This US Dollar-Backed Token Issued on Ethereum is a Ticking Time Bomb

2017 has been the year of issuing tokens on top of Ethereum, and one of the more intriguing tokens recently announced is Tether, which is backed by US dollars in a bank account. However, there is an issue with this token that makes it unlikely to stand the test of time, at least in its current form.

What is Tether?

The basic concept behind Tether is quite simple. An entity holds US dollars in a bank account and then issues Tether tokens based on that bank account balance. One Tether is equal to one US dollar.

The first version of Tether was issued on top of the Bitcoin blockchain by way of the Omni protocol, and there is currently over $430 million worth of Tether on the network (according to CoinMarketCap). With Omni, users are able to issue digital assets in a manner similar to the popular ERC-20 tokens seen on Ethereum.

Before creating Ethereum, Vitalik Buterin worked on the Omni project — although it was called Mastercoin back then.

What Happens When the Bad Guys Use Tether?

While questions over solvency may have been quelled by a recent report from Friedman LLP (PDF), there is another systemic issue with Tether that still exists: What happens when the bad guys use it?

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Governments around the world will undoubtedly try to clamp down on the use of digital currencies for illicit purposes at some point in the future. And this clampdown may happen sooner rather than later with the alleged use of bitcoin by North Korea to get around various sanctions placed upon it by the United States and others.

Last week, US Senator Ed Markey called for Bitcoin to be “shut off” (either entirely or just from North Korea) on CNN last week.

Of course, the point of Bitcoin is that it is supposed to be able to avoid censorship from governments. This same logic does not apply to Tether. The central point of failure for Tether is the bank account where all of the actual US dollars that back the token are stored.

Without real US dollars to back it, Tether would have no value. Putting US dollars on a blockchain does not remove the central point of failure that backs them.

So what will happen when governments decide to target Tether? The best place to look for guidance here may be the cases of Liberty Reserve and E-gold. When these centralized virtual gold currencies were being used for illicit purposes and the companies backing them did not implement the proper tools to track payments and holdings to real-world identities, they were shut down.

So, either the code that controls the Tether tokens on Bitcoin and Ethereum will need to be updated to track payments or the bank account backing the token will be seized.

In the case where the Tether token is updated, those who do not identity themselves will most likely not be able to send their tokens to anyone else or redeem them through Tether directly (this is how the process worked when E-gold was shut down), making them worthless. Even if a Tether user is willing to identify himself in order to claim his money, those funds will likely be unavailable to him during the legal proceedings following the shutdown.

If Tether does not comply with regulators, they’ll likely face the same fate as Liberty Reserve and E-gold.

This is Why Bitcoin is Not Threatened by Fiat Virtual Currencies

The potential regulatory issues around Tether illustrate the value proposition of bitcoin. Satoshi Nakamoto’s creation exists because any form of true digital cash must be resistant to censorship from attackers (governments or otherwise). If someone can shut down the Bitcoin network, then the intrinsic value of bitcoin is lost.

Recently, BTCC CEO Bobby Lee gave a presentation in New York where he discussed the properties of bitcoin and how they differentiate the cryptocurrency from various forms of fiat-based virtual currencies.

As I’ve written in the past for Nasdaq, there should be an opportunity for bitcoin to succeed as the world becomes increasingly digitized and governments do not want to relinquish their ability to track payments, seize assets, and inflate the money supply. Digital gold.