THE CRYPTO CURRENCY THAT COULD HAVE 'DEVASTATING' EFFECTS ON THE MARKET

Cryptocurrency markets took a hammering Friday and have been on rocky ground over the past month.

One key reason behind this is related to another cryptocurrency called tether and allegations that the people behind it are using tether to prop up the bitcoin market.

Fears are rife that any collapse in tether could have huge ramifications for the bitcoin market.

 explains the story.

What is tether?

Tether is a cryptocurrency that its creators claim is pegged to the U.S. dollar. The idea is that it's much more stable than most digital coins that have huge price swings.

It was invented in 2015 and theoretically a person would pay $1 for one tether coin.

Currently, there are 2.2 billion tether in circulation, according to data from Coinmarketcap.com, a website that tracks cryptocurrency prices.

Who made it?

The digital coins are issued by a company called Tether Limited that is governed by the laws of the British Virgin Islands, according to the legal part of its website. It is incorporated in Hong Kong.

It has emerged that Jan Ludovicus van der Velde is the CEO of cryptocurrency exchange Bitfinex, which has been accused of being involved in the price manipulation of bitcoin, as well as tether.

What's the point of tether?

Many people trading on exchanges, including Bitfinex, will use tether to buy other cryptocurrencies like bitcoin.

Tether Limited argues that using this method to buy virtual currencies allows users to move fiat in and out of an exchange more quickly and cheaply. Also, exchanges typically have rocky relationships with banks, and using Tether is a way to circumvent that.

"Exchange users know how risky it can be to hold fiat currencies on an exchange. With the growing number of insolvency events it can be quite dangerous. As mentioned previously, we believe that using tethers exposes exchange users to less counter-party risk than continually holding fiat on exchanges," the company explains in a whitepaper on its website.

So what's the controversy?

Firstly, many have raised concerns that tether is being issued by the people who own the Bitfinex exchange. Critics argue that there should not be such a close relationship.

But the issues run deeper than that. Fears have been raised that Tether Limited doesn't actually hold enough U.S. dollars to back all the digital coins in circulation. These rumors have been circulating for a few months.

Earlier this week, Bloomberg reported that the U.S. Commodity Futures Trading Commission sent subpoenas on December 6 to Bitfinex and Tether, citing an anonymous source.

Tether has also been releasing more coins onto the market In January, alone Tether has released 850 million new digital tokens. The company has been increasing the number of coins in circulation over the past few months, and this has coincided with the record highs seen in cryptocurrency prices, causing some critics to suggest there is price manipulation going on.

"Over the past couple of months, a huge amount of tether has been created, it has shifted to the Bitfinex exchange and presumably buys bitcoin and other cryptos. This, I believe, has been keeping the price up," Nicholas Weaver, a senior researcher at the International Computer Science Institute at Berkeley, California, told CNBC by phone Thursday.

To back these claims up, an anonymous statistical analysis posted online last week looked at the relationship between bitcoin price and tether. The conclusion was that tether is created when bitcoin is falling.

"Tether printing moves the market appreciably; 48.8 percent of BTC's price rise in the period studied occurred in the two-hour periods following the arrival of 91 different tether grants to the Bitfinex wallet," the analysis said.

What does Tether Limited say?

CNBC has reached out to Tether Limited for comment but has not received a reply.

In September 2017, the company released a document entitled "proof of funds," allegedly showing that it had the required reserves. However, it was far from clear and the names of the banks were blacked out.

Furthermore, Friedman LLP, the accountancy that carried out the audit, has cut ties with Tether. According to a report from CoinDesk last week, the two parties had "dissolved" their relationship.

What next?

Given that the anonymous report claims tether was responsible for 48.8 percent of bitcoin's price rise in 2017, the author said there could be a 30 percent to 80 percent correction. Perhaps this is already taking place as bitcoin fell below $8,000 Friday for the first time since November 24.

"If a tether debacle unfolds, it will likely cause quite a devastating ripple effect across many of the exchanges that see most of their volumes traded against the supposedly USD-backed cryptocurrency. In such a scenario, we may see cryptocurrency prices retreat quite dramatically in the next month or so," Thomas Glucksmann, head of APAC business development at cryptocurrency exchange Gatecoin, told CNBC by email Friday.

The other reaction could be something equivalent to a bank run. This would happen if the value of tether goes to zero and then people suddenly request their fiat money back. Tether can no longer prop any other cryptocurrency up.

"You could see a spike in prices in tether-only bitcoin exchanges. So, on those exchanges only you will see a run up in price compared to the bitcoin exchanges that actually work with actually money. So you would see a huge price diverge as people see that only way they can turn tether into real money is to buy other cryptocurrency then move to another exchange. That is a bank run," Weaver said.