Tether for Terrorists
Shadow banks must be regulated or prosecuted
This story on Tether from the Wall Street Journal has been making the rounds:
A giant unregulated currency is undermining America’s fight against arms dealers, sanctions busters and scammers. Almost as much money flowed through its network last year as through Visa cards. And it has recently minted more profit than BlackRock, with a tiny fraction of the workforce.
Its name: tether. The cryptocurrency has grown into an important cog in the global financial system, with as much as $190 billion changing hands daily.
In essence, tether is a digital U.S. dollar—though one privately controlled in the British Virgin Islands by a secretive crew of owners, with its activities largely hidden from governments.
Known as a stablecoin for its 1:1 peg to the dollar, tether gained early use among crypto aficionados. But it has spread deep into the financial underworld, enabling a parallel economy that operates beyond the reach of U.S. law enforcement.
Wherever the U.S. government has restricted access to the dollar financial system—Iran, Venezuela, Russia—tether thrives as a sort of incognito dollar used to move money across borders.
Russian oligarchs and weapons dealers shuttle tether abroad to buy property and pay suppliers for sanctioned goods. Venezuela’s sanctioned state oil firm takes payment in tether for cargoes. Drug cartels, fraud rings and terrorist groups such as Hamas use it to launder income.
I’ve been saying for many years that the Tether institution is a shadow bank, and that a “tether” is absolutely not a new cryptographic “currency,” but rather a very old technology – a banknote. Here’s my take:
While masquerading as cutting edge, paradigm-changing, disruptive technology, the tether is just a nineteenth-century banknote in new clothing. Tether is a shadow bank, and the tether token is shadow bank money. The token is indeed a token of credit/debt, held on the Tether institution. The denomination appears to be 1 tether; they even made up their own currency symbol to drive home this point. However, the actual denomination is 1 US dollar for a very simple reason: that’s what Tether owes me – not 1 tether, 1 dollar. Put differently, 1 tether token, marked with the tether symbol, represents not 1 tether of credit/debt, but one dollar of credit/debt. In reality, the tether symbol functions not to denominate the debt but to specify the issuer of that debt (again, the same way various banknotes have done historically).
In the early days, long before the crypto winter, both crypto advocates and sympathetic news stories (and explainers) about crypto would talk about crypto, including stablecoins, as an entirely new money that might change the world in all sorts of wonderful ways. Today the rhetoric of new money has fallen back down to earth, and the stories seem more likely to center on the devastation wrought by crypto scams (Ponzi schemes and rug pulls), on the one hand, and stablecoin financing of terrorism and war, on the other.
But even these critical stories assign far more power and mystery to crypto than they ought. Because Tether is absolutely not a new “digital U.S. dollar” for the simple reason that we have had “digital dollars” for as long as we’ve had computer spreadsheets and the networking capacity for banks to update their ledgers through digital communications.
What’s “new” about tether is itself quite old, but in a slightly different way than banknotes. While the issuance and redemption of tether functions exactly like a regular bank account – I deposit dollars and Tether issues me tethers (just like old-school banknotes), or I redeem my tethers and Tether transfers real money (i.e., a claim on a proper, registered banking institution) – the magic of tether is that tethers can circulate, a) without being redeemed and, b) without having to carry around huge duffle bags full of cash. In this respect, a tether is like an endorsed check. (People over 50 can skip the next paragraph.)
Most people today only deal with check endorsements in the most basic way: your employer pays you by check, you sign it on the back (that’s what “endorse” means) and above your signature write “for deposit only.” Your bank then credits your account; your employer’s bank debits their account; and your employer’s bank pays your bank in central bank reserves. But it used to be common in certain jurisdictions, including the states, to do a “special endorsement” or “third-party endorsement,” in which the claim on your employer’s bank was not cashed in, but rather transferred directly. You owed a friend money so you wrote on the back of the check “pay to the order of my friend,” signed your name, and then handed your employer’s check to your friend. They could then deposit it in their bank just as you would have done yours. Or, perhaps they too would endorse it over to someone else. In theory, this claim on your employer’s bank could start to circulate as money, the same way claims on the central bank (i.e., national currencies) do.1
When a tether circulates on the blockchain it is just like one of these endorsed checks being passed from creditor to creditor. If I want to buy a hundred kilos of heroin or a crate of AK-47s (or whatever), I don’t want to write you a check or use my credit card. Instead, I open an account at my local shadow bank, Tether. Then, rather than writing a check on that account (which you would need to deposit, leaving all sorts of records of our transaction), I pass along the tether token directly, just like an endorsed check. And you, the drug and weapons dealer, don’t redeem the tokens with Tether: you pass them along to someone else, perhaps even exchanging them for some other crypto token.
