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When it comes to discussing Tether, many (including me) try to analyze the solvency or liquidity of its reserves in an attempt to understand the situations in which they would be inadequate. However, I think it's unlikely that the quality or quantity of Tether reserves will be the reason that Tether fails – in large part because of how and where Tether is used.

Tether is commonly used in China for a variety of less-than-legitimate activities, including export of fentanyl precursors, gambling, money laundering, and evasion of capital controls.

Tether absolutely recognizes that this is one of its primary use cases. A blog post on its website helpfully explains that "USDT provides an alternative that allows entities and individuals to circumvent capital controls by utilizing an entirely different financial infrastructure."

Tether's history with China goes far beyond commercial paper

I previously described "demand sinks" for Tether; people who want USDT but are unlikely to redeem. Many of these use cases make having USDT in a digital wallet more important than trying to keep money in the banking system. The liquidity of Tether's reserves becomes less significant the more significant this source of USDT demand becomes.

It's really hard to estimate the size of this source of demand, but there are some clues that help us think about it:

Zhao Dong, a Tether shareholder and partner, pled guilty in China to charges roughly equivalent to money laundering $480 million of gambling-related funds.
Reports from 2019 suggested that multiple millions were crossing the border between Russia and China every single day.
In 2022, Chinese officials busted a money laundering ring that had laundered approximately $1.7 billion using USDT.

All of these things are quite small compared to the $83 billion in market cap for Tether, but there are some clues that the full total is likely much larger.

Alameda Research was the single largest issuer of USDT, issuing $36.7 billion as of November 2021. We know some Tether was redeemed, but far less than what was issued, and only a portion of that can really be attributed to Alameda.

This leads us to an interesting question: Where did it all go? The most recent analysis of shortfalls at FTX seems to suggest a total of 270 million in cash and stablecoin have been located so far for FTX, which is a pretty massive difference from $36 billion. There's also an additional $185 million in stablecoins at Alameda Research.

So again, we must ask, what happened with the rest?

HiveEx, Genesis Block, and SBF's trading desk network

Presumably some of this USDT was directed to various ill-fated investments of Alameda Research, but that doesn't seem to fully explain the volume of USDT it was issuing.

When the Tether Papers were initially published, we weren't yet aware that Genesis Block, an OTC trading desk in Hong Kong, was fully integrated into Alameda Research and FTX. Genesis Block was also a client of Tether which transacted hundreds of millions of dollars with the firm.

Genesis Block executives notably bragged about people lining up around the block with bags full of cash and that it maintained a network of dozens of bank accounts, which they described as "a very gray area."

We have also since learned that Alameda Research's activities in China were extensive enough that Sam Bankman-Fried ended up indicted for directing bribes of $40 million to Chinese officials in an attempt to get approximately $1 billion in cryptocurrency unfrozen.

Both of these seem to suggest that Bankman-Fried and Alameda Research were relatively active in China and that this activity, at least in part, was related to USDT.

Why was it worthwhile for Bankman-Fried to do this? USDT, as previously mentioned, is more valuable to some people than other currencies because of its relative stability, extensive ability to transact, and pseudonymous nature. Because of that, there have been multiple periods where USDT traded at a premium at OTC desks in China. For a firm that specializes in arbitrage, it certainly seems like trying to sell into this premium would be very attractive.

Clearly, we cannot absolutely say that Alameda Research was trying to aid evasion of capital controls using USDT, but it would help explain why Alameda Research was interested in issuing so many – and where many of them went. The firm attempted to make a small premium for most of them and only held them for a short period of time.

Is there anything else that would support this contention?

Crunchbase listed an investor in FTX in January 2018, far before its first reported seed round in 2019. This round had only one investor: Redline DAO, previously Redline Blockchain Capital, a Chinese investment firm that is, in no sense of the word, a DAO.

This investment date as listed on Crunchbase is far before FTX ever existed, but it does exactly coincide with the reported loans from Luke Ding and Jaan Tallinn, who supposedly loaned Alameda Research money in January 2018 with an interest rate of 43%.

Jaan Tallinn would later invest alongside Bankman-Fried, Caroline Ellison, and Nishad Singh in the $580 million Series B for AI safety company Anthropic.

Redline confirmed to Protos that it invested but wouldn't specify when. It also stated that it sold its position when Bankman-Fried acquired it, but wouldn't say when that occurred.

Was FTX funded by Chinese capital flight?

Alameda Research bought out Binance shortly before the FTX Series B-1. Overall, these facts suggest that use cases for USDT result in many of them being used in the Chinese market, a fact that benefits Tether because many of these individuals are very unlikely to ever redeem.

The more of this type of demand that Tether can create, the less important the relative illiquidity of its reserves. Practically, this means if Tether is going to fail, it's less likely to fail because holders suddenly stampede for the exit.

Instead, Tether's failure would likely result from regulatory or law enforcement intervention.

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