To answer your direct question, Tether is sold as a fully-backed instrument, so there's major (potentially billions of dollars of) fraud if it's not fully backed. That's an issue because consumers aren't getting what they paid for, i.e. the underlying risk profile is different from what they thought the were buying.

The big difference with Tether is that in traditional banking, fractional reserves are legal, and regulated (i.e. banks are required to prove their reserves, and are required to hold a certain percentage of their deposits).

If there's a run on a consumer bank, and they don't have enough reserves to repay their customers, then FDIC insurance steps in to protect the customers. In this case, there's no protection, so everyone holding tether will be screwed if there's a run.

So if Tether was FDIC backed, then you’d technically be OK with this situation?

Actually yes, because FDIC backing would mean they've gone through all of the necessary steps to become a real bank. I would have some confidence that they actually have the USD to back up their holdings as they claim. If still turn out to be a scam then at least I'd have something to fall back on, and some people over at the FDIC would have some questions to answer.

Not OP, but I presume the regulations would be important too. Part of being FDIC backed is maintaining a certain amount of currency that is VERIFIED.

Issue here is that there is no one giving confidence that Bitfenix has any currency at all, we have to trust their word.

If Tether was FDIC backed, it'd essentially be a bank with weird procedures for putting money in and getting money out.

No, as I said,

> Tether is sold as a fully-backed instrument, so there's major (potentially billions of dollars of) fraud if it's not fully backed

The fraud issue (not to mention the securities price manipulation issue) is still a big deal.

Fractional reserve banking is about the availability of funds, not their existence.

In a bank with fractional reserves, the assets and the liabilities all add up. If I deposit $100, and the bank lends $80 of that out to someone else, the bank has liability to me of $100 and assets of $20 cash + $80 loan (a loan is an asset on a bank balance sheet). I can't immediately withdraw all $100, but it all exists.

The bitfinex thing is more akin to the Federal Reserve, which actually can just make up money out of thin air. The big difference between bitfinex and the Fed is that the Fed is a federal agency, created through a legislative process and operated with clear public policy goals. Whereas bitfinex is just some random people somewhere claiming they have $billions in the bank.

banks are regulated to ensure they don't over-commit and are backed by a central bank to bail them out. That system isn't perfect, but it's a lot better then no regulation.

An unregulated system that allows fractional reserve banking can only end badly. Competition will cause private entities to take increasingly risky positions (if they don't play along, they get crowded out by those who do), and the systemic risk is unchecked. At its extreme, it becomes a ponzi scheme.

> is this any different than what banks have been doing for forever with fractional reserve

No. They are different. The bank turns liquid cash into much less liquid assets (houses, cars, boats, new businesses) by way of loaning out the money. All of the banks liabilities (the depositors) are backed by the banks assets (loans for stuff).

In a panic (which happens periodically) a lot of people try to convert at once. But there's no central bank to bail them out.

Other than the fact that they're committing fraud by doing so, in a bank run, the FDIC insures people's deposits.