The tether token is great for doing illegal things because Tether is not bothering to track all these many endorsements along the tether blockchain. I don’t see any reason they couldn’t technically do so, but it would be awful for their entire business model. That brings us to a key piece of the story that the WSJ leaves out. If you can’t do crime with them, there’s really no good reason2 to exchange your bank dollars for tethers in the first place.
Notice that Tether is not just a shadow bank, not just an institution operating absolutely like a bank, but with absolutely no regulation: tether is a bank that takes in massive deposits and pays absolutely no interest on them. This gets to the other part of the WSJ story that proves far too thin for my tastes: they say clearly in the lede paragraph that Tether “has recently minted more profit than BlackRock,” but minted more profit seems a strange phrase to me. Does it mean they are just “printing money”? After all, that’s what so many banks get accused of doing. Or does it mean that they are really clever and “innovative,” using cutting edge technology to generate these amazing profits?
No no no. They are just bankers, but bankers who get to both take in a stable deposit franchise on which they pay 0% interest, while taking advantages of some of the highest short-term interest rates of the century. Tether takes the money of terrorists and druglords and buys US Treasury bills with it. The US government is generating all of Tether’s profits by paying Tether over 5% interest on the money Tether gets for free. This is not some secret inside knowledge or highly conceptual speculation from me. Tether “transparently” reports that the asset side of Tether’s balance sheet is mainly US Treasuries.
The biggest mistake of the WSJ framing of Tether terrorism is the suggestion that Tether has somehow created their own dollar through technology. But anyone can issue their own dollars.3 The only questions are: will such dollar-denominated debts circulate freely (will people accept them in payment), and will they circulate at par (will the acceptors demand a discount for these particular dollars). Most crucially, the answers to those questions do not depend on the technology that creates the “dollar,” but on the reliability – the solvency and liquidity – of the debtor.
Tether is doing fantastic business right now because people see them as a very reliable debtor. And they aren’t wrong! But what makes Tether a reliable debtor? As always, the quality of their balance sheet. Tether is both more solvent and more liquid than they have ever been! Their net equity is over 4.5% and almost all of their assets are in extremely liquid T-bills.4
And all of this is made possible by their holdings of the highest-quality debt in the world, that of the US government. Yes, Tether is almost certainly looking the other way to allow criminals to use tether’s shadow bank money to do what criminals do. Yet all of this is enabled by the backing of US government debt.
If you want to open a bank, you have to get a bank charter and subject yourself to very high levels of regulatory scrutiny. To open a shadow bank just means to open a bank without getting a bank charter. That’s what Tether has done. Since they are not a bank, they cannot technically be regulated (the FDIC has no jurisdiction).
This leaves only one option: they must be prosecuted.5 Now.
Third-party endorsements are themselves nothing new, as Bills of Exchange circulated in a similar manner, many hundreds of years ago.
The main legal reason to swap bank dollars for tethers would be for the purposes of crypto gambling. In these cases, Tether functions as the casino cashier: you bring real money and they give you the chips you need to gamble (at a cheaper exchange rate than exchanging dollars every time you want to buy dogecoin).
This is my own custom blend of Minsky on creating money and Innes on the nature of a dollar.
Not that long ago Tether’s equity was less than 1/10th of this number, and with money tied up in Chinese ABCP, its liquidity was very questionable as well. Running a crypto shadow bank is much more lucrative in a higher interest-rate environment.
The SEC is loathe to prosecute Tether because their oversight is “securities” and there are a couple of reasons that a “tether” may not qualify as a security under current US law. One of those reasons is the recent (but potentially temporary) legal success of Ripple, which found a judge willing to limit the SEC’s power by suggesting the token of ripple, XRP, may not always be a security. But the more important limitation is that US law specifically excludes bank deposits from the definition of a security. This is an element of the legal framework for interpreting the Securities Exchange Act of 1934. To be clear, the intention was not at all to free banks from regulation but precisely to subject them to far greater scrutiny and oversight. Under US law, bank deposits are so important that we put them in their own category. However, in recent practice, the only real pushback to crypto criminality has come from the SEC, which is now hamstrung by this legal construction: they can’t go after Tether because what Tether is doing is way worse. I’m not a regulator, so I don’t know how to fix this problem, but law is flexible in many ways, and there’s no doubt that the point of the law was never to say: if you cheat at the highest levels, we’ll leave you alone.