As accountants we know the importance of internal controls, but I see an over reliance on this being the answer to cryptocurrency companies’ problems.
We’ve seen countless historical frauds where closely held and related parties control the ownership, which create an environment to circumvent controls. Internal controls are not helpful if the fundamental accounting is not addressed first.
In this article, I want to address the recent change in Tether’s definition of what they hold in reserves, the assets backing the stablecoin. Accountants I’ve heard commenting on this seem to only be thinking of cash equivalents such as US Treasury Bonds or Certificates of Deposit (CDs). Additionally, commentators are pointing to the need for Tether to increase its transparency and that because it continues to trade at or near its peg of 1 USD, the market is satisfied.
A Bit of Tether Background
Tether is the oldest and most widely traded stablecoin in the cryptocurrency space. It currently has a market capitalization of over $2 billion. If you are unfamiliar with Tether’s history, Amy Castor has a detailed outline here and Frances Coppola details the change of Tether’s transparency and potential issues of fractional reserve lending in Forbes. Additionally, in the past, I’ve covered the different levels of assurance and its current state in the cryptocurrency market here.
Tether originally engaged auditors in the second half of 2017, and subsequently disengaged citing the “excruciatingly detailed” procedures would not render a timely opinion. Very few accountants seem to find this odd and I believe that they are being misled into thinking this engagement would require specialized, highly technical, blockchain skills.
With mediocre Excel skills, I did the bookkeeping for the wallet addresses included in the original engagement, which was not difficult. What I suspect Tether did not anticipate was all of the third-party confirmations required in an audit.
Talking Tether’s ‘Transparancy’
As a former auditor, I do not give any credence to the bank letters or a media outlet examining a sample of bank statements. The point of a fiat-backed stablecoin is that the entity is supposed to be holding a customer’s fiat currency in reserve for when s/he is ready to redeem. In the absence of an audit, we have no idea the source of funds, restrictions or encumbrances.
The change: According to web archives, Tether changed the definition of their “reserves” on February 26, 2019 to the following:
Traditional currency and cash equivalents, I think we all agree could be fiat and other products that are liquid. Despite current guidance of classifying cryptocurrency as an intangible asset, it is likely that could be considered a cash equivalent also.
At issue is the source as it does not say that these may have come from customers. This may be an issue because if they are from another party, that other party may have rights to claim in advance of a customer.
Other Assets and Receivables from Loans Made by Tether
Tether has a simple balance sheet and business model and it offers a digital IOU. Other than lending some of its traditional cash (presumably customer deposits or interest generated from short term investments) the other possibility would be to carry a receivable of Tethers.
The issue with lending customer deposits is that there is the possibility of the funds not being available when the customer wants to redeem. I believe that they have covered this in their terms from a legal standpoint, but nonetheless, this should be a concern for customers.
It is conceivable that Tether would extend terms to an exchange, venture capital firm, or other customer. For example, they may agree to provide 200 million USDT to an exchange and carry a receivable for all or some of the balance.
The concern here should be that Tether is now stating that note receivable may be used as support. If the exchange defaults on the note, it is likely that Tether would be able to reclaim the USDT. Again, legally, I believe this is addressed in their terms. Conceptually, accountants should be questioning USDT is ultimately the only asset available.
Affiliated Tether Entities
Most know by now that Tether and Bitfinex have common ownership. However, this could also include affiliates of the company known or unknown.
Additionally, Tether announced a partnership with Tron. This partnership also appears to be strengthening the Tether exchanges as Tron is offering a 20% incentive for holders of Omni USDT to convert to Tron USDT on the Huobi and OKEx exchanges.
Although not included in this definition, there are a couple of other notes on Tether’s balance sheet that are ignored. Tether has the ability to quarantine compromised tokens. This takes them out of circulation without impacting cash.
The current amount recorded on the transparency report is $30,950,010. When one looks at the blockchain, s/he will find an additional 8,099,980 unrecorded, frozen USDT. This lends itself to reducing circulating supply and increasing equity. It is nearly 9M USDT that does not need to be redeemed.
Currently, we see stock repurchases as a common practice in the equity markets. This is the practice of management ideally using profit to repurchase stock, ultimately reducing the outstanding shares and reinvesting in the company.
In October of 2018, it appears that Tether may have contracted supply by purchasing USDT at a discount, approximately .96. The question would be if it used customer deposits, the reserves to repurchase these.
Trouble With Tether
What I find troubling also with some of the commentary is that this change occurred on February 26, 2019. This change went unnoticed for over two weeks until a group of critics on twitter detected it March 13, 2019. This should raise questions about whether any users are concerned or attempting to redeem. If they are not redeeming, it should lead to additional questions as to the market participants using USDT, as they are the ones responsible for it maintaining the peg.
Even if no one you advise in cryptocurrency uses USDT or any USDT exchanges, I believe it is irresponsible to avoid considering the potential accounting impact and possible systemic risks. For those only familiar with domestic, fiat exchanges, here is a current look at just how much USDT is used. (Source Coinlib.io)
About Kara Haas
Kara R. Haas, CPA, CITP, CFE provides research and advisory services for accounting and legal firms.