Thursday, June 30, 2022

Watching Tether


This is a quick post to share some of the things I've learnt from watching Tether over the last two months. I'm hoping other Tether watchers find this information useful and share some of their own Tether watching tricks in the comments section. (No conspiracy theories, please. Just analysis).

There's two sides to watching Tether. You can observe its real-world activity like its attestation reports, press releases, brushes with the law, and its social media accounts. Or you can follow its life on the blockchain, where it issues digital stablecoins. This post focuses on the latter. In particular, I'm going to analyze the blockchain for redemptions: those on-chain transactions in which Tether units move from Tether customers back to Tether itself.

I'm going to assume some basic knowledge of Tether and blockchain analysis.

To understand how Tether works on-chain, the most important wallets to track are Tether's two treasury wallets. Tether's Tron-based treasury wallet is located here, and the Ethereum-based wallet is here. (Tether also issues tokens onto other blockchains, but the amounts are relatively small, so for simplicity's sake I'm going to focus on Ethereum and Tron-based Tether activity.)

All Tether units begin and end their life in Tether's treasury wallets.

They begin life when Tether creates, or mints, new units. As long as they remain in Tether's two treasury wallets, these new units are not yet officially in circulation. Tether tokens only enter circulation when Tether issues themor transfers themfrom its treasury wallet to a customer.

Tether mints new units only rarely, and when it does, in large sizes.

In the 350 days from July 1, 2021 to June 15, 2022, Tether minted 24 times on Tron and 9 times on Ethereum. That's around one minting every ten days.

Tether almost always mints in $1 billion increments. This $1 billion balance gets slowly drawn down as customers submit requests to Tether for small batches of Tether units, often in the $10 million to $100 million range. Effectively, this means that Tether's two treasury wallet usually hold a large multi-million working inventory of non-circulating Tether units.

These balances of freshly-minted non-circulating Tether are regularly augmented by inflows of redeemed Tether units. Redemptions occur when customers transfer their unwanted Tether tokens to Tether's treasury wallet to be redeemed for a wire transfer of regular dollars. Each redemption reduces the quantity of Tether in circulation while increasing the quantity of non-circulating Tether units sitting in Tether's treasury wallets.

In the 350 days from July 1, 2021 to June 15, 2022, I count 432 redemptions (177 Tron, 255 Ethereum). That's an average of over one redemption per day.

Tether doesn't destroy, or burn, each incoming Tether redemption. It waits for a number of redemptions to accumulate in its treasury wallet and then burns them all in one big batch.

In the 350 days from July 2021 to June 15, 2022, I count just 12 burns (11 Tron, 1 Ethereum). The amounts burnt are large, often over 1 billion.

So to summarize, the inventory of Tether tokens held in Tether's treasury wallets is determined by the number of incoming Tether tokens (from occasional mintings and frequent redemptions), and outgoing Tether (from occasional burns and frequent issuance).

I've charted out what this treasury working balance looks like going back to late 2021. Note that the chart combines both Tether's Tron and Ethereum treasury balances.

You can see that in 2021 and early 2022 Tether typically let its treasury wallet balances rise to $2-4 billion before burning them. In May and June 2022 it altered this practice by allowing them to balloon to over $10 billion. (Tether recently burnt 11.1 billion Tether units, bringing its working balance back to more normal levels.)

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Having worked out how treasury wallets function, I want to focus a bit more on the redemptions themselves. Of the 432 redemptions that I counted from July 2021 to June 15, 2022, a total of 133, or 31%, come from wallets tagged as being owned by Bitfinex, a cryptocurrency exchange owned by Tether's parent. (26 Tron, 107 Ethereum).

Bitfinex maintains two Ethereum addresses that hold Tether tokens (Bitfinex 2 and Bitfinex 3) and one Tron address.

Why do such a large proportion of transfers sent to Tether's treasury wallet originate from Bitfinex? 

What I believe is happening is that rather than sending redemptions directly to Tether's two treasury wallets, large traders often send them to Bitfinex instead. Once the Tether tokens arrive in Bitfinex's wallet, Bitfinex makes the trader whole by wiring them actual U.S. dollars. So from the trader's perspective, the redemption process is complete. They have cashed out their Tether units.

From Bitfinex's perspective, however, the redemption process is not done. 

Rather than sending traders' redeemed Tether tokens immediately to Tether for cancellation, Bitfinex generally holds them for a period of time. I suspect that Bitfinex delays these transfers so that it can meet incoming requests from traders for new Tether issuance out of its own inventory. A delay also allows Bitfinex to accumulate additional redeemed Tether tokens so that it can send the balance in one convenient end-of-period batch to Tether's treasury rather than multiple small transfers.
 
