The story behind Tether: Crypto's unbreakable native bank

Original Title: 《Inside Tether, Crypto's (So Far) Unbreakable Buck》

Written by: Steven Ehrlich, Nina Bambysheva

Translated by: SevenUpDAO

On Monday, November 7, 2022, Tether executives received an unusual call from Sam Bankman-Fried, the CEO of long-time business partner FTX.

Bankman-Fried, a young, disheveled cryptocurrency executive, had amassed a personal fortune of $26.5 billion riding the cryptocurrency wave, which sounded enviable. Just five days earlier, a trade media report revealed that the highly leveraged balance sheet of his trading firm Alameda Research was backed by approximately $5 billion worth of tokens issued by Bankman-Fried, known as FTT. FTX and Alameda were major clients of Tether. To date, Bankman-Fried had minted $36 billion worth of the dollar-pegged stablecoin USDT, nearly half of the total supply created.

"He reached out to us seeking financial help," Ardoino said. "He didn’t disclose details or how much he needed, but we flatly refused."

Ardoino said the request felt off, and the refusal was an easy decision. "He suddenly asked for something he had never asked for before, and it wasn’t $10 million. The way he spoke indicated he had a big problem. His request was in the billions."

Tether's Chief Technology Officer Paolo Ardoino stated, "Everyone sees Tether as two Italians who can’t do anything right."

Despite Tether's proven resilience in the market so far, the stablecoin provider has yet to gain trust outside of cryptocurrency. Over the years, it has faced various accusations, from market manipulation and funneling customer funds into personal accounts of its executives to propping up Bitcoin prices. In 2021, the Commodity Futures Trading Commission and the New York Attorney General forced Tether to pay fines of $41 million and $18.5 million, respectively, for falsely claiming that, among other things, USDT was backed one-to-one by the dollar.

The company has never undergone an audit and has refused to disclose the exact composition of its collateral, which includes crypto tokens, loans, and other illiquid investments. In contrast, its closest competitor, USD Coin, operated by Boston-based Circle Financial, has published specific government bonds, CUSIPs, and maturity dates backing its $45 billion digital dollars.

However, if crypto survives the current harsh winter, its main liquidity provider, Tether, must grow up. That’s why Tether recently launched a campaign to clean up its image. Long accused of filling its balance sheet with questionable commercial paper, in June 2022, it pledged to eliminate all assets that were once valued at $30 billion from its reserves, redirecting most of it into U.S. Treasury bills and other cash equivalents. Then in August, it hired one of the top five accounting firms, BDO, aiming for a comprehensive audit. Last Tuesday, the company announced it would stop lending USDT by the end of 2023—its loans accounted for 9% of its assets.

Is this enough to silence critics who are increasingly uneasy about the loose stablecoin provider after the FTX collapse?

"Generally, stable and always stable are different," said Michael Hsu, the currency agent auditor. "Federal Reserve currency and central bank currency are always stable. If you belong to the category of always stable, you don’t have to publicly defend yourself."

Turbulent Times for Tether

In the weeks leading up to that desperate call, FTT plummeted from $26 to less than $2, evaporating about $3 billion in market value. FTX and Alameda were on the verge of filing for bankruptcy, and on December 12, Bankman-Fried was arrested and charged with eight counts of money laundering and fraud.

For Tether, the controversial company behind the $66 billion stablecoin USDT, which is used in over 50% of global Bitcoin transactions, Bankman-Fried's downfall was a mixed blessing.

FTX was Tether's largest client, but unlike Bankman-Fried, who cultivated media relationships and mingled with politicians, Tether has staunchly resisted regulatory scrutiny and has long been a source of media disdain.

Yet in the tumultuous year of 2022 for cryptocurrency, Tether held its ground. In May, when the then third-largest stablecoin TerraUSD and its sister token LUNA (with a market cap of $45 billion) suddenly collapsed, Tether faced $16 billion in redemptions from panicked crypto investors. Although USDT dipped to a low of 95 cents during the panic sell-off, it met redemptions and rebounded to its full value within a week. During the recent FTX collapse, approximately $3 billion in redemptions poured in within days, but Tether hardly missed a beat. All redemptions were honored at a 1:1 dollar value.

