The Truth About Tether: Conspiracy Theories Debunked

If recent events have taught us anything, it is that incorrect assertions can be made in the media with minimal legal repercussions — but with an outsized effect. Libel laws may exist, but applying courts of law to the court of public opinion is a costly and unreliable means of promoting truth. No matter one’s affiliation, it is impossible to deny the upsurgence of dubious stories regularly flooding our televisions and news-feeds. These claims are rarely supported by evidence, but the facts often seem not to matter. In our current age of spin, headlines and narratives can be crafted in such a way that their persuasive effect cannot be countered by facts alone — however true those facts may be. It may be uncomfortable to admit, but rationality is no match for a compelling narrative. Human storytelling long predates our modern human rationality, making our receptiveness to good stories a far more deeply-rooted trait than our ability to reason based on facts. Good stories can be more persuasive than good arguments. This is what makes conspiracy theories so seductive.

Once a story has been expertly crafted to achieve a certain persuasive effect, logic alone cannot reverse it. Once we believe something, we are resistant to change. This cognitive “first-mover” advantage makes it much easier to create false beliefs than to correct them. Good stories are powerful because they alter how we perceive and interpret new information. Known as “confirmation bias”, humans tend to search for, interpret, and recall information in a way that confirms or supports our prior beliefs. But whether we will admit it or not, our beliefs are primarily formed by narratives — not strict rationality. Once a good story has permeated our consciousness, we tend to interpret any new information from that story’s vantage point rather than through our own reason-based assessment. Taken to an extreme, this explains why some people still believe that the earth is flat, despite overwhelming evidence to the contrary.

The digital asset space has its own “Flat Earthers”: those who believe that Tether, the world-leading stablecoin, is engaged in a variety of complex and nefarious schemes that are intended to defraud the broader industry. Here are the top five Tether conspiracy theories:

#1: The Bit Short Accusations

Of the many Tether conspiracy theories, the recent “Bit Short” accusations are the most imaginative. Published on January 14th, this 22-minute read is cloaked in the format of a personal story. Frequently deployed in both advertising and political campaigns, personal stories are among the most powerful forms of persuasion. But unlike reason or science, personal stories require neither a factual basis nor peer review to be deeply persuasive. Even when crafted for a specific private purpose, personal stories carry an air of authenticity that will disarm a reader. The writer feels like a friend — someone inherently trustworthy. This is “weapons-grade” persuasion.

The anonymous writer begins by detailing their well-timed bitcoin trade (we rarely hear about poorly timed trades), before explaining how a series of revelations concerning Tether caused them to liquidate their position at a 600% gain. The plot is familiar, but what makes these claims new is that they reflect such an astonishingly poor understanding of bitcoin markets that only one conclusion can be drawn: the arguments were not intended for a knowledgeable audience. However, notwithstanding the author’s unknowable private purpose, these accusations are a testament to both the author’s imagination and the power of confirmation bias. Predictably, the author (1) admits that they were moved by a story, and then (2) goes on to search for, interpret, and recall information in a manner that confirms prior beliefs. Here are a few examples:

First, the author claims to have invested in Bitcoin in March 2020, but carried a belief into 2021 that Tether had been “purged from crypto markets’’. But Tether’s long-standing role as the sector’s dominant medium-of-exchange would have been obvious to even the most casual observer — let alone someone who secured “life-changing” gains. Tether is a simple product: it is a dollar-denominated digital asset that facilitates cheaper and faster transfers of value, particularly across borders. The clear advantages relative to fiat are such that it makes perfect sense for Tether to account for an outsized portion of digital asset trading activity.

Second, based on a conversation with “Bob”, the author takes issue — even injecting the drama of “gasping audibly” — with the fact that some digital asset exchanges accept neither US dollars nor US-based customers. The author characterizes this moment as an epiphany, likening it to a scene from “The Big Short” where an exotic dancer’s personal story confirms the protagonist’s investment thesis. But this comparison to a movie is merely a part of the narrative we are being told. While these situations have nothing in common, it is quite normal for a person to think of themselves as the hero from a movie. Once again, there is an obvious and less-scandalous explanation: as part of a wholesale de-risking, major banks have been deeply reluctant to serve digital asset exchanges. America’s sprawling financial regulatory environment is among the least friendly to digital asset enterprises. This is no secret. Quite the opposite: it has been thoroughly documented.

