Permissionless blockchains require an inflow of speculative funds at an average rate greater than the current rate of mining rewards if the "price" is not to collapse. To maintain Bitcoin's price at $4K requires an inflow of $300K/hour.I found it hard to believe that this much actual money would flow in, but since then Bitcoin's "price" hasn't dropped below $4K, so I was wrong. Caution — I am only an amateur economist, and what follows below the fold is my attempt to make sense of what is going on.
First, why did I write that? The economic argument is that, because there is a low barrier to entry for new competitors, margins for cryptocurrency miners are low. So the bulk of their income in terms of mining rewards has to flow out of the system in "fiat" currency to pay for their expenses such as power and hardware. These cannot be paid in cryptocurrencies. At the time, the Bitcoin block reward was 12.5BTC/block, or 75BTC/hour. At $4K/BTC this was $300K/hour, so on average 300K USD/hour had to flow in from speculators if the system was not to run out of USD.
Second, lets set the context for what has happened in cryptocurrencies in the last year.
Tether (USDT) is a "stablecoin", intended to maintain a stable price of 1USD = 1USDT. Initially, Tether claimed that it maintained a stable "price" because every USDT was backed by an actual USD in a bank account. Does that mean that investors transferred around sixteen billion US dollars into Tether's bank account in the past year? No-one believes that. There has never been an audit of Tether to confirm what is backing USDT. Tether themselves admitted to the New York Attorney General in October 2018 that:
the $2.8 billion worth of tethers are only 74% backed:If USDT isn't backed by USD, what is backing it, and is 1USDT really worth 1USD?
Tether has cash and cash equivalents (short term securities) on hand totaling approximately $2.1 billion, representing approximately 74 percent of the current outstanding tethers.
Tether transfers newly created USDT to an exchange, where one of two things can happen to it:
- It can be used to buy USD or an equivalent "fiat" currency. But only a few exchanges allow this. For example, Coinbase, the leading regulated exchange, will not provide this "fiat off-ramp":
Please note that Coinbase does not support USDT — do not send it to your Bitcoin account on Coinbase.Because of USDT's history and reputation, exchanges that do offer a "fiat off-ramp" are taking a significant risk, so they will impose a spread; the holder will get less than $1. Why would you send $1 to Tether to get less than $1 back?
- It can be used to buy another cryptocurrency, such as Bitcoin (BTC) or Ethereum (ETH), increasing demand for that cryptocurrency and thus increasing its price.
For simplicity of explanation, lets imagine a world in which there are only USD, USDT and BTC. In this world some proportion of the backing for USDT is USD and some is BTC.
Someone sends USD to Tether. Why would they do that? They don't want USDT as a store of value, because they already have USD, which is obviously a better store of value than USDT. They want USDT in order to buy BTC. Tether adds the USD to the backing for USDT, and issues the corresponding number of USDT, which are used to buy BTC. This pushes the "price" of BTC up, which increases the "value" of the part of the backing for USDT that is BTC. So Tether issues the corresponding amount of USDT, which is used to buy BTC. This pushes the "price" of BTC up, which increases the "value" of the part of the backing for USDT that is BTC. ...
Tether has a magic "money" pump, creating USDT out of thin air. But there is a risk. Suppose for some reason the "price" of BTC goes down, which reduces the "value" of the backing for USDT. Now there are more USDT in circulation than are backed. So Tether must buy some USDT back. They don't want to spend USD for this, because they know that USD are a better store of value than USDT created out of thin air. So they need to sell BTC to get USDT. This pushes the "price" of BTC down, which reduces the "value" of the part of the backing for USDT that is BTC. So Tether needs to buy more USDT for BTC, which pushes the "price" of BTC down. ...
The magic "money" pump has gone into reverse, destroying the USDT that were created out of thin air. Tether obviously wants to prevent this happening, so in our imaginary world what we would expect to see is that whenever the "price" of BTC goes down, Tether supplies the market with USDT, which are used to buy BTC, pushing the price back up. Over time, the BTC "price" would generally go up, keeping everybody happy. But there is a second-order effect. Over time, the proportion of the backing for USDT that is BTC would go up too, because each USD that enters the backing creates R>1 USD worth of "value" of the BTC part of the backing. And, over time, this effect grows because the greater the proportion of BTC in the backing, the greater R becomes.
- The "price" of BTC correlated with the number of USDT in circulation. The graph shows this in the real world.
- Both the "price" of BTC and the number of USDT in circulation growing exponentially. The graph shows this in the real world.