Tether's Leadership

In fact, stablecoins like Tether are essential on any chain, highlighting the evident weaknesses of Bitcoin and other cryptocurrencies. More than a decade later, the original cryptocurrency remains highly volatile. In just the past 18 months, Bitcoin's price has twice approached $70,000, only to fall back over 65% to a recent $17,000. Daily price fluctuations of 5% or more are not unheard of.

The invention of stablecoins was meant to address this issue, while cryptocurrency investors have long faced another problem. Most cryptocurrency exchanges, especially those located overseas, are avoided by banks, making it difficult, if not impossible, to conduct business in dollars and other fiat currencies. Stablecoins survive and move across various blockchains, like Bitcoin, avoiding central bank control. For USDT, which exists solely in digital form, it is pegged to the dollar.

If the existence of stablecoins outside the global banking system makes you uneasy, consider that the world's leading stablecoin provider, Tether, is run by a group of shadowy figures.

Its Chief Technology Officer, Paolo Ardoino, is Tether's spokesperson. All media information about Tether goes through him. According to sources familiar with its finances, Tether's Chief Financial Officer Giancarlo Devasini is the company's controlling shareholder, estimated to own 40% of Tether's parent company, DigFinex, which also owns the cryptocurrency exchange Bitfinex.

According to the official biography on the Bitfinex website, Devasini, 58, born in Turin, Italy, is a successful pioneer in the semiconductor market, with his business's annual revenue growing to €113 million before he sold it just before the 2008 financial crisis. However, a Financial Times investigation in July 2021 found that Devasini's business empire had only generated €12 million in sales in 2007 and entered liquidation in June of the following year. Additionally, a company called Acme, owned by Devasini, was the subject of a patent infringement lawsuit filed by Toshiba regarding DVD format specifications. (Tether stated that the lawsuit is baseless and has not resulted in any adverse conclusions.)

Many sources claim that Devasini, who once studied to become a doctor, is the architect of Tether and played a direct role in "minting" Tether's digital tokens for major clients like Alameda. Devasini's exact whereabouts are unclear, with various sources stating he is located everywhere from the African island nation of São Tomé and Príncipe to the Bahamas, Italy, and the French Riviera.

Tether's CEO is Dutchman Jan Ludovicus van der Velde. According to sources familiar with Tether's finances, he owns 20% of the merged entity and resides in Hong Kong. He also avoids interviews and stays behind the scenes.

If Devasini operates behind the scenes for Tether and Bitfinex, which are registered in the Virgin Islands, van der Velde appears more like a figurehead responsible for maintaining high-level strategic relationships with banks and regulators. According to Ardoino, van der Velde has traveled to Europol multiple times since the pandemic to explain how Tether operates. Van der Velde also helped the company obtain a digital securities issuance license in Kazakhstan and is leading efforts to secure new banking relationships in Europe and Turkey.

In addition to shared ownership, Tether and Bitfinex also have the same CEO, CFO, CTO, and General Counsel. The Chief Operating Officer of Bitfinex is actually Ardoino's wife, although she is not listed as a shareholder in documents seen by Forbes. Tether has about 50 employees, while the exchange Bitfinex has 200.

Tether's Business and Reserves

There are two ways to obtain Tether, known in crypto terms as USDT. It can be purchased on any of the hundreds of cryptocurrency exchanges listing digital assets worldwide, or it can be minted directly from Tether itself using smart contracts that it controls, running on multiple different blockchains. The latter method is reserved for high-stakes transactions, with a minimum minting of $100,000 USDT per transaction. Devasini is said to be involved in these large transactions, such as when Sam Bankman-Fried personally called to mint a large amount of USDT for Alameda. Sometimes the issuance amounts to as much as $500 million.

Such business can be very profitable. On the revenue side, the minting and redemption of USDT are significant profit centers for the company. A fee of 0.1% is charged for each transaction. Forbes estimates that since its inception in 2014, Tether has generated no less than $109 million in fee income, most of which came in the last two years when its market cap soared from $5 million in May 2022 to over $84 billion.

But the real money comes from how Tether invests the billions it receives from minting USDT. In theory, Tether should only accept customer funds and store them in cash and government bonds to fulfill its promise of a 1:1 backing with the dollar. However, Forbes found that Tether began creating models to diversify its reserve assets as early as 2015.

