Odd Lots - This Is What We Know About How Tether Works

Episode Date: December 12, 2022

2022 has seen numerous crypto disasters, most notably FTX. Also the price of most coins has tumbled massively. One coin that's done fine is the stablecoin Tether, which is interesting, because its had so many naysayers for so long. There are even hedge funds who have bet on its implosion. But what is Tether? How does it work? And where does it come from? On this episode of the podcast, we speak with Bennett Tomlin, co-host of the Crypto Critics' Corner podcast, who has an encyclopedic knowledge about the company. He walks us through what we know about the entity, and its relationship with other entities in crypto.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthall. And I'm Tracy Allaway. Tracy, you know, one of the funny things, I guess, I don't know if funny is the right word, but one of the funny things with crypto is that, you know, it's shocking when a big entity like FTX collapses and there have been other classes. as well. But on some level, I don't think anyone really thinks anyone in the space is like blue chip or like completely legit, right? Like there's no one in crypto that you would like trust the way like say you'd trust like putting your money at like JPMorgan or something. I think that's true, but everything in crypto is kind of relative. So I have previously described

FTX as like the Microsoft of crypto exchanges because it was the one that people thought was kind of best practice and it had all these connections with traditional finance and Sam Bankman-Fried was lobbying for stronger crypto regulation and everything seemed kind of like up and up and it had this wonderful liquidation engine that everyone talked about and clearly clearly that wasn't the case but you're right there are actors in the crypto space of varying quality let's say right and you said the the key word which you nailed is relative because sure there are some that seem to be kind of well run and decently well regulated. And then there are others that people have been saying, oh, this is going to collapse, this is a fraud, this is

whatever, for years and years. And you don't really know which one is going to go. And it turns out that a lot of the critics of crypto may get things right. But on the other hand, like, don't really know which domino is going to tumble next. It's been surprisingly hard to figure that out. Yeah, and again, I hesitate to use the word fun, but I guess that's one of the unusual things about crypto is the guys you think aren't going to make it can persist for a lot longer that those that you think have a better chance. So, you know, things like Dogecoin. How long has that lasted? I know. Like something that is clearly a joke still has a nominal monetary value. And then, of course, there is tether. Yes. And so I think when FTCS collapsed, both of us sort of had the same thought at the same time, which is like, man, you know, it's funny. Again, I don't know if funny is their word, but Tether is still here. And people have been betting against Tether or predicting its demise or claiming that it's a fraud or claiming that it's going to get shut down by regulators or claiming that it's going to lose its peg forever. Meanwhile, all of these things implode that aren't Tether. And Tether, as of right now, which is we're recording.

this on December 5th, is a trading about one to the dollar. Right. So tether is a stable coin. One tether is supposed to be worth $1 at all times. It has previously dipped below that level, particularly after the big crypto blowups in the spring of this year when Terra Luna collapsed. And then when FTX collapsed, it slipped slightly below its $1 peg, but it's come back. And I think it has been remarkably resilient. when you consider that literally for years people have been asking about this company, how it's run the sort of web of relationships around it, and perhaps most crucially, are there actually things backing Tether? Because as I mentioned, it's a collateralized stable coin. It is supposed to be backed by dollar assets, but there's always been a lot of doubt and questioning over whether or not those exist. In fact, last year, Tetherly, Heather and Bitfinex were ordered by the CFTC and also the New York Attorney General to pay millions of dollars in fines for misleading customers. And Tether's own PR strategy when it comes to this, I think it's fair to say it's been a little bit weird.

And I'm just thinking, you know, one of the ultimate ironies is I remember we had Sam Bankman-Fried on, the FTX founder with Matt Levine. I think our first conversation with those two. and we asked SBF about tether and he basically said something along the lines of like, oh, it's just a, you know, it's a complete mess. Like, you know, it's kind of a mess of a process maintaining this thing. And so if SBF is telling you that this thing is messy, I think it deserves its own episode, right? It does. And you know, SBF, FTX and Elameda, they were big tether users. He felt that. But anyway, I have so many questions about tether. And in the wake of FTX, I thought it would be a good time to, yeah, revisit what it is, what its role is, what we know about it, what we don't know about it, etc. And just sort of like take stock of this pretty, I think, critical piece of crypto infrastructure. Totally. And also why it's proven so resilient and what could actually kind of knock it down. All right. Let's go. We are going to be speaking with someone who knows the company very well, has been reporting on it and talking about it and analyzing it.

for a long time we're going to get all of our questions cleared up. We're going to be speaking to Bennett Tomlin. He is the co-host of the Crypto Critics Corner podcast, and he is also the head of research at Protos Media, and he is an encyclopedic knowledge of the crypto ecosystem and who does what and who is who. So Bennett, thank you so much for coming on Oddlots. Glad to be here. All right. Let's just start like really simple. Who started Tether and why? that's a surprisingly challenging question. I thought that would be an easy question to start with. Nominally, it was started in 2014 by a bunch of the master coin slash Omnichru.