- Spikes in the number of USDT in circulation following falls in the "price" of BTC. Is Bitcoin Really Untethered? by John Griffin and Amit Shams shows that:
Rather than demand from cash investors, these patterns are most consistent with the supply‐based hypothesis of unbacked digital money inflating cryptocurrency prices.Their paper was originally published in 2018 and updated in 2019 and 2020.
- Tether being extremely reluctant to be audited because that would reveal how little money and how much "money" was supporting the BTC "price".
Apart from the work of Griffin and Shams, there is a whole literature pointing out the implausibility of Tether's story. Here are a few highlights:
- JP Konig's 18 things about Tether stablecoins
- Social Capital's series explaining Tether and the "stablecoin" scam:
- Price manipulation in the Bitcoin ecosystem by Neil Gandal et al
- Cryptocurrency Pump-and-Dump Schemes by Tao Li et al
- Patrick McKenzie's Tether: The Story So Far:
A friend of mine, who works in finance, asked me to explain what Tether was.
Short version: Tether is the internal accounting system for the largest fraud since Madoff.
BaFin conducted multiple investigations against journalists and short sellers because of alleged market manipulation, in response to negative media reporting of Wirecard. ... Critics cite the German regulator, press and investor community's tendency to rally around Wirecard against what they perceive as unfair attack. ... After initially defending BaFin's actions, its president Felix Hufeld later admitted the Wirecard Scandal is a "complete disaster".Similarly, the cryptocurrency world has a long history of both attacking and ignoring realistic critiques. An example of ignoring is the DAO:
The Decentralized Autonomous Organization (The DAO) was released on 30th April 2016, but on 27th May 2016 Dino Mark, Vlad Zamfir, and Emin Gün Sirer posted A Call for a Temporary Moratorium on The DAO, pointing out some of its vulnerabilities; it was ignored. Three weeks later, when The DAO contained about 10% of all the Ether in circulation, a combination of these vulnerabilities was used to steal its contents.
David Gerard points out the obvious in Tether is “too big to fail” — the entire crypto industry utterly depends on it:
The purpose of the crypto industry, and all its little service sub-industries, is to generate a narrative that will maintain and enhance the flow of actual dollars from suckers, and keep the party going.Gerard links to Bryce Weiner's Hopes, Expectations, Black Holes, and Revelations — or How I Learned To Stop Worrying and Love Tether which starts from the incident in April of 2018 when Bitfinex, the cryptocurrency exchange behind Tether, encountered a serious problem:
Increasing quantities of tethers are required to make this happen. We just topped twenty billion alleged dollars’ worth of tethers, sixteen billion of those just since March 2020. If you think this is sustainable, you’re a fool.
the wildcat bank backing Tether was raided by Interpol for laundering of criminally obtained assets to the tune of about $850,000,000. The percentage of that sum which was actually Bitfinex is a matter of some debate but there’s no sufficient reason not to think it was all theirs.At the time, USDT's "market cap" was around $2.3B, so assuming Tether was actually backed by USD at that point, it lost 37% of its backing. This was a significant problem, more than enough to motivate shenanigans.
the nature of the problem also presented a solution: instead of backing Tether in actual dollars, stuff a bunch of cryptocurrency in a basket to the valuation of the cash that got seized and viola! A black hole is successfully filled with a black hole, creating a stable asset.
Weiner goes on to provide a detailed explanation, and argue that Tether is impossible to shut down. He may be right, but it may be possible to effectively eliminate the "fiat off-ramp", thus completely detaching USDT and USD. This would make it clear that "prices" expressed in USDT are imaginary, not the same as prices expressed in USD.
We saw about 300 million Tethers being lined up on Binance and Huobi in the week previously. These were then deployed en masse.See Cryptocurrency Pump-and-Dump Schemes by Tao Li, Donghwa Shin and Baolian Wang.
You can see the pump starting at 13:38 UTC on 16 December. BTC was $20,420.00 on Coinbase at 13:45 UTC. Notice the very long candles, as bots set to sell at $20,000 sell directly into the pump.
Lots of people deposited stablecoins to exchanges 7 mins before breaking $20k.Note that "7 mins" is about one Bitcoin block time, and by "exchange users" he means "addresses — it could have been a pre-programmed "smart contract".
Price is all about consensus. I guess the sentiment turned around to buy $BTC at that time.
ETH block interval is 10-20 seconds.
This chart means 127 exchange users worldwide were trying to deposit #stablecoins in a single block — 10 seconds.
 David Gerard points out that:
USDC loudly touts claims that it’s well-regulated, and implies that it’s audited. But USDC is not audited — accountants Grant Thornton sign a monthly attestation that Centre have told them particular things, and that the paperwork shows the right numbers.