Eric Nguyen is busy at his computer, sending his Tether ERC-20 address so that a small business owner in Wilmington, Virginia, can send him 500 USDT as payment for website development.

Nguyen, and scores of other designers, developers and online services providers from across the emerging world love USDT or Tether, as it’s otherwise know.

Forget about credit cards and bank transfers, from Buenos Aires to Bangkok, Ho Chi Minh to Hangzhou, Tether is as good as the dollar, not just to circumvent strict capital controls, but also to avoid the payment of taxes.

While the pandemic has accelerated the rise of the digital economy, providing opportunity for millions of people in the emerging world to deliver services from design to development, copywriting to customer support, it’s also accelerated the adoption of Tether.

And for scores of freelancers and other individual service providers, there’s no better way than to be paid than by Tether, especially in countries with strict capital controls and taxes and bribes that would otherwise need to be paid.

In many cases, Tether isn’t just convenient to receive, it’s also easy to spend, with merchants and service providers across many emerging markets more than willing to accept USDT at a hundred cents in the dollar.

Not a Problem Until it Becomes One

But this Tether-based economy is in grave danger of becoming, well, untethered, through no fault of the legions of hardworking people accepting payment in USDT, but from the implosion of the cryptocurrency exchange FTX.

The collapse and alleged fraud perpetrated at FTX has been covered ad nauseum, and investigators from around the world are unraveling the web of companies and conflicts of interests embedded within the FTX crypto empire of its once feted founder, Sam Bankman-Fried (“SBF”).

Buried within the reams of disclosures, filings, investigations and reports, a small, seemingly obscure discovery may threaten to surface and unravel one of the biggest issues that holders and users of Tether have been dancing around for the longest time — its role in facilitating questionable flows of cash.

Among the many surprising assets uncovered in the bankruptcy of FTX, one of the more peculiar things owned by SBF’s sprawling crypto empire was a significant stake in a tiny bank in the middle of nowhere.

Farmington State Bank in Washington State is the essence of nondescript.

A tiny bank with a single branch, Farmington State Bank (“Farmington”) had until this year just three employees and did not offer online banking services or a single credit card.

The relationship between Farmington and FTX started in March of this year, a date which is significant and will make sense in the broader context of events.

In March this year, the now infamous Alameda Research, proprietary trading arm of SBF’s crypto empire, and sister company of FTX, invested US$11.5 million in Farmington’s parent company FBH, even going so far as issuing a press release to commemorate the move.

Alameda’s investment in FBH wouldn’t be so interesting except for the fact that at the time, Farmington was America’s 26th smallest bank out of 4,800 with a net worth of just US$5.7 million according to filings with the U.S. Federal Deposit Insurance Corporation (FDIC).

The Alameda investment was more than double Farmington’s value, and was blessed by the Federal Reserve Board of San Francisco as well as the Division of Banks of the Washington Department of Financial Institutions.

But Alameda was hardly the company that introduced Farmington to cryptocurrencies.

Banking on Making Coin

Farmington bank was established in the frontier town of Farmington, that sits near Washington’s border with Idaho, in 1929.

Between the cattle ranching, sugar beets and fruit orchards, Farmington, or its bank, could hardly be said to have ever been the frontier for the future of finance, yet it looked to become the tip of the spear in 2020.

Because in 2020, a company named FBH, purchased Farmington State Bank.

FBH’s Chairman is Jean Chalopin, who coincidentally also chairs Deltec Bank and Trust, one of the main banks for both Alameda Research and, surprise, surprise, Tether, banking a whopping US$65 billion in assets for the latter.

After the FBH purchase in 2020, Chalopin joined Farmington’s board of directors and the tiny rural bank quickly pivoted to deal with cryptocurrencies and international payments, but not before joining the Federal Reserve System.

For over a century, Farmington never saw the need join the Federal Reserve System, after all, it had a habit of not taking on risky loans or really doing anything within the financial system of much import — the bank didn’t even have an ATM.

Yet on June 30, 2021, Mary Daly of the San Francisco Federal Reserve, welcomed Farmington into the fold of the Federal Reserve, allowing it to set up international wires and SWIFT transfers through the Fed.

And that’s when things got altogether much more exciting for the tiny rural bank in Farmington.

Before FBH and FTX entered the picture, Farmington’s deposits had been a relatively stable US$10 million for well over a decade, but by the third quarter of this year, deposits soared some 600% to US$84 million, with nearly all of that increase, some US$71 million, coming from just four new accounts, according to FDIC data.

New, substantial accounts, in and of themselves do not mean anything nefarious is going on, but when the offshore cryptocurrency exchange owner of that bank goes bankrupt, inviting scrutiny into the assets of said exchange is when things start to unravel fast.

Because it’s unclear how FTX was allowed to buy a stake in a U.S.-licensed bank to begin with, uncomfortable questions are going to start being asked of federal regulators who blessed the marriage.

While allegations that Tether has long been banking with institutions less reticent to transacting with and for criminals, when such forms of banking reaches the shores of these United States is when it becomes harder to brush off or ignore.

The connection between FTX and Tether is well-established and documented.

