The Tether Bubble is Washing Out of Crypto Exchanges
This isn’t the first crash in Bitcoin (BTC). The bubble in 2011 was followed by a 93% price decline and during 2014 BTC fell 67% from its high of $1125 in November 2013 — see the chart below. The burst of the 2011 bubble was caused by bad blockchain code and in 2013–14 it was caused by trading bots spoofing on the MtGox exchange, where 70% of BTC was traded at the time.[1]
So far this year the price has fallen 77% since the high of $19,357 on 16 December 2018. This latest bubble appears to have been caused by the printing of tether (USD₮), which is a so-called stable coin: “Every tether is always backed 1-to-1, by traditional currency held in our reserves. So 1 USD₮ is always equivalent to 1 USD”. Except, it isn’t. Since mid-October, when the issuers started to withdraw it from circulation, its price has been as low as 95 cents on many occasions, including at the time of writing.[2]
The issuers of Tether, also the owners of the (unregulated) Bitfinex exchange,[3] were subpoenaed earlier this year following suspicions that their USD reserves were far short of the reported $2.5bn required to back all the tether issued at the time.
In June 2018, after two failed audit attempts (by Wells Fargo and FSS) John Griffin and Amin Shams published a discussion paper showing how the flows of Tether (illustrated in a clockwise direction in their network diagram below) were being routed via Bitfinex (and two anonymous wallets) to and from US exchanges Poloniex and Bitrex (again via another two anonymous wallets) and to major Asian exchanges OKEx, Huobi, and Binance (depicted in green) via other, unregulated Asian exchanges.[4]
Starting in February 2017, more and more Tether was issued — until 14 October this year. Then over the next 2 weeks, $1bn equivalent was withdrawn from circulation as Tether switched to a bank (Deltec, in the Bahamas) which issued a suspicious-looking letter valuing their USD reserves at $1.8bn.
Casual observation of the header graph suggests that tether issuance was used to fuel the last bitcoin bubble; also the bubble in ether (and other coins and tokens) during January 2018. And so, we should expect a return to pre-tether-pumping values, i.e. those pertaining in the summer of 2017 — around $2,500 for bitcoin and $400 for ether — ceteris paribus.
Using on-blockchain data, Griffin and Shams claim that half of the 1,400% gain in BTC last year was attributable to price manipulation, with tether being printed and used to prop up bitcoin against selling pressure. The scatter plots below, showing the off-blockchain on tether issuance and the BTC price,[5] indeed indicate a similar story. Each plot shows the monthly P&L on BTC and the monthly net issuance of tether — the one below, which zooms to the smaller transactions, reveals a definite pattern, and a correlation of over 35% between tether issuance and BTC monthly P&L. Even including the larger transactions, as in the upper plot, the correspondence is clear from the data.
Tether is likely to have fuelled the recent bubble in bitcoin and other crypto, but it isn’t the only unethical practice being used by the new, unregulated crypto exchanges which trade crypto against tether not USD. Spoofing is rife, even on Coinbase the largest of the handful of exchanges which only trade against fiat currencies and major crypto crosses.[6] Wash trading (setting up two accounts used to buy and sell against each other to artificially inflate volume) is encouraged by zero-pricing/transaction fee mining practices adopted by these new exchanges, allowing them to rapidly rise in rankings.[7] Exchanges engaging in this practice do not offer real liquidity, as measured by slippage.
Yesterday, Bloomberg reported that the US Justice Department is stepping up its a criminal probe into unethical practices by crypto exchanges, currently focussing on price manipulation by tether-Bitfinex. As the SEC continues to crack down on unethical exchanges we should expect more banning trades on those exchanges which exist merely to launder or wash. Meanwhile, the large institutions like Fidelity and Goldman Sachs are preparing to move into the crypto space — big time.
Professor Carol Alexander, University of Sussex, UK. 21 Nov 2018.
cryptomarketisk is the Medium account for the Crypto Asset Risk team of the Quantitative Fintech Network (QFIN) at the University of Sussex Business School. The views and opinions expressed in this article are those of the author and do not necessarily reflect those of the University of Sussex.
[1] See the academic paper by Neil Gandal et al. (recently published in the Journal of Monetary Economics) for more details on the trading bot manipulation.
[2] Using the Cryptocompare volume-weighted average. Like other ranking websites, this reports an average price over several exchanges. The good thing about Cryptocompare is that they don’t include exchanges which report tether cross rates.
[3] JL van der Velde (CEO), Giancarlo Devasini (CFO) Matthew Tremblay (CCO) and Stuart Hoegner (General Counsel) of both Bitfinex and Tether. Phillip Potter, CFO of both companies, recently resigned.
[4] John Griffin and Amin Shams are the University of Texas academic team that previously blew the whistle on the manipulation of the VIX index — publishing a paper now cited in several class actions associated with malpractice in volatility exchange-traded products.
[5] These data are from the exchanges contributing to Cryptocompare.
[6] These are Bitstamp, Gemini, Coinbase (GDAX) and Kraken.
[7] According to research by Blockchain Transparency Institute (BTI), about $6bn in daily (mainly tether) volume is being faked through wash trading.
