The mechanics are probably this: suppose someone goes to Bitfinex to redeem 10million USDT into USD. Since Bitfinex is behaving fraudulently, they don't actually have the 10million USD they promised they would hold to back the USDT. But they do have the ability to issue new unbacked USDT.

So they issue 11million unbacked USDT and use it to buy bitcoin. They sell the bitcoin for 10million USD on one of the exchanges that allows bitcoin to hard currency exchange. The 10% loss is because you have to pay a premium to exchange bitcoin to real currency. Bitfinex then pays the 10million USD to the customer in exchange for the 10million USDT which is retired.

The net results are 1million new unbacked USDT have been printed, and the illusion that USDT is backed by USD has been maintained.

Possibly the "Bitfinex issues unbacked USDT to buy bitcoin" step is being done not based purely on customer demand, but on a periodic basis when bitcoin price is falling.

Maybe Bitfinex has a hope to preserve their fraud by propping up bitcoin, or to dig out from under the fraud by building a big long bitcoin position and hoping it will rise in value.

Or maybe the timing of USDT issues with market drops is just that bitcoin price falls when there are more sellers than buyers, which is the same time there are more USDT redemptions. So to carry out the mechanics above, Bitfinex has to print tether to fund the redemptions at the time of the drops.

> So they issue 11million unbacked USDT and use it to buy bitcoin.

Who is selling them BTC for USDT apart from a few daytraders? Where is the sink of 2.8 billion USDT?

That's a very interesting and plausible hypothesis.

One wonders whether the prolonged slump might lead to some sort of bursting of outfits like Tether/Bitfinex. It seems like a downward spiral of people selling BTC and Bitfinex doing the dance you described, and a bigger hole being created.

The other allegation (which is pretty viable) was with large reserves to play with, they could cause crashes or spikes in order to gobble up their users risky shorts. Shorts they would know the exact number and values of.

Well, I could see how the government might not like people printing their own money without going through the central bank.

yeah, i thought it was a ponzi scheme too.

No, not necessarily. Ponzi schemes can survive redemptions for years or even decades; they blow up when there's finally a run.

You're confusing a Ponzi scheme and fractional reserve. Two very different systems.

A fractional reserve bank is a bank where:

Cash on hand < Outstanding liabilities (Deposits)

Cash on hand + Investments > Outstanding liabilities (Deposits).

A ponzi scheme is where:

Cash on hand + Investments < Outstanding liabilities.

A fractional reserve bank doesn't have the cash to let 100% of its depositors withdraw their accounts tomorrow. It does have the assets to let 100% of its depositors withdraw their accounts once its investments mature, or if they are sold at market value.

A ponzi scheme can't do either of the above. It's a pure scam.

>It does have the assets to let 100% of its depositors withdraw their accounts once its investments mature

This line of thinking is what caused the 2008 crisis. The two metrics are interdependent. If a bank doesn't have liquidity, it can't make loans, which cant support the prices of the assets it owns which results in financial collapse.

Ponzi schemes are 'investment' promises that require ever growing layers of patsies to be recruited for each patsies' pay off to occur. Fractional Reserve is a practice where an institution leverages themselves by only keeping the expected liquidity needs in reserve and using the other capital for other means. Eventually they blowing up, when the market demands the apparent liquidity.

A ponzi scheme has to continue to grow or else it will collapse. Frantional reserve risks can perpetuate indefinitely until the liquidity is request:

StableCoin takes $100MM in USD deposits. Issues 100MM StableCoins. StableCo notices that it's 'never' had more than $10MM in USD of liquidity tapped. It decides "Hey we could make a stack of cash investing the remaining $90MM USD in XYZ" not until X years later does the fractional reserve issue arise as 'unforeseen circumstances' cause a liquidity demand of $15MM

Yes, what led to the 2008 crisis was a misvaluation of investments. Fortunately, there exist solutions to that problem, built into the system. Short-term interbank loans, the FDIC, and nationalization. Notice how not a single American bank stole it's depositor's money... And that the rules of fractional reserves were changed, to reduce the likely hood of such a catastrophe.

There is a world of difference between that and a Ponzi scheme. How many investors took a haircut from Madoff's little game, again?

Tether is claimed to be fully backed by USD. If it is not then it quickly ends up being an effective Ponzi scheme.