Third, getting to the meat of the conspiracy theory, the author claims that “preventing USD and Tether from meeting on a transparent market is crucial for ensuring that the true price of Tether stays opaque — making it hard for an outsider to dispute its $1 peg.” For the author, only US-based exchanges qualify as “transparent markets”. But since Kraken — a regulated American exchange — offers Tether trading pairs, the author needed an explanation that would keep the fraud story consistent. Enter “The Big Lie”:

“…whenever someone sells Tether for USD on Kraken, Tether Ltd. has no choice but to buy it — to do otherwise would risk letting the peg slip, and unmask the whole charade. My guess is that maintaining the Tether peg on Kraken represents the single biggest ongoing capital expense of this entire fraud.”

This theory reflects zero understanding of financial markets and the extent to which their connected nature facilitates arbitrage-based price discovery. But it fits the story. Whether they are demonizing leverage or extolling the virtues of illiquid markets (crazy!), this anonymous start-up founder consistently displays what can only be described as a child-like view of finance. Perhaps having heard of George Soros’ famous attack on the British Pound’s peg, the author urges readers to sell Tethers on Kraken, claiming that “if you can manage to sell enough Tethers for USD on Kraken, then Tether Ltd. will run out of dollars and this whole machine… will fall apart.”

Good luck with that.

Fourth, while using the subtitle “Inside Crypto’s Doomsday Machine”, the author is offering a decidedly outsider’s perspective. Despite being administered by two distinct companies in different jurisdictions and with different target markets, the author treats any difference between Tether issuance and USDC issuance as being de facto evidence of Tether’s misbehaviour. This is confirmation bias. Furthermore, having already expressed the belief that only US-based exchanges can be above board, the author treats business models which deviate from Coinbase as being automatically suspect. Bybit and Binance offer superior promotions? Fraud. Tethers are uniquely authorized in round numbers? Fraud. (In fact, Tethers are authorized in larger and rounded numbers to reflect anticipated demand and market forces, and in order to limit the use of highly sensitive security keys in their creation. Importantly, they’re not yet backed and part of Tether’s market cap; they are a bit like issued but unbacked inventory, waiting for sale to customers based on demand.) Tethers are issued on weekends? Fraud. The mechanics of Tether issuance has been explained in detail by Tether leadership, but the author’s plot was much better served by ignoring this information rather than engaging with it. This is a clear example of how our perception of new information can be distorted by a powerful story.

Finally, in perhaps the most egregious display of biased information gathering (a hallmark of confirmation bias), the author reveals their “last nail in the coffin”: Tether’s bank is the Bahamanian Deltec bank, and the Bahamas publicly discloses how much foreign currency its domestic banks hold each month. From January to September 2020, Tether’s market cap surged from $4.6B to $10B, but foreign currency deposits at all domestic banks in the Bahamas increased by only $600 million. The evidence of Tether’s fractional reserve was therefore clear; there were not enough dollars in all of the Bahamian domestic banks to cover even a fraction of the billions of Tether in circulation!

The only problem is that Deltec Bank is not a Bahamian domestic bank.

As explained by Deltec’s Deputy CEO Greg Pepin during a recent Unchained Podcast episode, Deltec is not licensed to take local Bahamian deposits. They are licensed as an international bank, meaning that the data cited in the Bit Short accusations is wholly inapplicable. Had the author taken just two minutes to scan a list of 143 domestic banks registered in the Bahamas, they would have noticed Deltec’s absence. But strengthening a scandalous narrative was far more important to this author than performing basic fact-checking.

#2: Class Action Lawsuit from Traders Seeking Excessive Damages (“market manipulation”)

In 2021, with a fortune worth over US$188 Billion, automobile and space engineer Elon Musk overtook Amazon’s Jeff Bezos to become the world’s richest man. In 2018, five disgruntled traders hatched a plan that could see them eclipse Musk’s and Bezos’s wealth — if successful. In their dramatic 95-page lawsuit, David Leibowitz, Benjamin Leibowitz, Jason Leibowitz, Aaron Leibowitz, and Pinchas Goldshtein alleged that Bitfinex and Tether were engaged in a scheme that was “part fraud, part pump-and-dump, and part money-laundering”. Many of the New York Attorney General’s untested assertions were recycled in this filing. However, whereas the OAG’s investigation sought primarily a court order to prevent further financing arrangements between Bitfinex and Tether, these plaintiffs wanted cold hard cash — to the tune of 1.4 Trillion US dollars.

