Tether has been one of the most controversial topics in the cryptocurrency community over the last two years — and things have come to a head over the past few weeks.

The wider crypto community has been skeptical of the stablecoin and its claims that it was operating legitimately, due to concerns around its reserve policy.

Stablecoins are centralized cryptocurrencies that are typically pegged to a fiat currency like the United States dollar or valuable commodities like oil or gold. Tether (USDT) claimed to be backed by the U.S. Dollar at a 1:1 ratio.

For the last two years, industry critics have speculated that Tether did not have the necessary cash reserves in its bank accounts to back the amount of USDT in circulation.

Those claims have finally been validated by Tether itself as a result of an ongoing legal battle involving cryptocurrency exchange Bitfinex — which shares personnel and ownership structures with Tether — and the Office of the New York Attorney General (OAG).

Tether’s history

Tether’s journey began back in 2015, with its rebranding from realcoin. It was founded by Brock Pierce, the director of the Bitcoin Foundation, with the help of software engineer Craig Sellars and entrepreneur Reeve Collins.

Tether aimed to provide a true stablecoin platform for the crypto community with a utility token that was backed by the U.S. Dollar at a 1:1 ratio, with all the benefits of traditional blockchain technology.

The cryptocurrency was built and is operated using an OmnilLayer platform on the bitcoin protocol. This allows anyone to see whenever tether tokens are issued, which has played a big role in the focus on the stablecoin in the past 24 months.

The Bitfinex connection

Tether has had an association with Bitfinex since 2015, when the exchange integrated the cryptocurrency operation into its exchange. The two companies are operated by parent company iFinex.

Tether’s website shows that the two companies share the same leadership, with JL van der Velde listed as the CEO of both companies. Giancarlo Devasini is the chief financial operator of both Tether and Bitfinex.

Critics started raising concerns about Tether and Bitfinex’s connection and operations toward the end of 2017, as bitcoin rallied during its famous bull run.

To allay these fears, Tether employed Friedmann LLP to conduct a short review of its accounts in September 2017. The unofficial audit was met with further criticism by the crypto community, and an eventual subpoena from the Commodity Futures Trading Commission (CFTC) in December 2017 put the pressure back on the company.

Tether got Friedmann back on board to conduct a full third-party audit of its accounts this time around. But less than a month into the process, the parties split, with Tether claiming that the auditors were taking too long to carry out the job.

The crypto community never got a third-party audit from Tether, which could have allayed concerns considerably.

Bitfinex accused of using Tether reserves to plug losses

Fast forward to April 2019, an investigation started in 2018 into iFinex, Bitfinex and Tether was revealed by the Office of the New York Attorney General in 2019.

The OAG alleged that Bitfinex had lost $850 million of funds needed for user redemptions and borrowed money from Tether’s cash reserves to plug the gap.

Attorney General Letitia James announced the court filing that alleged that Bitfinex had then used $850 million from Tether’s reserves to cover a shortfall due to funds of its payments processor, Crypto Capital Corp., being seized in several different countries:

“Our investigation has determined that the operators of the ‘Bitfinex’ trading platform, who also control the ‘tether’ virtual currency, have engaged in a cover-up to hide the apparent loss of $850 million dollars of co-mingled client and corporate funds. New York state has led the way in requiring virtual currency businesses to operate according to the law. And we will continue to stand-up for investors and seek justice on their behalf when misled or cheated by any of these companies.”

The OAG wants the companies to stop using or spending the U.S. dollars that came from Tether’s reserves. It is also requesting the companies produce documents and information related to the ongoing investigation.

However, the OAG is also looking to obtain an injunction that will compel Bitfinex and Tether to continue their operations to ensure the stability of the crypto markets and protect its customers.

The Martin Act affords the attorney general of New York extensive law enforcement powers to investigate issues relating to securities fraud as well as bringing criminal charges toward those responsible for alleged violations of the act.

Tether, Bitfinex hit back

Tether and Bitfinex have not hesitated to tackle the New York OAG and its intended course of action against them.

The companies responded to the allegations brought forward by the OAG last week, claiming court filings were “riddled with false assertions.” They continued:

“The New York Attorney General’s court filings were written in bad faith and are riddled with false assertions, including as to a purported $850 million ‘loss’ at Crypto Capital. On the contrary, we have been informed that these Crypto Capital amounts are not lost but have been, in fact, seized and safeguarded. We are and have been actively working to exercise our rights and remedies and get those funds released.”

Both parties are insistent that the OAG has overstepped the mark and that its court filings could ultimately harm its customers.

