Tether: Maybe Everyone Is (Partially) Telling The Truth

Lots of things about Tether are controversial.  A few things about Tether aren't:

1. That it is controversial.
2. Issued during holidays & weekends.
3. Issued in round amounts.
4. The disclosures are non-standard and not maximally transparent.
5. Tether uses some smaller offshore banks and there are reasonable questions about exactly what is going on.

Background

The original Tether design was for a currency board setup.  Setting aside what was really happening or what is now claimed: a currency board is simple.  There are myriad examples of these and similar arrangements around the world.  And we know what makes them work: a transparent and credible monetary authority that continually discloses adequate reserves.  Among countries currently operating credible regimes similar to this are Denmark, Hong Kong and The Bahamas.  Yes, The Bahamas, where Tether's bank sits.  The Bahamas has a currency that is pegged to the USD.

The Bahamas discloses the composition of foreign reserves including USD cash and government securities.  Denmark and HK do something similar (and more frequently).

Whatever is really going on this all could have been much simpler if someone just asked the Central Bank of The Bahamas for a meeting to explain how a currency board works.  Google maps tells me it's a 27 minute drive from the Deltec head office.  That's quite far on Nassau.  The Central Bank is on Market Street in the financial district while Deltec is, somewhat famously, in a more residential part of the island.  Anyway it's a small island.

Deltec's Accounts

We know Tether uses Deltec.  We know Deltec has various currency accounts around the world including, at least at one time, Citibank in the UK.  There are settlement instructions floating all over the web for various cryptocurrency-related businesses going through those accounts such as this.  Whatever is going on there -- that is not how a "correspondent bank" works -- Deltec has various foreign currency accounts around the world.

Normal accounting for these accounts would consolidate them onto Deltec's balance sheet and they would show up in any reporting that aggregates bank balance sheets including Deltec.  The accounts are clearly in the name of the Bahamanian entity.  Maybe there is some unknown Deltec Bank UK related entity and the assets don't roll up to the Bahamas.  Who knows.  Anyway Deltec has hard currency in accounts with other banks.

One imagines Deltec itself runs USD and other accounts internally.  Those wire instructions include a comment "23336 Deltec FFC Alameda" which is likely intended to route the payments to the correct internal account.

This leaves us with two choices:

1. Deltec comingles all client assets in it's own external bank accounts and tracks the split somewhere (Excel?).
2. Deltec runs foreign currency accounts internally.

Scenario 1 is just ridiculous (and quite Madoff-esque).  Let's go with 2.  This somewhat contradicts this podcast interview but then the very existence of non-GBP accounts at Citibank UK contradicts that discussion.  Let's call that a good faith misunderstanding and assume Deltec holds normal corporate bank accounts with normal banks in major money centers.

Tether's Accounts

When Tether says they have an account at Deltec the assumption is an account of type 2 as described above.  This is 100% normal stuff.  Per the currency board discussion above the simplest thing to do is to provide frequent disclosure of the balance of that account.  For reference the HKMA publishes pretty much exactly that information here every day and for many years.  Whatever is happening in HK now that report has been around and trusted "forever."

Various entities in the cryptocurrency world claim they can send USD to Tether to create USDT.  One imagines what they mean is transferring into these accounts, having them moved over to Tether's Deltec internal account, and then receiving tokens.  This Twitter thread suggests this is exactly right.  Let's not worry which banks they are, or that "correspondent bank" is an abuse of notation here, and just go with this flow of funds.

This would explain issuance on weekends.  Citibank UK doesn't process USD wires on weekends.  But it does allow some forms of internal transfer on weekends and holidays.  What if Deltec is just doing the same thing?  Deltec can surely shuffle it's internal records to transfer USD among its clients on weekends so long as Deltec's office is open.  These are just journal entries in an internal system.  FTX wants some USDT so it instructs Deltec to transfer USD to the Tether account and get some USDT out.  This is 100% normal.

A Theory

If this was the entire story it would be trivial to produce a series of bank account statements and transfer records and put this to bed.  Let's assume there is more to the story than some pretty epic trolling.  What if instead sometimes:

1. A client takes out a USD loan from Deltec
2. Deltec credits their account and records a corresponding asset for the loan
3. The client transfers those USD to the Tether account
4. Client receives USDT

USDT are not "unbacked" from Tether's perspective.  Tether's USD bank account has the right balance.  But it is funded by the USD loan from another Deltec client.  Deltec's net USD assets don't change here and consequently any reporting they roll into would be unchanged.  These USD wouldn't show up in aggregate Bahamas reporting because the net asset impact is 0.

In this scenario Tether is telling the truth -- they got USD before any USDT issuance.  Deltec and the auditors are also telling the truth as USD are in their account.

But what are those USD really worth?  Deltec's balance sheet has that deposit as a liability with the USD loan as the corresponding asset.  The backing, in practice, is a loan to some other cryptocurrency business.  It might even be a collateralised loan (BTC, shares, whatever).

Implications If Right

These gigantic USD deposits -- USDT is over 50B as of this writing -- are unsecured liabilities of a small offshore bank.  There is a world of difference between having 50B in a UST money market fund, JPM NY or a small offshore bank.

What we have here looks a lot like the 2008 money market fund crisis.  Everyone involved is marking these USD at par.  But there is essentially 0 chance Deltec can send an outgoing wire for all of this money to the traditional banking system.  Deltec's net USD assets are unchanged by this operation: they are the same before step 1 and after step 4.  Properly marked the USDT are worth whatever the loan is.  This is likely well below par.

We are wholly ignorant of the Bahamanian banking rules.  But it's a reasonable working assumption that if Deltec is a privately owned bank without any domestic presence they can do pretty much whatever they want.  That's what offshore financial centers do and the shareholders are supposed to police this.

It is likely the median Bitcoin Maximalist thinks this is exactly how fiat currency works: banks just make it up and credit their clients.

But trying to redeem the USDT poses a problem.  There is little chance the borrower in step 1 has the cash.  And even if the loan is collateralised it seems pretty unlikely the collateral can be quickly turned into cash at par.

Terminology

If the loans are uncollateralised any end-user redemptions require a fresh injection of USD.  They are "tak[ing] money from new investors to satisfy the [liquidity] requirements of the existing investors.  There is a name for that." From 9:30 in a talk everyone should watch.

If the loans are inadequately collateralised this is an accounting issue.  Watch the rest of the linked talk.

In either of those cases Deltec is balance sheet insolvent.  Were it operating in a regulated space it would be shut down.

If the loans are adequately collateralised all is fine.  Deltec may have a bit of a maturity mismatch but it's a bank so that isn't shocking.  If it was regulated maybe there would be a capital raise or something.

Maybe Nobody Is Lying

To the extent there is any issue in this scneario it's an accounting problem.  And maybe a future liquidity problem.

It is entirely believable the entities involved have clear audit opinions and approved accounting policies that permit these activities.

There are obvious-but-confusing inconsistencies all over the Tether-Deltec story.  Wouldn't it be supremely ironic if the real story was simply a case of turbo-charged fiat financial engineering.