Specifically, Brock Pierce, Yantis, Quigley, Reeves, and Sellers came over and decided to start. But they called at the time Real Coin, which they advertised is this dollar-batt token on the blockchain that was going to use what was then called the master coin layer and is now called the Omni Layer on top of Bitcoin. Sometime in that summer of 2014 when they were going around pitching this idea, Juan Carlo Davicini, Gene Ludovidicus Vanderveld, and Phil Potter got involved. And the exact timeline of their involvement and when the control of this entity fully shifted is difficult to parse out. But by the time the first Tethers were issued in October, November of 2014, Tether was entirely under the control of Juan Carlo Davicini, Phil Potter, and Gene Ludovidicus Vanderbilt,

the Bitfinex executives. So it started by this group of people from MasterCoin and then taken over and really launched under the Bitfinex executives in 2014. So I'm going to ask the same question in a slightly different way, but why the need for stable coins at all? Like why in crypto can't you just transact in US dollar deposits for the majority of offshore exchanges. Like why this market need that this group of very disparate people came together to serve? My understanding is that it was very challenging, even for the most quote unquote, legitimate of cryptocurrency businesses in this era to get and maintain consistent banking relationships. And so the idea with Tether is that Tether would build these relationships.

And in doing so, allow a variety of other cryptocurrencies. currency businesses to effectively benefit from their banking relationships by allowing them to have this pseudo-dollar token that allowed them to mimic trading against the dollar and all the conveniences therein without having to seek out and maintain relationships with banks that could transact in the U.S. dollar. Right. So this is a really key thing rather than if you want to set up a crypto exchange, rather than you going through all of the work to set up bank accounts and different countries and all that,

You're just like, oh, you just like create a platform that allows you to onboard Tether. Tether already has the banking relationship. And instead of trading in dollars, you trade in the dollar denominated stable coins. Now, who is Tether's bank in the beginning? So if they're going to have this dollar denominated stable coins, they're going to hold their dollars, where were they holding their dollars? How did they get a banking relationship? Again, it's a little bit difficult to parse completely. We know at least part of the reserves were held at a variety of Taiwanese banks, many of which relied on well,

Wells Fargo for their U.S. correspondent banking services. And we found this out because in 2017, Wells Fargo ended up cutting off correspondent banking access for BitFinex and Tether. And Bitfinex and Tether filed a lawsuit they described as purely to buy time against Wells Fargo at that point. So yeah, they were banking at a variety of Taiwanese banks and getting correspondent banking from Wells Fargo. The reason I'm pausing is that BitFinex's and Tether's relationship with payments processor Crypto Capital Core stretches back to 2014. And so it is possible that some portion of the reserves besides being held in these Taiwanese banks was already being held in Crypto Capital Core. Besides that, we know from the CFTC settlement with Tether that as early as 2016, Tether was being backed by non-cash assets. And so we have to expect that some portion of those were being held outside of those bank accounts as well. So this kind of gets to the question over the weird PO. strategy, which I expect that's going to be sort of a theme that comes up a lot in this conversation.

But if we know that Tether was created to allow sort of easier onboarding of dollar deposits into the crypto system by allowing them to build and establish these relationships with various banks, why wouldn't they just be upfront about who their bank partners are? Bitfinex and Tether in Whalepool Team Speaks and official communications have often expressed a fear that if the extent of their relationships with various banking partners is made public, those banking relationships will cease to exist. For some reason, it seems that Tether and Bitfinex's banks and the relationships therein have to be kept somewhat secret in order for Tether and Bitfnex to continue to offer that. the fear when they say something like that is that the reason they need to be coy about it is because the banks are not fully aware of what they may be banking or there is some other challenge that presents itself to these banks when it becomes public that they are banking these entities. You know, speaking of, okay, maybe the bank doesn't want you to do crypto stuff or maybe an entity is obfuscating what it did or what its relationship with bank. the bank was when they opened the account. I seem to recall there being some video in which

Sam Bankman-Fried talks about having named Alameda. Elimita Research so that it wasn't just Alameda. Is that, am I hallucinating that or did that actually happen? No, there was an interview where Sam Bankman-Fried was asked why Alameda Research was named Alameda Research. And he talked about how when he was arbitraging the Japanese premium, that having the name Alameda Research and convincing people that this was a research firm made it easier for him to access and maintain banking relationships that allowed them to arbitrage that premium. On April 4, 2023, around 2 in the morning, a man was found stabbed multiple times on a sidewalk in downtown San Francisco.

