For months, critics have raised questions about Tether, a cryptocurrency whose value is supposed to be "tethered" to the United States dollar. The company behind Tether claims to have a dollar in the bank for every tether that's in circulation. And the Tether website claims that these cash holdings are "subject to frequent professional audits."
But those "frequent professional audits" have been slow in coming. The accounting firm Friedman LLP had been working on an audit of Tether and Bitfinex—a cryptocurrency exchange that is closely linked to Tether—since May. But last Saturday, Tether admitted to Coindesk that its relationship with Friedman had "dissolved."
"Given the excruciatingly detailed procedures Friedman was undertaking for the relatively simple balance sheet of Tether, it became clear that an audit would be unattainable in a reasonable time frame," a Tether spokesperson told Ars by email.
So much for "frequent professional audits."
This is particularly alarming because in recent months Tether has been rapidly expanding the supply of tethers. Last April, there was a little more than $50 million worth of tether in circulation. Today, the figure is $2.2 billion—with $850 million worth of additional tethers created in January alone.
Yet Tether says that during this same period, it has been unable to receive international wire transfers. So where did the $850 million in cash backing these tethers come from?
Some critics suggest that these new tethers might not be backed by anything at all.
"I, and many others, suspect tether is being used to effectively counterfeit hundreds of millions of dollars of perceived value," wrote security researcher Tony Arcieri in a January blog post.
The possibility of $2 billion in funny money floating around is alarming enough. The even bigger concern is that some in the cryptocurrency community have started holding them at cryptocurrency exchanges and treating tethers as a direct substitute for dollars. These tether holders might be in for a rude surprise if it's revealed that Tether doesn't actually have $2.2 billion in the bank.
"I think there is an incipient financial crisis in the cryptocurrency world," said Robleh Ali, a lawyer and former financial regulator who now studies financial markets and cryptocurrency at MIT.
"Financial crises happen when you get these big reversals of expectations," Ali continued. "Many people don't realize that it's not dollars."
Maybe Tether really does have $2.2 billion stashed away in a secret bank account—critics certainly haven't proven otherwise. But the company has been astonishingly slow to produce evidence that it has cash in the bank to back up the cryptocurrency it has issued.
After 17 months, we don't know if Bitfinex is solvent
To understand Tether's potential predicament, you have to go back to August 2016. That's when hackers stole 120,000 bitcoins—then worth around $70 million—from Bitfinex, a cryptocurrency exchange whose ownership is closely linked to Tether. (One executive has described Bitfinex as the majority owner of Tether.)
Bitfinex apparently didn't have enough reserves to cover these losses, so instead it confiscated 36 percent of each customer's deposits, replacing them with an IOU called a BFX token. Customers then had two options: they could convert their IOUs into Bitfinex shares at a price set by Bitfinex, or they could hold on to the tokens and hope that Bitfinex would eventually earn enough profit to repay them at face value.
Over the next few months, some customers took the share-conversion option. On April 3, Bitfinex triumphantly announced that it was able to repay 100 percent of the remaining BFX tokens.
But some people still wondered if Bitfinex had really achieved solvency. The fact that Bitfinex had awarded cash credits to IOU holders didn't necessarily mean that Bitfinex had enough cash to redeem all those credits if every customer asked for their money back.
Bitfinex had been promising a full audit of its books ever since the hack was announced. "We are in the process of engaging Ledger Labs to perform an audit of our complete balance sheet," Bitfinex wrote on August 17, 2016.
But on April 5, Bitfinex abruptly announced that Ledger Labs "has not been engaged to perform a financial audit of Bitfinex." It turns out Ledger Labs doesn't actually do audits, Bitfinex said. Bitfinex hadn't realized that when it published its original blog post. We've emailed Bitfinex to ask why it took seven months to alert the public to this fact, but we haven't received a response.
But all wasn't lost: "We are pleased to announce that Bitfinex has engaged Friedman LLP to complete a comprehensive balance sheet audit," Bitfinex announced in May. "We are confident that Friedman is a great match to meet our accounting needs."
But the Friedman audit never finished. It dragged on throughout 2017 and into 2018. Last month, Friedman dropped Bitfinex and Tether as a customer, quietly and without explanation.
Tyson Cross, a tax attorney who specializes in cryptocurrency, says this is a situation where actions may speak louder than words. "It's not a good sign if an accounting firm withdraws," Cross told Ars. Accounting firms are "bound by confidentiality," he says, so if they find something isn't right with a client's books, they often can't say anything about it publicly.
The bottom line is that despite Bitfinex's promises, there has been no professional audit of Bitfinex's books made public since the exchange was hacked 18 months ago. Bitfinex has repeatedly claimed that it has enough reserves to redeem all customer deposits, but no independent third party has verified the company's claims.
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