We have evidence that redemptions are happening via the intermediation of Bitfinex. In a 2021 article. Alameda Researcha crypto trading firmspoints to a set of Tether redemptions that it claims to have completed. They were all processed through Bitfinex rather than Tether. (ht @ Matt Ranger)

To get a feel for how Bitfinex manages its Tether balances, I've charted out the quantity of Tether balances held in Bitfinex's #2 wallet below. The chart covers May 1 to June 15, 2022. 

Admittedly, this was an unusual period of time for Tether due to record-high redemptions. (At one point in May it had built a balance of over 1.7 billion Tether units!) In any case, you can see how Bitfinex steadily accumulates Tether tokens as traders redeem Tether units. In the chart, each dot is a transfer into Bitfinex's #2 wallet. Once Bitfinex deems that balance to be large enough, it sends it all back to Tether's Ethereum treasury wallet for cancellation. The large collapses in the chart are when these transfers occur.

If you are interested in investigating Bitfinex's involvement in the redemption process closer, I've noticed that Bitfinex's #2 and #3 Ethereum wallets work together to manage Bitfinex's inventory of Ethereum-based Tether tokens.

The #3 wallets interfaces with the public. When the public wants to withdraw Tether units, Bitfinex sources the Tether units from its #3 wallet. Conversely, when the public makes deposits of Tether units they flow into Bitfinex's #3 wallet. When the balance of the #3 wallet rises above 105 million units, Bitfinex waterfalls all amounts in excess of $105 million into its #2 wallet. The inventory in the #2 wallet builds until it is deemed large enough by Bitfinex to be sent to Tether's treasury. (It's not always that cut and dried. I've seen Bitfinex transfer Tether units out of its #3 wallet to Tether's treasury wallet, thus bypassing the #3 wallet.)

Note that while Bitfinex manages its Ethereum-based Tether units using two wallets, it only uses one for Tron, which makes Tron-based analysis of Tether much more simple.

So let's sum up the on-chain Tether redemption process. There appear to be two routes by which Tether units can be redeemed. Some redemptions get sent directly to one of the Tether treasury wallets. Others get sent to Bitfinex. After a period of accumulating redeemed Tether units, Bitfinex eventually transmits the entire batch to Tether's treasury wallets for cancellation. At this point they fall out of circulation. After a period of time passes the quantity of Tether units sitting in treasury reaches a high enough trigger point that Tether burns it all, leaving its treasury wallets close to empty.

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To finish off, I want to provide a quick look at who is doing the redeeming, and why.

From May 12 to June 30, Tether has contracted by almost 17 billion units, or 20%, which means that a massive amount of redemptions have occurred. A single Tron wallet has been responsible for 3.3 billion worth of redemptions alone. We'll call it the 6DNE wallet after the last four digits in its address.

We can surmise why these redemptions have been occurring by looking more closely at 6DNE's transactions. 

Created on May 12, 2022, the 6DNE wallet has made 3.3 billion worth of transfers to Bitfinex in 108 separate deposits (as of June 30). The average deposit size is 30.5 million Tether units. Most of the Tether units that 6DNE acquires are sourced from wallets associated with three major exchanges: Kraken, Binance, and FTX. (It also acquires Tether units from these two wallets, which I suspect are Binance-satellite exchanges.)

Through much of May and June 2022, the U.S. dollar price of Tether units has regularly fallen below $0.999 on major exchanges like FTX and Kraken. Put differently, one Tether unit is worth a little bit less than an actual U.S. dollar. Prior to May 2022, Tether had clung quite closely to $1.00. To illustrate, I've included a chart of the trading price of Tether units in terms of U.S. dollars on FTX:

Tether's fall in price occurred because large amounts of Tether units were being desperately sold on markets like FTX as the crypto-economy deflated. Tether sets a redemption minimum of $100,000, which means that most Tether owners can't directly redeem unwanted Tether units via Tether's treasury wallets. That leaves them with no choice but to sell on exchanges.

This is where arbitrageurs like 6DNE step in. The owner of 6DNE appears to be buying Tether units in large multi-million batches on exchanges like Binance and FTX at prices of $0.9985 or so, and sending them to Bitfinex to be redeemed at $0.999. By harvesting the tiny $0.0005 difference between the purchase and sale price, the owner of 6DNE earns a near risk-free profit.