Hey, who did this to you? What happened next turned the story into a political firestorm. Reports have identified the victim as Bob Lee, the founder of Cash App. From Bloomberg Podcasts, this is Foundering, The Killing of Bob Lee, beginning April 16. Maybe just going back to the beginning of Tether for a second. So I understand the function that Tether was serving in the crypto community, but what was their own business model? So what was the idea behind how Tether as a company was going to make money? They charged a few basis points on issuance and redemption.

and I think if their reserves were going to be earning any yield in the bank accounts they were stored in, then that yield would go to tether the corporation. Stable coins are a challenging business model. Circle has struggled to do it profitably. So just on this note, and again, we're sort of diving headlong already into one of the bigger issues with tether. But it does seem like if you're expecting tether to maintain the peg with dollar-denominated assets, but the company itself is making money by generating yields from those assets. That would seem to be almost immediately a conflict of interest, right?

Or at least a temptation to potentially invest in higher yielding, riskier assets to generate more money for the company itself. Well, I think that Bloomberg Business Weeks reporting, Zieg Falks is reporting on this really kind of points to that specifically, where you see when they're banking at Noble Bank and Trust, founded by John Betts and Brock Pierce, supposedly, Juan Carlo Davicini going to John Betts and pleading, asking for ways that they can earn additional yield on their reserves. And I think this is consistent with Juan Carlo Davicini, the chief financial officer of Tether, and Silvano di Stefano, the chief investment officer of Tether being partners together in BlueBit, the cryptocurrency hedge fund, right? Is that around this period, we have pretty solid reporting that Tether was very much

interested in going out and trying to find additional ways to earn yield, and that if we look, even if we take tether completely at their word, if we look at their attestations today, their reserves are far riskier than they were promised to be back when tether was started in 2014. The original promise was that every single tether issued would have a corresponding dollar in a bank account to back them. Now the promise is that there is a dollar of value in some nebulous collection of assets that backs that tether. so I think that it's very clear it has presented a conflict of interest and that tether has

continued to move further and further away from their initial promise as a way to generate additional yield and income for the people running tether. Yeah, you mentioned the word nebulous, and I remember there was this great note from Barclays from their money market and credit guys basically saying that tether was using language around its investments that no one in the financial industry had ever seen. They kept referring to something called a reverse. repo note. Yes, I remember that. Yeah, they seem to imply it was some sort of like structured credit note, but also a reverse repo, which was all very, very strange. So speaking of language, you know, I want to get a little bit more to the bank, the post-Wels Fargo or post-Taiwanese

banking relationships. But before going, what is an attestation? Because I know that Tether does not get a formal like audit, but they say they publish this attestation. What is that? So I'm not an accountant or an auditor or a lawyer, and so I want to get that off the jump. But based on the auditors I've talked to about this, an attestation is a much lower level of assurance where the auditor or accountant is looking at a set of records compiled for them by the management of the entity, and they are attesting that the records they have received match up with whatever they're supposed to. Generally, they don't involve the same kind of controls testing as an audit. They're generally done point in time and are not looking at necessarily the flows leading up to that point in time, which has historically been a problem with tether's attestations.

And so they provide some level of assurance, but notably less than like a full financial audit. So let's go back, two things, I guess, but after the loss the ability to use the correspondent, the banks that had a corresponding relationship with Taiwan or sorry, with Wells Fargo, with whom did they start banking? and can the assets that Tether claims it has, can they be seen on published regulatory filings of those banks? So after they lose correspondent banking from Wells Fargo, Tether's banking becomes a bit of an enigma. They held a little over $60 million at the Bank of Montreal in Stuart Hoagner's account, their general counsel. The remainder of their banking from that period until they opened their account at Noble Bank was supposedly a receivable from Bitfinex's account at Noble Bank, which was the international financial entity started by Brock Pierce and John Betts in Puerto Rico.

The issue with this is that if you look at Bitfinex's account at Noble Bank during this period, and this is based on the New York Attorney General Investigation, Bitfinex only received deposits from two other institutions, and neither of those institutions purchased tethers. The amount in Stuart Hoagner's account over this entire period did not change at all, and yet the number of tethers in circulation exploded during this period. And so it is incredibly difficult to figure out what the flow of funds was during this era and how they were directly backing tether. My guess is that many users were interacting with crypto capital core, the payments processor that both Bitfinex and tether depended on, and that they were sending

both tethers and dollars to crypto capital court to issue and redeem tethers. And these were then marked on their accounting records as funds that were then owed to the account at Noble Bank, which was nominally holding the reserves of Tether, despite being in the name of Bitfinex. This continued until it was time for Friedman LLP to finally give their September 15th attestation to Tether's reserves. On the morning of September 15th, Tether finally got an account at Noble Bank and Trust. and they transferred hundreds of millions of dollars from Bitfinex's account that morning to Tether's account on that day.

