The Not-So-Fun Adventures of Tether & Bitfinex

Legend has it that if you say Tether five times in a row, the ghost of Mt. Gox will appear in the mirror and take all your Bitcoin…

At the risk of diving too deep into a subject thoroughly discussed, I wanted to write about the latest Tether fiasco and it’s potential implications. Lots of people have tackled this discussion from different viewpoints, so what I would like to do is take a look at a few different angles and attempt to help you draw conclusions on what the future might look like due to these events. Hopefully along the way you find something interesting you hadn’t thought of previously. I’ll be staying away from legal implications as that’s best left to lawyers.

First, an explanation of what happened.

As many of you already know, Tether is a stablecoin company domiciled in the British Virgin Islands. Bitfinex is a cryptocurrency exchange also domiciled in the British Virgin Islands. Both Bitfinex and Tether started as separate entities but then sometime between 2015 and 2017 became inextricably linked, a suspicion many in the space had and was finally confirmed by a Bitfinex representative who confirmed the two companies shared a CEO, Jan Ludovicus van der Velde.

As many cryptocurrency companies unfortunately know, banking is difficult and traditional banks generally don’t support companies that transact large volumes of cryptocurrency. Due to this, both Bitfinex and Tether have bounced around banks quite a bit. After losing it’s relationship with both Wells Fargo and HSBC, Bitfinex put out a statement saying that have “solved” their banking issues. As we now know, this was because they contracted with Crypto Capital, a crypto-native payment processor, to act as their bank. Tether on the other hand managed to secure a relationship with Deltec, a Bahamas based bank.

  • Fun note: in a twist, Bitfinex’s account at HSBC was actually a sub-account of Global Trading Solutions, which was the owner of Crypto Capital (both were run by the same people…who have now been indicted!) So when HSBC terminated the account, they were onto something.

This is where it really starts to go south. According to the AG report:

During November 2018, Tether transferred $625 million held in its account at Deltec to Bitfinex’s account at Deltec. Bitfinex, in turn, caused a total of $625 million to be transferred from Bitfinex’s account at Crypto Capital to Tether’s account at Crypto Capital, through a ledger entry at Crypto Capital crediting Tether’s account in the amount of $625 million and debiting Bitfinex’s account by a corresponding amount. The purpose of this exchange was to allow Bitfinex to address liquidity issues unrelated to tethers.

Oof. That’s no good. So basically what’s happened is that Bitfinex had a bunch of funds locked up (that’s bad). Tether had a bunch of liquid funds (that’s good). Tether gave Bitfinex a bunch of liquid money (that’s bad), and then Bitfinex gave Tether a bunch a locked up money (…that’s really bad). Of course, they didn’t actually give Tether anything other than a claim to the locked up money if it ever gets unlocked.

If you really want to get into the weeds, I’ll note that technically this transaction of $625M was a sub-transaction of a $900M credit line that Tether extended to Bitfinex. Bitfinex in order to secure this credit line, Bitfinex pledged iFinex shares (the holding company of Bitfinex).

Now, according to the participants — this money is theoretically safe. It’s being housed by governments who would never steal the money and will eventually return the money to Tether holders. This is in line with the thoughts of the market, seeing as Tether’s peg is holding steady after an initial drop off.

The recent timeline:

  • April 25th: The Attorney General of NY State releases a statement claimingthat Bitfinex has lost access to $850M due to a third part payment processor (Crypto Capital) getting it’s funds seized and that Tether loaned them money to help them process withdrawals. The statement alleges that Bitfinex was not truthful to it’s customers about the state of it’s capability to withdraw. Many articles come out with drastic headlines such as “Tether insolvent, missing $850M”…
  • After the press release, Bitcoin drops 1–2%, holds steady, then plummets ~9% after further spread of the news. Bitfinex outflows begin to heat up and the Bitfinex:Coinbase premium spikes from around ~1% to 8%, another telling sign people are running to get their money off Bitfinex. Note the large spike on the April 26th.
  • April 29th: Rumblings that Bitfinex is looking to host a token sale begin. The target is said to be $1b, indicating they do not expect to gain access to the frozen funds soon.
  • April 30th: Bitfinex issues a scathing statement accusing the NY-AG of harming investors, and also confirms that Tether is now 74% backed by liquid securities + cash. 26% of Tether’s backing is locked up with Crypto Capital. The market reacts positively to these announcements and Tether continues to climb back to it’s $1 peg.

General thoughts on the matter:

  • From a markets perspective, it doesn’t seem like the market cares. Right at the moment tether is trading at a .5% discount. Despite Bitcoin’s immediate crash, the price has held up well and is now trading within 4% of the pre-crash price indicating two things (1) the bear market is probably over (2) the market
  • Bitfinex’s Bitcoin is still trading at a premium and represents an opportunity for those with long time preference. It’s unlikely that these funds will be lost, which means Bitfinex at some point in the future will regain access and offer fiat withdrawals since their balance sheet is only temporarily affected. If you can wait, you can probably make money. Here are the calculations for breakeven based on cost of capital (lending rate) being 6% a year.
  • This highlights infrastructure problems and the perverse nature of regulation. Due to stringent regulations and high scrutiny, banks cut off cryptocurrency companies. This by definition forces the hand of these companies to use shady solutions since they cannot access the professional operations. QuadrigaCX (the victim of a $200M dollar loss) also struggled to find banking relationships, with contributed to their use of shady platforms. This event should send a message to both regulators and to companies that there exists a gap that needs to be filled.
  • Tether was in fact backed one to one. It was only when recent issues with Bitfinex cropped up that they became a fractional reserve system. This bullish but also reminds us that we should probably introduce transparency standards for stablecoins, and why they should not be associated with any other business model (Glass Steagall anyone?)
  • The case for DAI just got that much stronger. Decentralized stablecoins by nature do not contain any of the risks outlined in this summary. While they do contain a host of other risks, those that value transparency will likely begin to migrate to DAI. DAI is now up about 3%, and is back to dollar parity. This may be due to stability fee hikes, but I’m quite sure the Tether situation played a role. You can confirm this by looking at the DAI charts (DAI/USD spikes right after the press release)