Stablecoins are a key cog in the cryptocurrency machine. The recent bull market has rekindled a long-simmering debate over whether the biggest such coin is, well, stable.

While bitcoin, ether and altcoins have seen astounding price rallies over the past four months, some of the most important growth has been in the cryptocurrencies known as stablecoins. These blockchain-based assets, usually pegged to the U.S. dollar, are a critical part of cryptocurrency trading activity and have taken in billions from investors who use them on exchanges around the world. 

The biggest of them all, tether (USDT), has an eye-popping $25 billion market capitalization. However, tether’s critics charge its lack of transparency in everything from finances to the way its issuing company operates threatens the overall crypto market. 

At issue is one of the most fundamental questions hanging over the cryptocurrency markets: Is the price of bitcoin and other cryptocurrencies inflated because the backing of tether may not be as strong as people think it is? 

Despite hitting a $1 trillion market capitalization in January, freely floating cryptocurrencies, though more liquid than before, are still quite volatile. For example, for the past five years, bitcoin hasn’t been able to consistently maintain a 30-day volatility below 20% as gold does. This makes claims that bitcoin is “digital gold” a poor fit, which is where stablecoins come in.

Jeremy Allaire, chief executive officer of Circle, part of the CENTRE Consortium (with Coinbase) that manages USD coin (USDC), says cryptocurrency market traders need stablecoins to move quickly given constantly gyrating digital asset prices. 

“If you’re active in the markets, you’re going to keep your money in a stablecoin because it’s radically faster, cheaper, better than the legacy banking system,” he told CoinDesk. 

Allaire’s USDC is in many ways the sort of transparent enterprise stablecoins promise to be. A top 20 crypto asset, it has almost $5 billion in market capitalization and $2.7 billion in daily trading volume as of press time. Every month, the CENTRE Consortium publishes attestations from accounting firm Grant Thornton LLP to prove the amount of USDC in circulation matches up with the amount of dollars in a bank account, meaning the asset is fully backed by dollars. In accounting-speak, attestations are different from audits. Auditing is defined as an independent examination of data, whereas attestations evaluate and review how true data is. 

Just a year ago, USDC’s market capitalization was merely $445 million. It saw a tenfold rise as the crypto markets skyrocketed amid uncertain times.

While USDC is one of the more successful stablecoins, it’s relatively small compared to its most formidable and controversial competitor, one that is dominating the sector. The largest stablecoin – and the third largest cryptocurrency – in the entire digital asset ecosystem is tether (USDT). 

In the past year, tether’s market capitalization has risen from $4.2 billion to a whopping $25 billion. In a span of four days in 2020, from March 31 to April 3, its market capitalization jumped by $2.1 billion alone. 

“We’re not sure that anyone could have foreseen this level of growth and use cases of tether at the very beginning. We were confident that it was a useful token, but didn’t anticipate quite how useful it could be,” Paolo Ardoino, the chief technology officer of Tether and the cryptocurrency exchange Bitfinex, told CoinDesk

So far in January alone, Tether has plowed $3.8 billion more USDT into the crypto ecosystem.

It is true that Tether is likely an original. It is a project that started as Realcoin, founded in 2014 by entrepreneurs Brock Pierce, Craig Sellars and Reeve Collins. Nonetheless, many in the industry – and law enforcement – have questioned its legitimacy. Multiple ongoing investigations, including from the U.S. Department of Justice (DOJ) and the New York Attorney General’s office, have dogged the stablecoin company. At the center of the DOJ’s criminal investigation into Tether as an organization is whether or not USDT is used to inflate the cryptocurrency markets. 

Tether General Counsel Stuart Hoegner provided this statement to CoinDesk regarding the U.S. investigations: “We work with regulators and law enforcement agencies around the world to help their investigations and help them understand our business. We always want to support law enforcement’s legitimate objectives. With respect to the New York Attorney General’s special proceeding, we believe that our discussions with their office has been constructive and we look forward to continuing the conversation.”

Like USDC, USDT is closely associated with an exchange; USDC is used on Coinbase’s exchange and USDT is utilized on Bitfinex, although both are also used on other exchanges. But the behavior of the two assets on the two exchanges is quite different, according to data analytics firm CryptoQuant. 

“Compared to bitcoin, there’s no multiple stablecoin addresses for exchanges,” Ki Young Ju, chief executive officer of CryptoQuant, told CoinDesk. Because of this, Ki’s firm has been able to use data from exchanges to calculate what it calls a “stablecoin ratio.” The calculation is the bitcoin reserves from known hot wallets in U.S. dollar (USD) terms divided by the stablecoin reserve addresses exchanges. The higher the ratio, the higher the selling pressure.