However, Tether’s appeal has revealed a fact that has long been feared by critics. The legal documents from Tether show that it only has 74% of cash reserves in its bank accounts to back circulating Tether tokens:

“In fact, Tether’s reserves of cash and cash equivalents alone (without the line of credit) would cover approximately 74 percent of the outstanding amount of tether. This sort of “fractional” reserving arrangement is similar to how commercial banks work. No bank holds in liquid cash more than a small percentage of depositors’ money. The funds are invested. The markets clearly remain confident in tether, as it currently trades just shy of $1 dollar per U.S. Dollar tether — even after the Attorney General’s highly inflammatory and misleading public application. Any suggestion that tether holders face liquidity risk is unsupported speculation.”

This finally proves that Tether is not fully collateralized by cash equivalents, as it had claimed for an extended period of time.

Its lawyers also directly likened their operation to that of “fractional” reserve arrangement commonly used by commercial banks. This is at odds with information Cointelegraph was given by Tether two months ago.

In March, Cointelegraph had contacted Tether for comment on a change to its website that indicated that tether tokens were no longer backed by only cash but by “cash equivalents” as well. According to the change, that would “include other assets and receivables from loans made by Tether to third parties, which may include affiliated entities (collectively, ‘reserves’).”

Stuart Hoegner, general counsel at Tether, told Cointelegraph that it was not running a fractional reserves and that it was able to handle all redemption requests for USDT:

“Tether is not operating a fractional reserve. It does not have a banking business lending out reserve amounts to retail customers. Tether's reserves remain, and have always been, 100% backed by its reserves. Tether maintains the ability to honour all redemption requests.”

Latest events

This week, parent company iFinex filed court papers in an effort to vacate the OAG’s court order. The company claims that the OAG’s injunction is based on “incorrect facts and the wrong legal standard.”

IFinex argues that the OAG did not provide substantial evidence for its claims that tethers qualify as securities or commodities covered by the Martin Act. Furthermore the company believes that the attorney general cannot prove that an injunction is fully appropriate.

The company further argues that the OAG’s injunction is hugely disruptive to both Tether’s and Bitfinex’s operations because it freezes the use of $2 billion of Tether’s reserves, which could be used for further investment.

IFinex believes that Tether was transparent with users and investors about its reserves, and the possibility that those reserves could be loaned out to affiliate businesses like Bitfixex:

“The undisputed facts show that there was no ongoing fraud, and no ‘victims’ in need of the drastic remedy of an injunction to protect them. Specifically, there is no dispute that Tether disclosed that its reserves could consist of loans to affiliates, and did so before the line of credit transaction the Attorney General challenges.”

Despite all of the activity over the last two weeks, Tether is still trading at a 1:1 ratio with the U.S. dollar, with a market capitalization of over $2,7 billion, according to data from CoinMarketCap.

It should be noted that on May 6 CoinMarketCap has excluded Bitfinex trading data for its global average bitcoin price due to the cryptocurrency’s $300 premium on its exchange.

Bitfinex mulling native token launch?

While controversy surrounds both companies, Bitfinex is reportedly on the cusp of launching its very own native token in an ambitious launch.

According to initial reports, Bitfinex shareholder Zhao Dong has revealed details of a $1 billion initial exchange offering (IEO) for the native token launch. This was followed by the release of a promotional document by Dong on Twitter that outlines the plans for the IEO.

It is reported that the IEO will include a total supply of 1 billion tokens - dubbed LEO. Tokens will be priced at $1 each, but investors will be required to put forward a minimum buy in of $1 million.

It is understood that more that investors have expressed interest in $500 million in tokens already. Reports also claim that only qualified foreign investors will be permitted to make investments and a soft commitment to the IEO by May 5.

Prospective investors will be given the chance to review the token’s white paper before either confirming or cancelling their soft commitment. If they wish to continue with their involvement, a 10% deposit will be required.

According to the marketing material released by Dong on Twitter, U.S. citizens and a number of other jurisdictions listed by the Financial Action Task Force will not be able to participate in the token sale.

LEO token holders will reportedly benefit from reduced crypto-to-crypto trading fees on Bitfinex’s exchange as well as iFinex’s decentralized exchange, EOSfinex.

The token is being likened to Binance’s native BNB token.

What’s next?

Cointelegraph has reached out to Tether’s general counsel, Stuart Hoegner, for comment in relation to the ongoing disputes between these parties and the OAG.

As it stands, both companies seem to be continuing with their operations and the OAG has made it clear that it does not wish to harm investors and customers of Tether and Bitfinex during its investigation.

With an in-depth investigation underway, details may be few and far between but this story will be one to keep an eye on in the weeks and months to come.