Arbitrage conducted by traders like 6DNE helps to prevent Tether's price from falling much below $0.9982 or $0.9981 on exchanges like FTX and Binance. This process doesn't work perfectly, though. On May 12 the price of Tether collapsed to 95¢ on major exchanges, as the chart above shows.

Note that I said that the trader is redeeming at $0.999, and not $1. This is because Bitfinex and Tether both charge a 0.1% wire fee. This fee reduces Tether's effective redemption price from $1 to $0.999.

Let's work out an actual trade. If the owner of the 6DNE wallet purchases 30 million Tether units on FTX at $0.9985 and sends them to Bitfinex to be redeemed at $0.999, the trader earns a profit of $15,000 ($0.0005 x 30 million). The owner of 6DNE may have to pay fees to FTX, which will eat into the bottom line. However, if the trader was making liquidity rather than taking it, fees may be zero to negligible

6DNE completed 3.3 billion in redemptions, which assuming a profit of $0.0005 per Tether unit translates into around $1.5 million in gains. Not bad for a two month's work.

After 6DNE's Tether units arrive at Bitfinex, Bitfinex holds them for a while and ultimately sends them to Tether's treasury wallet. At this point 6DNE's formerly-owned Tether units are officially out of circulation. And then after a few days or weeks, Tether burns them. They have ceased to exist.

And that, in short, is how and why Tether tokens flow from the market back to their issuer.

8 comments:

  1. Great post, many thanks

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  2. So do I understand you correctly in that:
    1. Bitfinex 2, Bitfinex 3 and the Tron address you mentioned hold exclusively redeemed USDT and
    2. there are other Bitfinex addresses (Bitfinex 1 supposedly) that correspond to Bitfinex's cold wallet where Bitfinex holds the USDT belonging to its customers?

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    Replies
    1. 1. In addition to Tether units, Bitfinex #2 and #3 also contain ETH and a number of other tokens. Bitfinex's Tron wallet also holds TRX.
      2. Apart from the wallets mentioned, I don't think there are any other Bitfinex wallets that hold Tether units.

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    2. If apart from the wallets mentioned there are no other Bitfinex wallets holding USDT, and the mentioned wallets are regularly emptied into the treasury wallet, then where are the deposited USDT of Bitfinex's customers?

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    3. My guess guess would be something like this...

      Let's say a bunch of customers deposit $100mm USDt at Bitfinex. These customers now own $100m worth of Bitfinex-issued USDt-denominated IOUs. Bitfinex sends the $100m in USDt over to Tether's treasury wallet. Tether then has its bank debit its US dollar account by $100mm and credit Bitfinex's account by $100m. So the Bitfinex IOUs that customers own are supported by $100mm sitting in Bitfinex's bank account. If customers all suddenly want to withdraw USDt, Bitfinex sends the $100mm back to Tether's bank account, buys $100mm worth of USDt, and pays those out to its customers.

      Just a guess, though.

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    4. Hm, that seems strange to me. It would mean that every USDT deposit on Bitfinex is, from Tether's perspective, a redemption. Every such redemption unnecessarily involves a fiat transfer (potentially costing banking fees) and a reduction in circulating USDT supply (resulting in a perceived loss of market share). So, what would be Bitfinex's or Tether's incentive to go through this procedure instead of simply letting Bitfinex store the deposited USDT in its wallet as it does with every other cryptocurrency?

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    5. In practice Bitfinex lets its balance of USDt build up, as the chart shows, so not every customer redemption corresponds to an immediate fiat transfer between Bitfinex and Tether -- they're processed in a big batch. Tether and Bitfinex probably use the same bank, so this transfer is very easy to do, and there may even be no fees involved.

      It's also possible that I never found all of Bitfinex's exchange wallets. If I did miss a wallet it'd probably be a Tron one --- compared to Etherscan, there's much less documentation on Tronscan, the blockchain explorer I used to document Tron activity.

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    6. I think you are right. I just looked up my past USDT deposits (via Tron) with Bitfinex and they are all immediately routed to TXFBqBbqJommqZf7BV8NNYzePh97UmJodJ. So, it seems Bitfinex doesn't have an own USDT wallet. While it is possible that there are compensating USD transactions (from Tether to Bitfinex) as you described, I think it's more likely that Bitfinex's and Tether's USDT are simply commingled and, consequently, their fiat USD are probably commingled as well. This would mean, that USD deposited with Bitfinex can be used for USDT redemptions. While that provides more leeway for Tether in case it suffers a liquidity bottleneck, it also means that Tether could possibly drag Bitfinex with it into insolvency. Your thoughts?

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