October 28, 2024 | Read Online

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"There is nothing more deceptive than an obvious fact."

— Arthur Conan Doyle

Crypto's Gray Rhino risk

In 2013, US federal prosecutors filed an indictment against Liberty Reserve SA, the issuer of a dollar-pegged digital currency (also called Liberty Reserve), as well as its co-founders and executives.

The indictment described the proto-stablecoin as "the primary form of money laundering used by cyber criminals worldwide."

This made its issuer a "black market bank," according to the lead prosecutor, US attorney Preet Bharara, that was created and structured to "facilitate criminal activity."

The accused had claimed to simply be facilitating international payments.

Among other legitimate uses, Liberty Reserve was one of the main methods of purchasing bitcoin, making it "one of the chief enablers of the Bitcoin economy's early growth," as the budding crypto journalist Vitalik Buterin reported at the time.

But the accused had little chance to mount its defense.

Due to its dependence on the US banking system, Liberty Reserve's accusers also served as judge, jury and executioner — the currency effectively ceased to exist as soon as the indictment was filed.

If you read the Wall Street Journal this weekend, you may see where I'm going with this.

"The federal government is investigating cryptocurrency company Tether for possible violations of sanctions and anti-money-laundering rules," the Journal reported.

"The criminal investigation, run by prosecutors at the Manhattan US attorney's office, is looking at whether the cryptocurrency has been used by third parties to fund illegal activities such as the drug trade, terrorism and hacking — or launder the proceeds generated by them."

This is the same Manhattan attorney's office that prosecuted Liberty Reserve in 2013, alleging the same crimes.

If the Journal's reporting is correct, the consequences may be about the same, too.

"The Treasury Department, meanwhile, has been considering sanctioning Tether because of its cryptocurrency's widespread use by individuals and groups sanctioned by the US, including the terrorist group Hamas and Russian arms dealers. Sanctions against Tether would generally prohibit Americans from doing business with the company."

That may not sound too worrying to crypto natives accustomed to seeing Americans blocked from doing business with crypto companies.

But in the case of a stablecoin issuer, it should be very worrying, because most of Tether's assets are controlled by American bankers.

As a result, if the US government sanctions Tether, holders of its USDT stablecoin seem likely to face a total — and permanent — loss.

This would not be an FTX situation where a conservator is brought in to distribute Tether's assets to its creditors (aka, USDT holders).

Instead, the assets seem likely to be seized — and probably kept — by the US government.

That, at least, was the fate of Liberty Reserve. The assets that backed its digital currency were indiscriminately treated by prosecutors as the proceeds of crime.

As the New York Times reported in 2013, prosecutors might have considered otherwise: "Mr. Bharara said the exchange's clientele was largely made up of criminals, but he invited any legitimate users to contact his office to get their money back."

If any of Liberty Reserve's users bothered to try, the attempt left no discernable trail on the internet — the US government appears to have kept the money they seized from dozens of Liberty Reserve's banks.

As it turned out, they only scraped together about $40 million — a small fraction of the $6 billion of funds Liberty Reserve was accused of laundering.

That's probably because Liberty Reserve's users really were mostly criminals and as such, they knew to cash out their suspect digital currency as soon as possible.

Liberty Reserve itself, knowing the risk of indictment was high, was busy stashing funds in a tangle of shell companies when its assets were seized.

This is where the Tether story diverges, because only a small fraction of stablecoin transactions are complicit in facilitating illegal activity (probably smaller than the fraction of US dollars, even).

So perhaps the US government would make an effort to accommodate USDT's many legitimate users.

But I'm not sure how.

Tether, by design, has no record of who its customers are, so there would be no straightforward way for the US government to disentangle Tether's many legitimate users from its small minority of illegitimate ones.

Maybe legitimate users would again be invited to contact the US attorney's office in Manhattan to make a claim, but good luck with that — I doubt any such claims would trade for much more than $0.

But I may be missing something because the market has had little, if any, reaction to the Wall Street Journal's reporting that Tether faces imminent legal action — Tether's AUM has not budged.

This is puzzling to me.

If you ascribe even a small probability to the Journal being correct, why not switch into USDC or any other of Tether's functionally identical competitors?

Perhaps USDT holders are taking Tether's response that "the allegations in the article are unequivocally false" at face value.

Or perhaps they've heard so much anti-Tether reporting for so many years that it no longer registers.

For whatever reason, USDT holders appear to ascribe zero probability to the Journal being correct and that could be setting us up for a shocking reaction to an unsurprising event — Tether's legal jeopardy may be a "gray rhino" that everyone knows about, but no one is prepared for.

Whatever the merits of the Journal's reporting, the risk of asset seizure at Tether feels like one of Arthur Conan Doyle's obvious facts that the crypto market is deceptively ignoring.

— Byron Gilliam

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