And then that evening, Friedman LLP, comes in in a test to the state of Tethers reserves. Then from that point on, they bank believed to be largely continuously at Crypto Capital Core and Noble Bank until Noble Bank starts to close down in 2018. Then we get to the period where they start relying really heavily on crypto capital core until crypto capital core ends up having about 850 million total dollars seized. And we eventually in the summer of 2018 into the fall of 2018 get more and more into their reliance on Deltec Bank and Trust in the Bahamas. Deltech Bank and Trust, you were able to see a large inflow of deposits based on the Central Bank of Bahamas regulatory records, showing that Deltech was receiving a bunch of assets that they had not had before, suggesting that tether was moving something into there at that point. So we kind of have a couple of things to look at when it comes to trying to figure out what tether is actually doing. So we have the attestations, you know, which may or may not be accurate.

But we also have just the sheer volume of tether in existence because we know that every tether issued is supposed. host to be backed by, you know, it used to be $1, and now it's $1 of dollar denominated assets. But what does the sort of expansion of tether supply actually tell you about what the company has been doing and experiencing? I don't know that the expansion of tether supply really gives us that much information, except that it's supposed to indicate that actual dollars are flowing from other entities in the space into Tether's accounts. and then tethers are being issued. And so it's primarily interesting because there should be a corresponding,

like there should be corresponding flows through the banking system for all the tethers that have supposedly ever been issued and redeemed. And that is a reasonably large amount of money to have been flowing through the banking system. So just on that note and also kind of going back to the Barclays analysts who were talking about, we've never heard anything called a reverse repo note. But there is this expectation that if Tether is out in the market with, you know, 50 or 60 billion dollars worth of assets that it's investing, that someone in the traditional financial system would know them and be familiar with them and that people, you know, on repo desks and things like that would be familiar with them as a customer. And yet if you talk to people in traditional finance, that doesn't really seem to be the case. Like, no one is talking about how they're transacting with Tether on a regular basis. What's going on there?

That's a really fantastic question, Tracy. And I think it was last year that Financial Times went out after Tether announced that they were one of the seven largest holders of commercial paper in the world and asked a whole bunch of commercial paper desks, hey, have you noticed this new entrance into the commercial paper market and they all universally said who? So, yeah, that's a fantastic question. Where is Tether in these markets? It's possible that Tether is transacting using entities that aren't called Tether, like, for example, Bluebit Capital, the cryptocurrency hedge fund that Juan Carlo Davicini and Silvano di Stefano are partners in could be DelChane, the cryptocurrency focused offshoot of Deltec Bank and Trust that Paulo Ardoino used to be an executive director of. It could be Fulgar Alpha, the cryptocurrency hedge fund spun off from Delcane that was onboarded onto BitFenex. well, Paulo was a director at Del Chain, there's a possibility that just these deaths don't recognize the name of Tether because Tether isn't transacting in the name of Tether.

Or it could be a lot of other things that we don't have visibility into yet. But it is challenging to figure out just where is all this money coming from, where is it going, and why is no one noticing it coming or going? Right. You know, I want to compare and contrast Heather a little bit to other stable coins. The other, like, really big one is USDC. And, in fact, just today, December 5th, we got the news. They're actually canceling. Circle is no longer doing its SPAC.

So that's kind of interesting timing. But, like, okay, with something like USDC, do we have very clear visibility into where their money is and, like, compare, like, the sort of level of transparency we have? with Tether versus these other stable coins, which my understanding is they seem to be, people are less suspicious of them. I'm generally less suspicious of Circle than of Tether. Part of this is because Circle has made fewer misrepresentations in public than Tether has. Though, to be clear, there was a period where Coinbase was advertising USDC is fully backed

by cash after they had started using other assets, including treasuries and commercial paper to back it. But broadly, USC and Circle have been much better at their disclosures than Tether has. They are not being forced by the New York Attorney General to do attestations, but are doing them monthly instead of quarterly. They have a more expected mix of assets. You don't see the lending on Circle's books. You don't see the reverse repos or fiduciary deposits. You don't see Bitcoin backing Circle.

