult for tether to continue operations it's somewhat unclear though if the criminal charges are going to be brought like fully

against tether the corporation or just some subset of the executives so it's a bit unclear to me if others going to be able to fake it till they make it. There is, I think, a non-zero percent chance that they're able to sufficiently reduce their U.S. nexus, make it seem as though they're not significantly interacting with the United States to try to make jurisdictional arguments, and then make it sufficiently difficult for regulators to go after them that it won't be worth however i think it is significantly more likely that we will see regulatory action that would seriously impair tether's operations okay and i have one more question before we end what's the point of all this stuff like isn't it just i kind of have hard time grasping like

the bigger picture like is it all just to buy more cryptocurrencies is that the only thing just buying more digital assets that aren't like it just seems like it's all for not it's all for nothing right maybe i don't know i don't want to be like an anti-crypto guy but it's like is it is it for like what's this all for for dollars in the end yeah i think i think it's a way to make money in the end and i think we kind of see that in like uh zeke fawkes's recent reporting for Bloomberg Businessweek about Tether suggested that at some point in 2017, Juan Carlo De Vecini started basically going to John Betts, who was the CEO of the bank they were at, trying to convince him to find ways that Tether's reserves could earn more money. And like

Juan Carlo De Vecini and Silvano Di Stefano, the chief investment officer of Tether, are both partners in a cryptocurrency investment hedge fund called BlueBet Capital. And Paolo Arduino, No, the chief technical officer of Bitfinex and Tether was a director at Dell Chain, the cryptocurrency focused offshoot of Dell Tech Bank and Trust, where Tether banks and Dell Chain launched like Fugue Alpha, the cryptocurrency hedge fund that trades almost exclusively in Bitfinex. And so I think that often the incentive for them would be to make money. I think we see that a lot of time in especially like Juan Carlos actions. Okay, well, that's a great way to end it. this was a fantastic overview for anyone that wants to

hear more about Tether where can they go read up about stuff and where can they find you? Sure, so I'm on Twitter at Bennett Tomlin that's three T's in a row because that's how my name works my blog is

BennettFTomlin.com where I have dozens of articles about Bitfinex and Tether and I'm the co-host of Crypto Critics Corner which is a podcast you can get wherever you listen to podcasts where i discuss a lot of this as well all right i'm gonna have to turn into that to maybe uh

we're not a you know it's a learning curve it's a learning curve uh but i think uh it's such an interesting story but either way thanks again for having us or sorry thanks again for coming on ryan's usually the host ryan's usually the host so i'm not good at this but i appreciate the time appreciate the time all right glad to be here we want to remind our listeners that brett and i are not financial advisors so anything we say or discuss here at chitchat money is not formal advice or recommendation. We are, however, general partners at Arch Capital, so clients may have positions in the securities discussed in this podcast. Thank you all for listening. We'll see you next time. This family is on the brink of civil war. On September 18th, Mobland,

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