“The ratio for stablecoins like USDC is like 18%-25%,” depending on the exchange, said Young Ju. “But tether is just 7%, meaning most of the demand didn’t come from exchanges.”

So where is the demand coming from? While USDT does have a transparency page on its website showing assets and liabilities, it does not appear to provide a regular attestation from any third party that the amount of USDT in circulation matches a bank account somewhere. 

John Griffin, a professor at the University of Texas, wrote with Amin Shams, a former student who is now a professor in the Department of Finance at Ohio State University’s Fisher College of Business, the academic peer-reviewed paper “Is Bitcoin Really Un-Tethered?”

The 2018 paper said one entity, demarcated in the paper with a single bitcoin address, exerted a remarkable amount of control over the bitcoin bull market in 2017 by minting tether that was then used to buy bitcoin. “We find that one large player is associated with more than half of the exchange of tether for bitcoin at Bitfinex, suggesting that the distribution of tether into the market is from a large player and not many different investors bringing cash to Bitfinex to purchase tether,” according to the research. 

The report added that very little tether is returned to the issuer to be redeemed, suggesting the crypto market is at least somewhat inflated by the USDT used by that address to buy bitcoin during the 2017 bull market time period.

Bitfinex/Tether did not respond to specific inquiries regarding the paper, which was updated in 2019. However, in a blog post they slammed the study. 

“We have now reviewed the updated Tether article by John M. Griffin and Amin Shams,” begins a Bitfinex blog post from Nov. 7, 2019. “The purported conclusions reached by the authors are built on a house of cards that suffers from the absence of a complete dataset.”

In response, Griffin and Shams disputed that a complete dataset wasn’t used and said blockchain data is easier to obtain for analysis than most realize. They also said it took them a long time to parse and verify all the data to come to the conclusions they did for peer review and publishing.

“One of the things that our paper found is that tether was being printed unbacked and being used to push up cryptocurrency,” Griffin told CoinDesk. “At the time that we printed our paper Tether rigorously denied that.”

However, Bitfinex’s general counsel, Stuart Hoegner, who also represents Tether, conceded in an affidavit filed in a case brought by the New York Attorney General that at least as of April 2019, Tether assets circulating in the crypto ecosystem were only 74% backed by cash and cash equivalents. The case alleges Bitfinex lost $850 million and subsequently used funds from Tether to secretly cover the shortfall.

When asked by CoinDesk to provide specific information regarding redemptions and issuances, Bitfinex’s Ardoino gave this answer: “Much of the information for which you’re looking is available on public blockchains. The data shows that demand for redemptions is far surpassed by the demand for issuances.”

In 2018, the DOJ’s Criminal Division awarded Griffin’s forensic data analysis firm, Integra FEC, $400,000 for “Tether Investigation,” according to a previous version of the contract’s webpage. On Dec. 27, 2020, the contract was updated to reflect completion before the end of 2021, although there is no longer any reference to Tether on the site. 

Shams, Griffin’s collaborator on the paper, doesn’t have any involvement with Integra FEC and told CoinDesk he has not taken any money for his research. He says the paper was well-received in the academic community but believes, like Griffin, that it should be taken more seriously in the cryptocurrency ecosystem, especially given the rigorous peer-review process. 

Shams noted the paper was published in the Journal of Finance, which according to statistics on its official website, has accepted only 4.38% of submissions since 2016. “It’s by far the best finance journal,” he said.

An unlikely defender of tether is CEO Allaire. He is one example of a longtime participant in the cryptocurrency community who isn’t convinced tether has undue influence on the crypto market. 

“I think what I can say is the academic theory that they have run a giant fraud to create tether out of thin air, to buy bitcoin, to drive up prices, I think that’s complete BS,” Allaire told CoinDesk. “If you want to deploy capital into the markets, you do it through stablecoins and then you go bring those dollars into the markets and you buy things and trade things.”

“In particular in Asia where, you know, these are dollar-denominated markets, they have to use a shadow banking system to do it,” Allaire said. “You can’t connect a bank account in China to Binance or Huobi. So you have to do it through shadow banking and they do it through tether. And so it just represents the aggregate demand. Investors and users in Asia – it’s a huge, huge piece of it.”