Ponzi schemes are 'investment' promises that require ever growing layers of patsies to be recruited for each patsies' pay off to occur.

Fractional Reserve is a practice where an institution leverages themselves by only keeping the expected liquidity needs in reserve and using the other capital for other means. Eventually they blowing up, when the market demands the apparent liquidity.

The only difference is that ponzi schemes promise a positive return on investment while fractional reserves just make the people holding the fractional reserve more money.

> USDT is only 0.5%-0.8% of the market.

This is false. Market cap is a meaningless statistic when applied to cryptocurrencies. If I create a billion 'FOOCoins' and sell one to a friend for $1, FOOCoin now has a 1 billion market cap, but only a single dollar has changed hands. He sells it back to me for $2, now FOOCoin has a cap of $2 billion! With only $3 having changed hands.

This is clearly an exaggerated scenario, but it does show that the market price multiplied by the number of coins is not meaningful.

> Do you really think that a 300-500 billion dollar market is being propped up by less than pennies on the dollar?

I don't think it's a 300-500 billion dollar market.

In fact the article you linked to goes on to explain this very phenomenon! That in fact it's possible that only around $6 billion in inflow has gone into cryptocurrencies, ever. This puts tether at around 1/3 of the entire inflow. Is that still trivial?

> If I create a billion 'FOOCoins' and sell one to a friend for $1, FOOCoin now has a 1 billion market cap, but only a single dollar has changed hands. He sells it back to me for $2, now FOOCoin has a cap of $2 billion! With only $3 having changed hands.

Only $1 has changed hands in this.

$1 changed hands, but the trading volume is $3.

There's a lot of speculation that this sort of "wash trading" happens in Bitcoin - some exchanges permit buying/selling to yourself, which lets someone boost both price and volume trivially.

Well true, in aggregate. But we may have used up to three different notes :)

Did you read the article you posted?

It makes the point that it is in fact possible to influence the market with pennies on the dollar.

Remember that market cap is meaningless while no matter how USDT were created(backed or not) those represent at least some fiat inflows.

My personal opinion: Tether initially had some USD backing maybe not 100%. Now, I'd be surprised if Tether has backing in excess of 10%.

That is still enough to control Tether if you have issuing authority and can limit redemptions for fiat.

In fact Bitfinex/Tether has done exactly that. You would be hard pressed to redeem Tether for dollars.

> What can be said about Tether: it's a trusted third party that's vulnerable to fractional reserve

What? Isn't the entire friggin point of Tether that it's _not_ a fractional reserve system?

From their own FAQ (emphasis mine):

> All tethers are pegged at one-to-one with matching fiat currency (e.g., 1 USD₮ = 1 USD) and are backed 100% by actual assets in our reserve account.

https://tether.to/faqs/

Their FAQ also promises to have audits of their USD reserves, which as I understand it they've since reneged on.

I think by "vulnerable to fractional reserve," he means that since there is no way to transparently verify or audit their USD reserves, they could run a fractional system while claiming to be fully backed, like Mt Gox did.

Ah. I guess that my reading was "vulnerable to [bank runs, due to] fractional reserve."

If tether isn't a scam, why have then not yet found an auditor willing to actually audit them?

This.

A fractional reserve means you keep a fraction of your total assets in cash and the rest of your assets in loans or investments that are less liquid, but entirely real.

It doesn't mean that you have assets that all total up to be a fraction of your liabilities. You're severely misunderstanding what fractional reserve means.

What I wonder is: Even if it is totally a ponzi scheme/scam, it seems like the price holds even if people have little faith on whether or not it's properly backed.

So, has it _psychologically_ managed to create price stability? So long as there isn't a giant run on the currency where they actually did run out of the necessary US Dollars (as well as insufficient people stepping in willing to pay $1 for 1 USDT), does it actually matter whether or not they have fully collateralized the currency?

I find that to be sorta interesting.

Fractional reserve BANKING is when a bank keeps a fraction of its deposits on hand while the rest is being INVESTED so that they can earn money to pay you interest. The money exists, but most of it is tied up in long-term investments.

Is Tether a bank? Does it invest its reserves? If you answered no to either of those questions, then you have no business comparing it to a fractional reserve banking system.