Tether, regulated or not?
Newcomers to the crypto space are quickly confronted with a popular distinction between regulated stablecoins and unregulated stablecoins. But what is the difference? Tether, the largest of the stablecoins, is often described as unregulated. But Tether executives and supporters disagree with this claim. Who is right?
Tether is the most popular medium of exchange in the crypto economy. With almost $25 billion worth of U.S. dollar tether stablecoins in existence, it has become one of the world's largest non-bank issuers of dollars. For context, there are around $32.5 billion worth of PayPal balances outstanding. It took PayPal 20+ years to get to this level. Tether did it in just six!
Tether’s story is even more intriguing as it has been dogged for years by speculation that its reserves are deficient. In fact, New York Attorney General Letitia James is currently investigating Bitfinex, a Tether affiliate, for allegedly violating New York securities law by using Tether reserves to cover up losses.
For potential users of stablecoins, it’s easy to be confused by these mixed signals. Tether's incredible growth implies a high degree of market confidence in the stablecoin, yet persistent rumors about its reserves say the opposite.
One of the rules of thumb that anyone can use for establishing trust in a financial institution is the presence of regulation. Is there a neutral government body that supervises or regulates a financial institution’s finances? If so, that provides users with a layer of protection.
Unfortunately, even the topic of regulation can be confusing. Podcaster Laura Shin recently had a conversation with Deltec Deputy CEO Gregory Pepin, Tether's banker. Pepin was addressing recent accusations that Tether does not have a sufficient number of dollars in its bank account for each Tether issued. The conversation turns to regulation at 20:50 when Shin asks Pepin whether Tether is regulated or not:
Shin: Can you name a regulator for Tether?
Pepin: The regulator related to Tether, and related to Paxos and USD Coin and all of them, they're all registered FinCEN. And that means that for AML and KYC [anti-money laundering and know your customer], and that’s what matters the most because if you look at all the comments from Janet Yellen, it’s all about money laundering and terrorism. And at that level they're all regulated the same, they're all registered with FinCEN.
In his response, Pepin maintains that Tether is regulated. And he suggests that it is Tether's registration with FinCEN that imbues Tether with regulated status, putting it on par with its stablecoin competitors such as USD Coin, which are also registered with FinCEN. FinCEN, by the way, is the Financial Crimes Enforcement Network, a bureau of the US Department of the Treasury that defines rules for combating money laundering.
Paolo Ardoino, Tether's chief technology officer, has also made the same claim about Tether being on par with other stablecoins because it is “regulated under FinCEN.”
Tether's general counsel, Stuart Hoegner, has also made the same suggestion. In response to a question on Twitter about how Tether is regulated, Hoegner implies that it is Tether’s registration with FinCEN that qualifies Tether as a regulated financial institution:
So here we have a datapoint that might assuage the worries of crypto neophytes about Tether backing. Tether is regulated, so presumably users are protected.
Unfortunately, this claim is misleading.
Tether isn't regulated by FinCEN. Rather, it is registered with FinCEN. These two R words are quite different. When an institution is registered with FinCEN, this means FinCEN has provided it with an electronic account for uploading suspicious transaction reports (SARs) and $10,000 cash transaction reports (CTRs). As per FinCEN requirements, a registered entity must also implement measures for collecting and verifying the identity of customers.
While it is commendable that Tether has chosen to register itself with FinCEN, collect customer information and regularly file SARs, there’s nothing special about this status. Even Dale & Jackie's Discount Liquor in Decatur, Ill., is registered with FinCEN:
By the way, take a look at the disclaimer FinCEN tacks on at the bottom of Dale & Jackie's registration status. "The inclusion of a business on the MSB Registrant Search Web page is not a recommendation, certification of legitimacy or endorsement of the business by any government agency." In other words, neither Dale & Jackie's Discount Liquor nor Tether should be advertising its registration with FinCEN as a regulatory seal of approval. Yet, this is what Deltec and Tether executives seem to be doing on Twitter and in podcasts.
What neophyte stablecoin users need to understand is FinCEN doesn’t provide a financial regulatory framework for money services businesses like Tether, PayPal or Dale & Jackie’s. That is, FinCEN doesn't care about Dale & Jackie's capitalization or its net worth. It doesn’t check to see if the dollars that these issuers create are 100% backed.
We have a separate set of government institutions that vet money services businesses for capital adequacy and sufficient backing. In the U.S., the financial regulation of money services businesses is carried out by state financial services departments. (Here is a list).
PayPal, which I mentioned above, is regulated as a money services business in over 50 different U.S. states. Circle and Coinbase, which together issue the second-largest stablecoin, USD coin, are licensed by multiple state financial services departments.
Each state financial services regulator has its own rules, but in general they all require money services businesses to limit their investments to a range of permissible securities, to post a surety bond or letter of credit with the regulator as security, and/or to maintain minimum net worth requirements. Money services businesses must also provide their state financial services regulator with yearly audited financial statements and submit to examinations when required. State regulators often stipulate background checks on executives and directors in order to prevent fraud.
Stablecoins Paxos standard and Gemini dollar are regulated a bit differently than USD coin. Issuers Gemini Trust and Paxos Trust are licensed by a single state financial services department, the New York State Department of Financial Services ( NYDFS), to operate as limited purpose trust companies. To qualify, they are obligated to meet the same standards a bank would. (The requirements are here).
So PayPal, Coinbase, Circle, Gemini Trust and Paxos Trust all have the distinction of being able to tell the public the dollars they issue must adhere to a specific financial regulatory framework created for money services businesses. That is, customers have some guarantee that a regulator is setting quality standards for the dollars fabricated by these issuers.
Tether, by contrast, is not regulated by the NYDFS. Nor is it regulated by any other U.S. state financial services department.
We know that Tether has a connection to the Bahamas (Deltec, after all, is located there) but a quick check of the Central Bank of Bahamas (CBB) registry reveals that Tether isn't licensed with the CBB as a money transmission business or as an electronic money service provider. Tether is incorporated in the British Virgin Islands, but a search of the British Virgin Islands Financial Services Commission, which regulates BVI-based banks and money services businesses, does not reveal Tether to be one of its regulated entities.
So if Pepin, Ardoino and Hoegner want to assuage public worries about Tether’s reserves by claiming that Tether operates under some sort of financial regulatory framework, then they need to tell us: What exactly is the government body that is acting as the financial supervisor?
FinCEN registration should not be invoked in a debate over how financially secure Tether is. When it comes to questions about a money services business’s reserves, the pertinent regulator would be something like NYDFS or another state financial services department or the Bahamas central bank (which has a licensing framework for money services businesses). Only these regulators make it their job to check out a money services business’ financial statements, vet executives and directors and set rules about permissible investments. FinCEN doesn't.
It's not a sin to be an unregulated financial institution. There are plenty of well-run and legitimate money services businesses that do not operate under any particular financial regulatory framework. However, it is a sin for a financial institution to claim that its finances are regulated – and point to FinCEN registration as evidence for that – when in fact it does not adhere to any specific financial regulatory framework. That's false advertising.