When Allaire refers to “shadow banking” he’s talking about a term created back in 2007 by an economist to refer to unregulated or lightly regulated non-bank financial institutions. The problem is, shadow banks are not backed by typical FDIC insurance to protect deposits in the U.S. Also, shadow banks were singled out as nefarious participants in the 2008 financial crisis. 

When asked about how Tether helps those without proper banking, Ardoino says the liquidity component of USDT is key to the crypto exchange ecosystem. “Tether allows for a more efficient experience across exchange platforms and in digital token commerce more generally,” Ardoino said. “Tether realized early on the importance of a common asset in the crypto ecosystem that can be used seamlessly across multiple blockchains and communities to access and provide liquidity.”

However, Griffin compares problems with tether to traditional financial markets and highlights a gap the stablecoin still has to bridge. 

“Having a stablecoin and using stablecoins in the space is a good idea, but you need to have a stablecoin that undergoes proper auditing and proper monitoring,” Griffin told CoinDesk. “It would be equivalent to saying, ‘Hey, let’s make an [exchange-traded fund] in the U.S. on the Russian ruble,’ and then you got the North Koreans and [Russian President] Putin manipulating the ruble,” he said. “And then you wonder, like, well, ‘I wonder why the ruble went up so much this weekend?’”

Kevin Lehtiniitty is the chief strategy officer of Prime Trust, a Nevada-based trust company that has worked extensively with stablecoins. The firm, as a financial institution, has developed a “stablecoin as a service” product for the crypto market, providing custody, payments and instructing of the minting and burning of stable tokens for exchange. 

“We were the first financial institution to be a stablecoin as a service provider,”  Lehtiniitty told CoinDesk. “Basically the exchange is a technology layer on top of the stablecoin.”

Prime Trust has worked with over 38 stablecoin products, the first being the venture capital-backed TrueUSD in 2018. “Now, obviously, 38 stablecoins are not going to win,” said Lehtiniitty. “It’s going to be kind of like a winner or top two or three take all kind of a market.”

Lehtiniitty did not mince words on his thoughts about stablecoins without transparent asset backing, calling tether a “partial reserve stablecoin.” “I think the general market sentiment, at least from our perspective, is that people know that – people just don’t think it’s going to crash when they are doing what they are doing.”

“What are the odds that it’s going to crash in the next few hours that I’m holding?” Lehtiniitty continued. ”And that’s that is the world’s dumbest excuse. But I hear it time and time again from OTC and trading partners, other folks, and it drives me nuts.”

Yet, it likely would take a loss of tether’s peg to the dollar for anyone to even raise any alarm because market forces appear to be keeping prices in line, according to another paper, funded by Ripple, called “What Keeps Stablecoins Stable?” by Richard K. Lyons of University of California, Berkeley and Ganesh Viswanath-Natraj University of Warwick.

That paper argues that traders are helping stabilize prices around the peg. And while tether’s peg to the U.S. dollar hasn’t dipped in quite some time, it has happened before, the paper points out.

“A lot of very well capitalized people believe that tether is better off existing than not,” Lehtiniitty said. He pointed to the May 2019 $1 billion LEO token offering Bitfinex conducted as an example. “They were willing to put their money where their mouth was to the tune of a tremendous amount of capital to keep tether propped up,” Lehtiniitty added.

In the U.S., the Office of the Comptroller of Currency (OCC) has said this month that federally regulated banks can use stablecoins for payments and other services. Also this month, the U.K. released a paper and request for commentary on the use of stablecoins in finance. 

All of this, Lehtiniitty suspects, is to build a framework around stablecoins backed by banking in an effort to weed out possible systemic risks that partial-reserve stablecoins like tether may cause should a peg break. 

“The only way tether kind of stops and we then go to fully backed stablecoins is regulatory pressure. And what I mean by that is basically saying banks can deal with fully reserved stablecoins, not with other types of stablecoins,” he said.

In a recent video interview, Gregory Pepin, the deputy CEO of Tether’s bank, Deltec, said, “Every tether is backed by a reserve and their reserve is more than what is in circulation.” 

More trouble for Tether as an organization looms on the horizon. A federal criminal trial involving real estate investor Reggie Fowler, who was involved in allegedly providing Tether and Bitfinex with shadow banking at one point, is underway in New York. In the case brought by that state’s attorney general, key documents were supposed to be provided by Bitfinex and Tether by Jan. 15. And the DOJ’s Criminal Division investigation is ongoing with Integra’s contract running until the end of 2021.

Even USDC’s Allaire regards Tether as pretty non-transparent. “They’re very opaque about a lot of things,” he told CoinDesk.