You don't see investments in Samson Mao's gaming company exhortions. backing circle. And like Circle itself, when they were preparing for their spec, did go out and get audits for their firm as a whole. And so there is kind of that structural difference. Over time, the claimed asset mixes for the two have moved closer together. Tether has claimed to ditch commercial paper in favor of increasingly relying on treasuries. And the mix of like treasuries to cash and stuff for Tether is now much closer to circle

than it was like a year ago. So I think broadly the difference between the two is the level of disclosure, the level of openness and the history of deceit. There's also like both Circle and Paxos in the United States have started the process of trying to acquire banks or apply for bank charters, likely anticipating that at some point some kind of legislation is going to pass that is going to move stable coins into the broader banking regulatory framework. Tether has not started those moves and I expect would have a. difficult time getting approval for a banking charter or approval to buy a bank in the United States. I'm June Grasso, inviting you to join me for the Bloomberg Law podcast. Every weekday, we help you make sense of the legal stories that shape the nation and the world. Listen for complete analysis of the biggest court cases, the latest actions from Congress and regulators, and the legal moves driving the

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with me, June Grasso. Subscribe today wherever you get your podcast. You know, you mentioned the word deceit, and I think certainly at a minimum, you could say that Tether has pursued a rather weird strategy of disclosure and public relations, where, you know, sometimes it seems to intentionally be kind of coy with information or maybe outright deceiving people. But it doesn't really seem to have mattered to the people. who are still using Tether to do a lot of crypto transactions. And at various times, Tether has been described as a sort of linchpin in the environment that is the crypto universe. You know, it is the thing that allows a lot of transactions and trading and betting to take place. Why does it not seem to matter that much to people who are using crypto? Well, Tether has existed since 2000.

and has been mostly worth a dollar since 2014. Like, I can talk and list many very specific lies in things that Tether has done, but the truth is that over most of that time, for most of the people who used Tether, it was worth what they expected it to be worth. It was able to be transferred from exchange to exchange, and it broadly represented about a dollar's worth of value. There's also the dynamic that many of the largest issuers and redeemers of Tether, like Alameda Research, who was the largest as of November. November 2021, they did not hold on to the Tethers for very long. They were often selling them directly into the market, using them for trades. And so their overall exposure to Tether was more of like the systemic exposure of this thing existing rather than like the exposure to them specifically of their tokens suddenly becoming

valueless. The other thing with Tether and BitFenex that becomes part of a challenge is that after they were hacked in 2016, they issued their BFX token. And many of those tokens, rather than eventually being redeemed for cash, were redeemed for equity in the parent company for BitFinex. And so many people who had been trading on BitFenex in 2016 ended up becoming equity owners and having a vested interest in these entities being successful and growing because it directly benefited them. So there's a whole bunch of kind of different competing dynamics. One is that tether has been largely good for what it was supposed to for the time it's existed. Tether has been around and has connections to many of these other entities in the cryptocurrency industry.

And then a decent portion of people in the industry, especially those who've been around for several years, have at least some vested interest in these entities being successful. You know, I saw a tweet right before we started recording this episode, and it was someone saying my pet theory is that an amazing amount of crypto is going to turn out to be 20 dudes and an army of shell companies. And when you describe this sort of web of relationships, it does seem, and this is something that came up with FTX and Alameda clearly, but it does seem so incestuous the entire industry. I wanted to ask you specifically about Celsius as well, what the relationship was between FTX and Celsius. And also just generally, how much of crypto is just collateralized by more crypto?

because Tether is sort of the ultimate collateral in the ecosystem, and you do get a sense that there is a lot of leverage built on that foundation. You asked about the relationship between FTX and Celsius. I'm going to start the relationship between Tether and Celsius. So Tether was the lead investor in Celsius's series A round. According to the lawsuit by Jason Stone, one of the former traders at Celsius, Tether's loan to Celsius in 2020 was effectively a bailout to allow Celsius to continue operating. And we know that Tether continued to have these secured loans that they extended to Celsius as they went.

Celsius's exposure to FTCS in Alameda has been a little bit more challenging to figure out, especially with Mishinsky's tweets the last couple days trying to muddy the water. But it was clear that Alameda research was lending from Celsius and they were trading together. but the full extent of the relationship is not entirely clear. Now, as to how much of the industry is like crypto collateralized loans, loans to related party, and things like that, I think it is quite large. And that tweet you were talking about it was from a conversation from a couple of years ago. And what we were talking about at that time was crypto capital core, the payments processor for BitFinex, Tether, Quadriga CX, and then they also provided services for several other exchanges, Crackin, BitMax, etc. And we were talking about them because the directors for that,

even Manuel Molina Lee, Oz, Yosef, and the rest were directors for a ton of other small companies around the world, including like nominally mining companies, resource companies, and these other things, but they all primarily existed to provide banking to cryptocurrency companies. And so we were talking about when in that conversation the people who made the tweet about how all of these different things that were providing payment services to all of these different cryptocurrency exchanges were, these couple of individuals around the world who were just starting up tons of different companies and trying to get access to bank accounts for them. And I think we've now seen, moving back to your question about like crypto collateralized stuff, we saw the FTT collateralized loans. We've seen a variety of

other crypto collateralized loans. And we've even seen a ton of large lending deaths, including ones like BlockFi, who are claiming not to do unsecured lending. We're doing large amounts of unsecured lending as well, not even crypto collateralized, just giving out money, right? And so I think that it is quite likely, and I think we're going to continue to see as this FTCS bankruptcy progresses, that a lot of entities were doing this kind of lending and had various exposures that would seem atypical or surprising to people in the traditional finance industry. Speaking of the web, the web, everyone connected. What's the deal with this tiny bank that, like, FTX, I bought a stake in, in, like, I think Washington State that had, like, three employees, the New York Times reported on it? What's that all about? And I think there's a tether connection there?