“Calculating damages at this stage is premature”, the plaintiffs write, “but there is little doubt that the scale of harm wrought by the Defendants is unprecedented. Their liability to the putative class likely surpasses $1.4 trillion U.S. dollars.” The specific allegations contained in this suit mirror other Tether conspiracy theories — e.g. unbacked tether tokens being used to inflate the price of bitcoin, etc. — but these plaintiffs are especially distinguished. Anyone can make baseless allegations against Tether, but it takes a special combination of creativity and cajones to do so while seeking US$1.4 trillion in legal damages.

These traders will not be overtaking Musk or Bezos any time soon.

#3: Tethers are “Printed” Indiscriminately and are not backed by anything

In “Is Bitcoin Really Un-Tethered?”, a paper published in 2018, finance professors John M. Griffin and Amin Shams shared research that amounts to an attack on the entire digital token space. Since the rejected “investor demand” explanation would be corroborated if full reserves existed for all outstanding Tether tokens, a related aspect of Griffin and Shams’ claim is that tethers are “unbacked”, or created without a corresponding amount of dollars being received from customers. Others have alleged this, most notably the anonymous Twitter handle “Bitfinex’ed”, whose Tweets regularly appeared in articles with titles such as: “Tether accused of minting almost $400 million in uncollateralized USDT to prop up bitcoin”:

But once again, a basic logical fallacy is at play: an absence of evidence is not evidence of an absence. Just because you can’t see something doesn’t mean it’s not there. Tether has been under the microscope of regulators for years who appear to have drawn no such conclusion. Many call for Tether to be professionally audited, but such audits failed to detect fraud at Enron, Worldcom, or WireCard. Just as the presence of an audit does not preclude fraud, the absence of an audit does not imply fraud. For the most crazed Tether conspiracy theorists, there is no amount of evidence that would satisfy them. The lure of a good story is simply too strong, and deeply affects how we process new information. This is what happened following 2019 media coverage of the New York Attorney General’s Office’s ongoing fraud investigation into Bitfinex and Tether, as many pundits accepted the OAG’s report as established truth without hearing Tether’s side.

#4: Allegations Stemming from the New York Attorney General’s Fraud Investigation

This conspiracy theory relates to allegations of fraud made by the New York Attorney General’s office in its ongoing investigation into Bitfinex and Tether. The claimed fraud is not the assertion that Tether is engaged in a process of minting unbacked coins. Rather, the claim is that both Tether and Bitfinex defrauded their customers by failing to disclose a series of related transactions between themselves. Long since revealed to be affiliated, Bitfinex and Tether are managed by overlapping executive teams. Bitfinex is not alone in letting its users trade Tether. Most digital asset exchanges offer Tether pairs on their platforms, with many preferring to eschew direct fiat deposits in favour of stablecoin-based trading pairs.

The transactions at issue in this investigation involve an entity known as “Crypto Capital”, a little-known Panamanian payment processing company whose principal would later be indicted on fraud charges. What happened was this:

1. Bitfinex deposited over US$850M of customer funds into Crypto Capital with the understanding that this third party would process customer withdrawals.

2. These withdrawals continued to not be processed, but Crypto Capital blamed the delay on issues with their own banking relationships.

3. To resolve the liquidity problem at Bitfinex, US$625m was transferred from Tether’s account at Deltec to Bitfinex’s account at Deltec, with Bitfinex transferring an offsetting US$625m from their Crypto Capital account to Tether’s (a swap of liquidity).

4. Once fraud was suspected at Crypto Capital which caused the friendly deal to turn sour, the two related entities negotiated a commercially reasonable agreement under which Tether would extend a revolving line of credit to Bitfinex that would be secured by shares in the highly profitable exchange. (The credit facility eventually expanded to a total utilised of $750m.)