Over US$36 billion in USDT from Tether was received by Alameda Research right up till October 2021, much of which ended up on FTX but where things get altogether more interesting is when the flows of Tether-on-Tron (not to be confused with a location in the United Kingdom) dry up on FTX.

Rats Always Know When the Ship is Sinking — They’re the First Off

Somewhere in April of this year, Tether announced that it was going to slash commercial paper holdings.

While it’s likely that the term “commercial paper” was a stretch of the term, it’s always been somewhat obvious that Tether was loaning USDT to outfits like Alameda Research for whatever reason required.

Whether that Tether was ultimately backed or not didn’t really matter — on the surface, it looked like Alameda had a sure-fire way to make money — front run other traders on FTX, gun protective stops and basically walk up or down the price of a token so that the exchange could liquidate margin positions — and pay whatever loans to Tether in real dollars.

Anyone with any degree of experience of trading on FTX would have recognized Alameda’s modus operandi and assumed that they were making money hand over fist.

The problem of course wasn’t so much that Alameda was doing these things — it would have been making money had it done so — it was that it was doing these things in a way that made no sense.

For instance, let’s say a market maker has walked down the price of a token and liquidated all the long positions, instead of actually liquidating those positions, Alameda absorbed them, going long instead.

And when prices went up, Alameda didn’t cash out these positions, instead going degen-long long.

One possibility of course is that by April, Tether, which had been perfectly happy to lend out potentially unbacked USDT to Alameda Research, which appeared on the surface to have a way to turn these fictitious dollars into real one by trading against its users, didn’t actually possess those means.

And that would go a long way to explaining why the flow of Tether to FTX dried up suddenly in April of this year.

It would also go some way of explaining why suddenly Tether hands over the reigns of Farmington to FTX at around the same time.

Here’s a list of the flows of Tether-on-Tron to FTX, produced by 

DataFinnovationearlier this month, it’s obvious that by May, nothing was flowing into FTX.

Yet some US$3.3 billion in Tether-on-Tron was minted.

One possibility is that when it became obvious FTX had some issues, or that Tether was no longer prepared to loan USDT to FTX anymore, users needing Tether-on-Tron found other ways to get it, water, which is essential to cleansing, often finds its path.

When the Tide Goes Out

Under non-bankruptcy circumstances, none of this would be a real issue, but now that FTX has gone under and as liquidators and investigators pour through the ruins of SBF’s former crypto empire, some of the assets held in that complex portfolio will attract greater scrutiny, including banks that had SWIFT rails such as Farmington (now known as Moonstone Bank).

And therein lies the bigger problem that could be looming on the horizon, one that few are expecting — that Tether isn’t backed in the way that most users think it is.

The question of whether Tether is backed by real dollars has been debated ad nauseum, but 

DataFinnovationprovidesa more or less unequivocal explanation that confirms what most expect — Tetherisbacked, just not how many would imagine.

Thinking in terms of Treasury Bills and commercial paper is all fine and dandy if the question is simply “is Tether backed by real dollars or dollar equivalents?”

But the real question Tether users should be asking is, what sort of dollars is USDT backed by?

The United States and its allies were perfectly happy to freeze offshore Russian dollar-deposits after that country invaded Ukraine.

It’s not hard to imagine authorities freezing dollars if evidence were found that Tether has been using entities such as FTX to launder money.

Although there isn’t clear evidence to suggest that that’s what Tether has been doing all this while, the bankruptcy of FTX will mean that regulators and investigators who haven’t been scrutinizing some U.S. banks or its owners, may now be forced to do so, and what they may or may not find, could have major implications for USDT.

Because it’s not that USDT isn’t backed, it in all likelihood probably is, but that it may be backed by dollars that could be subject to seizure by the U.S. Federal Reserve or other authorities means that USDT could have some issues, just not in the way that most expect.

For as long as FTX was running, the cozy relationship between Deltec Bank & Trust (the Bahamian bank for Tether), Tether and Alameda Research, eluded greater scrutiny, but now that a major cog has come off, one of the wheels of whatever schemes that may have existed has come, well, untethered.

It’s entirely unclear what authorities and regulators will find, if anything at all, but if they should find something (likely), it puts at risk potentially billions of dollars in Tether, with the very assets backing USDT, possibly frozen.

And that could be a problem.

Although a cottage industry that is prepared to deal in Tether in exchange for goods and services has sprung up, just like any other “real” currency, the minute that counterparties perceive the value of the thing being bartered for is worth less than its face value, is when a run on the currency begins.

And if a run on Tether occurs not because of issues of its backing, but because of law enforcement freezing that which backs USDT to begin with, the race for the exits will be sudden and brutal.

Liquidity for USDT-USD swaps will gum up, OTC providers and market makers once happy to provide liquidity for USDT swaps regardless of chain will suddenly withdraw their bids and offers and the ensuing chaos could possibly see a deep discount for USDT.

Where it will hurt most is for USDT users in the shadow economy that has developed over the past several years in many emerging markets.

And as with many a crisis, it’s those right at the bottom of the food chain, those who were simply using Tether because they may have been unbanked, who will suffer the most.

Or maybe none of this will happen.