Yeah, so that is Farmington State Bank in Washington. And Protost was actually able to get an interview with Hanover Shalupin, the chief digital officer of that bank, where we got some additional context on this. So as of a couple of years ago, it was an incredibly small bank, like $10 million total in deposits, putting off a total of like $60K in revenue per year, had a few dozen accounts, three employees,

tiny little branch, like one of the 30 smallest banks in America. And that was true until the head of Deltech Bank and Trust in the Bahamas. The bank I already mentioned was banking tether, and Alameda Research went out and decided, sorry, they didn't go out. They've been very careful to say they didn't go out, so I should be careful as well. The chairman of their bank went out with no connection to the bank he's a chairman of and decided he wanted to purchase a U.S. bank for no reason that had anything to do with his bank in the Bahamas. And he found this bank in Washington again with nothing to do with his bank in the Bahamas and was able to get $11.5 million from Alameda research to go out and buy this bank.

They were giving it like a post-money valuation of like $120 million and $10 million in deposits, which is an absurd bank valuation. But continuing, they rename it Moonstone Bank and Trust, according to Han Vieer, because they wanted to bank cryptocurrency assets which were going to the moon and cannabis assets, which, as we all know, are great for getting you stone. their entry into the I didn't know that about the stone part Oh yes

Is that really why the second half So the moon is crypto and the stone is cannabis? Yes Oh my gosh Oh my gosh That's so good I just got that Yeah I'm glad I didn't

I'm glad I stopped and paused there Because that is a great detail That I wouldn't have wanted anyone to miss Okay the moon stone Okay sorry that's good though And so then they get four new accounts Their deposits go from like 10 million to 30 million with these four new accounts,

and they were able to get Federal Reserve approval, start using Fedwire and things like that. And this tiny little bank in Washington got this investment from Alameda Research and suddenly became much, much larger. First of all, can I just say it's incredibly impressive the way you are able to keep this very, very complicated web of relationships and names in your head

because I certainly wouldn't be able to do it. But Bennett, I just wanted to ask a really obvious question, and I suspect I know the answer, but I think it's kind of important to touch upon. But who regulates tether, if anyone? Well, I mean, they have one money transmitter license in the United States to an old Taiwanese entity that they don't really use anymore. So, FinCent, right? but more seriously, there is no like single regulator overseeing tether's operations. There's, I think, a variety that could try to make a claim that they have jurisdiction over tether, but they're going to have to probably do that via enforcement actions.

It's a British Virgin Islands and a Hong Kong domiciled company. So nominally, the British Virgin Islands regulators and the Hong Kong regulators might have a claim over it. Part of the challenge with any of these cryptocurrency companies is that they are very deliberately set up with the goal of avoiding regulators in most regulatory tactics. They pick locations where they think they can gain regulator approval or avoid regulator ire. And then they try to structure their operations and even their executives in a way where it's going to be challenging for countries with more active regulators to pursue them or to stop them from doing what they want. I want to just go back to the question that Tracy asked because I still feel like I think there's a lot of hair on tether, so to speak, all these like questions, et cetera. I get why in the beginning maybe, you know, various entities used tether to trade and it did

the job and maybe they had an interest in seeing tether's success due to other equity exposures that they may have had. But today in 2022, given the sort of relative, of transparency. Given the perceived level of scrutiny that faces tether, why do you think there's still so much demand for using it both as a money transfer device between exchanges, as a base pair for trading? Like, where is the demand coming from today? Well, I mean, I think first we should be very clear that it seems like the demand for tether has plummeted over the last several years. Like if you look at the relative stable coin dominance from like April 2019 when the New York attorney, filed their injunction. And 2022 now, Tether's dominance has vastly decreased among stable coins, right? And if we look at the like broader defy area, we often see Tether being priced at a discount or valued at a discount to other stable coins. MakerDAO won't even use Tether as collateral for a lot of their things, right? And you see that across some other lending protocols and things