5. No customers lost anything as a result of the credit facility or because of Crypto Capital’s fraud on Bitfinex.

The lost funds in question turned out to have been seized by numerous government authorities and are currently in the process of being recovered. But what matters here is that Bitfinex and Tether, themselves victims of fraud by Crypto Capital, were painted by the OAG as being perpetrators of fraud themselves. There were no victims or complaints. Withdrawals at both Tether and Bitfinex continued uninterrupted. Tether had modified its reserve policy prior to the transactions in question, specifying that reserves may include other assets and receivables from loans made by Tether to third parties, which may include affiliated entities. The users had been notified. Yet, there was no meaningful market reaction.

To overcome the financial difficulties associated with being victims of Crypto Capital’s fraud, Tether and Bitfinex engaged in a good faith financing arrangement which prioritized the interests of their customers and stakeholders. But for some unknown reason, the OAG has attempted to characterize these transactions as a fraud intended to dupe their own customers. It is no wonder that Bitfinex and Tether’s lawyers maintain that the OAG’s arguments were written in bad faith. Skeptics may eagerly await the conclusion of the NYAG’s investigation, but Tether and Bitfinex have essentially already been vindicated by the Crypto Capital indictment. The temporary cash shortfall caused by the Crypto Capital fraud meant that Tether was “only 74% backed” at the time, causing some to conclude that Tether was running a fractional reserve. But this was a temporary anomaly caused by being the victim of a fraud. Even without having recovered the confiscated funds, Tether now claims that the Bitfinex loan accounts for 2.5% of its reserves (at 20:18). As Bitfinex seems profitable, the loan seems solid and a justifiable way of claiming the 100% backing, even when it may have been up to 26% of the reserves.

#5: Issuance of Tether is Propping up the Price of Bitcoin

In their paper, Griffin and Shams made claims that amounts to an attack on the entire digital token space. After “using algorithms to analyze blockchain data’’, Griffin and Shams concluded that “rather than demand from cash investors, these patterns are most consistent with the supply-based hypothesis of unbacked digital money inflating cryptocurrency prices.” The numbers were in: Tether was a massive fraud designed to buy bitcoin with unbacked tether tokens, thus inflating the price and preventing legitimate price declines. The correlation was clear. As illustrated by Griffin and Shams, whenever bitcoin’s price started to decline, large volumes of Tether would subsequently be issued and used to buy bitcoin:

But a basic principle of statistics is that correlation does not necessarily imply causation. The obvious alternative explanation is that investors use stablecoins to buy bitcoin. This conspiracy theory was recently called out by Nic Carter of Castle Island Ventures, who sarcastically applied this same flawed logic to USDC, a competing stablecoin that has been conspicuously immune to criticism:

Carter lists studies out of UC Berkeley and Warwick Business School, the University of Queensland, and Charles University Prague, which all refute Griffin and Shams’s research.

While paying lip service to this less sensational explanation, Griffin and Shams all but dismiss the possibility that Tether is issued in response to legitimate demand. A basic understanding of bitcoin markets would have revealed an important fact to these activist academics: investors use Tether to purchase bitcoin. Many large digital asset exchanges prefer to use stablecoins for their operations, causing their users to first acquire stablecoins. That many large traders and investors prefer to buy assets after prices have fallen easily explains why stablecoin issuance rises when the price of bitcoin falls. But this plain-vanilla explanation would not have garnered as much publicity for Griffin and Shams as their imaginative claims of bitcoin’s price being propped up by unbacked Tether. Furthermore, and as others have pointed out, the Griffin and Shams results are highly dependent on arbitrarily picking the right periods through which to filter the data. The periodicity is highly selective to manufacture the ‘correct’ result for Griffin and Shams.

Conclusion

On one hand, Tether could certainly do more to alleviate concerns by becoming more transparent about their operations. On the other hand, the power of confirmation bias means that skeptics will continue to craft fanciful explanations to fit the facts to their preferred conspiracy theory. No matter the evidence, they won’t stop believing. The myth of the Loch Ness Monster reminds us that low visibility into something does not mean that the worst case or most imaginative scenario is true — but such uncertainty is guaranteed to stimulate the human imagination, as well as our deep-rooted tendencies to both create and receive narratives.

Good stories are powerful.