Why does Tether need to invest in risk assets beyond U.S. Treasury and money market funds? Ardoino stated that Tether is obligated to be profitable to obtain certain licenses. "One of the most important things for our company, and one of the distinctions between us and Circle (the issuer of USDC), is ensuring the business model remains profitable," Ardoino said, expecting the stablecoin company to generate excess profits of $600 million this year. In the third quarter of 2022, Circle, which has the motto "transparent and stable," reported a profit of $43 million and revenue of $274 million—its first since its founding in 2018.

Like other stablecoins, the largest portion of Tether's reserves has always been "cash and cash equivalents, as well as other short-term deposits and commercial paper." According to its current reserve breakdown, 82.45% of its assets are cash and cash equivalents, with 70% in Treasury bills. The remaining 17.5% is invested in various higher-risk assets, including secured loans, which Tether has long been reluctant to disclose details about.

Tether has never undergone a final audit of its $66 billion reserves, and its website only lists so-called attestations, which are merely snapshots without any accounting firm actually tracking the flow of funds or conducting any serious due diligence.

According to sources familiar with Tether's operations, some of its counterparties include crypto trading firms Jump Crypto and Cumberland/DRW. Additionally, the company provided a loan of $841 million to the now-bankrupt cryptocurrency lender Celsius, secured by Bitcoin. Ardoino stated that Celsius's loan has been fully repaid. The company did not specify whether other counterparties are affiliates.

In a recent Wall Street Journal article, a company spokesperson stated that Tether itself holds all collateral for its outstanding loans.

Other portions of Tether's assets (about 4%) are invested in tokens and equity of private crypto companies like Blockstream, Dusk Network, and Renrenbit. It has also invested in ShapeShift, OWNR Wallet, STOKR, LN Wallet, and Exordium Limited. Given that the total market capitalization of cryptocurrency has dropped by 63% this year, these assets are likely to be severely impacted.

Tether's Goals

Although Tether is taking steps to become more transparent, Ardoino believes that no matter what the company does, it will never satisfy its critics.

"Genesis recently stopped withdrawals. Voyager is a public company, and then you have Celsius and BlockFi, which are giants praised by all sides. Three Arrows, seen as perfect traders," Ardoino said. "Everyone is always better than Tether."

Surprisingly, Ardoino pointed out that Tether's $18.5 million settlement with the New York Attorney General's office in 2019 proves his company's resilience. In that case, Tether secretly used its customers' collateral to provide an emergency loan of $850 million to its sister company Bitfinex, as the cryptocurrency exchange's bank, Crypto Capital in Panama, had its own funds seized by government regulators. In response, Tether stated at the time, "This loan was to ensure the continuity of Bitfinex's customers. It has been fully repaid in advance, including interest. This loan never affected Tether's ability to handle redemptions."

"It's good that people ask questions," Ardoino said, "but the fact that we keep proving ourselves wrong and changing the goalposts means to me that there are ulterior motives."

Meanwhile, Ardoino does not lose sleep over how to meet others' expectations of how Tether should operate or disclose information. Tether has no plans to become a publicly traded company and does not expect any changes to its management structure.

Ardoino, Devasini, and van der Velde are more concerned about the state of the entire cryptocurrency market, of which Tether is a major liquidity provider. Stablecoins are crucial for active traders, but the crypto winter has seen Tether's market cap drop by over 25%. Now, significantly higher interest rates provide traders with numerous alternatives outside of cryptocurrency and DeFi, exacerbating the situation. The yield on USDT at major cryptocurrency exchanges currently averages 2%.

If crypto technology rebounds, Tether is likely to see other competitors vying for its position. In addition to already holding a 29.8% market share and favored by Wall Street firms like BlackRock and BNY Mellon, major exchange Binance has also created its own stablecoin, BUSD. Then there is the possibility that at some point, a large bank or central bank insured by the FDIC will offer a digital dollar.

"We do not intend to remain the largest stablecoin in the market forever. If JPMorgan decides to create their JPUSD or anything else tomorrow, they will be bigger than us in two seconds," Ardoino said. "What matters to us is that our product is being used by people in emerging markets and developing countries. They are the ones who truly need access to dollars."