like that where Tether will be priced materially different than USDC. There has been a certain repricing of tether risk over the last several years. I think just broadly, it is an old instrument that's existed for a long time. And that one of the more recent things that really drove tether's growth before BUSD and before Binance across collateral was that like when Binance launched their collateralized futures products, the easiest way to collateralize those was with tethers. And so there was this massive increase in the issuance of tethers from these firms like Alameda Research in Cumberland Global, and these that wanted to trade futures on Binance and needed to collateralize those positions. And so because Binance chose Tether for that, you saw this massive increase in the number of Tethers issued during that period,

so these firms would be able to trade that product. Once Binance switched to cross-asset collateralization and started favoring BUSD and stuff for those assets, we started to see a lot of the dominance in position for Tether and those markets start to decrease. So why is Tether still used? Because it's been used for a long time. There's a lot of them out there. And Tether's perceived position in the industry, especially outside of the United States, is that they have been around for a long time. And some even see their ability to survive a New York Attorney General investigation and a CFTC investigation and continue operating as proof that there must not have been anything so objectively criminal that those organizations wouldn't choose to try to get them shut down.

You know, you mentioned the fact that for most of its history it's been able to. maintain the one-to-one peg with the dollar as another, you know, sort of selling point for people in the crypto ecosystem. I guess my question is, like, what would be the thing that would prompt the peg to start to fall apart? Because as we mentioned in the intro, we have seen it dip below one at various times in history, notably during the spring crypto blowup when Terra Luna collapsed and recently in November with FTX. But it hasn't really dropped to the extent that I think a lot of critics of Tether might have expected it to. Yeah. So when Tether is below a dollar, those who are able to redeem Tethers should be redeeming Tethers. It's free money that's sitting out there, right? If you can buy it up for less than $0.99.9 cents and give it back to Tether for $0.99.9 cents, you're making easy money in that trade.

And that's what we've seen a lot of firms do. During the terra-depegging, Alameda research was very actively arbitraging the tether peg, buying up tethers and sending them back to the treasury, presumably, to redeem and make that easy money. If one of those firms that does the arbitrage sends it back to tether and the process is even more abnormally messy than Sam Bankman-Fried would normally claim it is, then they may decide that whatever money they're going to be. making from that arbitrage is no longer worth trying to make. And when those firms decide that and they stop trying to arbitrage the peg, then whatever is causing it to deviate continues to deviate.

The fact that we've seen it return suggests that there are entities that have been able to buy up and redeem tethers and make that trade. What would cause it to break would be something that makes that no longer true, where people are trying to extract that value and are not receiving it in turn. part of the strange dynamic for me with tether that makes this a more complicated question is that its supply dynamics don't necessarily match what we would expect. Like it doesn't seem to expand and contract in time with the rest of the cryptocurrency industry. Yeah, this is why I was asking you about the sort of outstanding number of tethers before. But go ahead.

Yeah, and this is, yeah. And so like we see tether for a long time, it basically just monotonically increased with like, one brief decrease. And we've seen more redemptions now than we have historically, but still generally tethered tends to be slower to start decreasing in market cap than the other stable coins. And the reason for this has not been entirely clear. For a while, it looked like the explanation was that many tethers were destined for purchasers and entities who were not likely to redeem. So for a long time, there was an active demand for tethers in, like, the Chinese over-the-counter trading market or for Chinese Bitcoin miners and things like that. And many of these entities preferred having the tethers because of the ease of transacting them than the corresponding dollars.

And the relative risk of tethers was, like, acceptable for their purposes. And this seems to have been a pretty important, like, sync for tethers. We see this in, like, the decrypt reporting on the babble. finance blow up where supposedly in a manner very similar to the Celsius bailout, Tether stepped in and bailed out the bailed out Babel finance, right? Now it's a little bit less clear to me why we don't see Tether expand and contract in quite the way we expect. And I think that's part of the challenge in figuring out why Tether doesn't lose its peg in the way people expect. I think there are people for whom Tethers are worth more than the dollar backing them because of

some additional convenience they provide, and that some of these people who are interested in these tethers are people who are unlikely to redeem them. So because there's this kind of demand sink for tethers, these tethers that go out, but that are unlikely to ever come back in, there's a little bit of a cushion in tether's operations that make it easier for them to handle the remaining entities who are the larger cryptocurrency market-making funds and quantitative trading funds who are actively redeeming, issuing, and transacting in these instruments. So I just want to sort of reiterate this point because I think it's really important. If you have Tether or USDT, you can redeem it directly with Tether itself. But I believe you have to set up an account

and there's like a minimum of 100,000 worth of tokens or something like that in order to transact directly. So what most people would do is you would go into the secondary market and just say, there. And in the secondary market, the peg is maintained through, you know, basically market makers who kind of operate like exchange traded funds would, where if there is an arbitrage opportunity, if Tether is trading below the $1 peg, they would go in and sort of arbitrage that and make money in order to keep it close to that peg. So what you're saying is if the market makers are no longer able to fulfill that capacity, if there have, having balance sheet issues, if they're risk averse, that kind of thing, then that could be

what would trigger a substantial depegging event for tether. Yeah, basically. And I think part of that is like when Sam Bankman Fried came on here, he talked about how the process of redeeming tethers was sometimes messy. And like, that's not generally or necessarily what you would expect for this. You would expect that Alameda research sends the tethers back to the tether treasury and tether from their bank account wires Alameda Research the corresponding number of dollars, right? That doesn't seem like it should ever be a messy process, but we know from one of the largest

tether issuers and redeemers that it was. And so whatever is causing that messiness in the process is the thing that I would expect might someday cause it so that one of the firms that does the arbitrage will blink and choose to stop doing it. Bennett, I think we could go on for a pretty long time. because this is like a fascinating conversation, and your knowledge of the detail is great. But I think that is also a great place to stop it.

So thank you so much for coming on Apple. Thanks for having me. That was really great, Bennett. Thanks so much, Bennett. That was amazing. Tracy, I thought that was really fantastic. And again, you know, this sort of the web and the degree of like interconnectedness among,

and we only looked at a slice, but it really is striking the degree to which every entity seems to have some sort of relationship with every other entity in crypto. Totally. I kept getting, what's that meme of the guy and he's like standing in front of like a board? I think it might be from it's always sunny. Yes, it's always sunny in Philadelphia. I think that's it.

And he looks kind of crazy, but he's on to something. Like that's, yeah, I kept getting images of that in my head. You know, one of the, I guess, again, fun. One of the interesting things about crypto is, Because so much of it happens on chain, it does seem like there is this role for like the sort of like crazy internet detective to sort of like, this is Tethers wallet. This is Elamita's wallet. This is FTX. And you can sort of do it for real because like people have always been trying to do that.

But in crypto, you actually can legitimately do that to some extent. Totally. Or you can also just point out the obviously insane things like naming your bank Moonstone. I love that detail. It was going to the moon and you can use it to get stoned. That's nuts. Yeah. But the other thing, I mean, I thought Bennett's explanation of the whole thing was

fantastically impressive. In particular, the way he laid out the sort of relationship between the market makers slash arbitrages and the messy process and this idea that, well, in theory, it really shouldn't be this messy, but it is in practice, which kind of suggests or points to future vulnerabilities, you would think. But that said, I also think, you know, just going back to this idea of why Tether has so far proven relatively resilient, like, I also think there is this overarching theme of illiquidity, right? And if people just like aren't transacting with it as much, then it can stay at one for far longer than you might expect. And this idea that, you know, there's a lot of

interesting stuff on that question too, because like even if you were to take the attestation at face value, you know, like a lot of assets have declined a lot in value, including treasuries and including like anything that has any sort of credit element over the last year. Chinese commercial paper? I mean, like... Everything is sort of weird there, but to then Bennett's point, maybe there's some tethers out there that will never be redeemed and that creates some sort of buffer. I don't know. It's very interesting. You know, another thing is that like, and that sort of makes it makes the persistence of Tether as this important vehicle.

I mean, he mentioned that Tether's dominance within DFI or within Crypto has gone down. It's still bigger than USDC by a substantial margin, according to the coin market cap, $65 billion versus $43 billion. So it's still, I mean, it's still really big. But, you know, there's also all this. Everyone knows like there's all this scrutiny over it and they have been sued, et cetera. So the persistence of Tether is still just like in itself like a fascinating story. Absolutely. So I guess we will see how long it goes on for.

We'll see how long it's there. Shall we leave it there? Let's leave it there. All right. This has been another episode of the All Thoughts podcast. I'm Tracy Allaway. You can follow me on Twitter at Tracy Allaway. And I'm Joe Wisenthall. You can follow me on Twitter at The Stallwart. Follow our guest, Bennett Tomlin. He's at Bennett Tomlin. Follow our producer, Carmen Rodriguez, at Carmen Armin, as well as Dash Bennett.

at Dashbot and check out all of the podcasts at Bloomberg under the handle at Podcasts and some other housekeeping. We're going to be doing an AMA episode where you, the listener, can ask me and Tracy questions. So if you want to be included in the episode, if you want to hear your voice on the Odd Lots podcast, record a voice memo, ask us a question about literally anything and send it to Odd Lots at Bloomberg.net. Please include your name and location and we'll try to answer your question. And for more Odd Lots, content, go to Bloomberg.com slash oddlots where you can find transcripts, Tracy and I blog, and we have a newsletter that you can subscribe to where we talk about these topics each week.

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