Bitfinex Crypto Case Shows Smaller Investors Face Greater Risk 

(Bloomberg) -- The latest allegations against a major player in the nascent world of cryptocurrencies have something in common with past financial scandals: The little guy may end up holding the bag.

In a civil suit filed Thursday, New York’s attorney general accused one of the largest Bitcoin exchanges of hiding the loss of about $850 million in client and corporate cash. Multimillion-dollar accounts were protected, sometimes by the use of custodian banks in New York. Smaller investors received less assurance, with their funds sent to firms around the world, according to two people with knowledge of the matter.

The lawsuit targets the Bitfinex exchange and affiliated company Tether. What isn’t spelled out fully is how Crypto Capital Corp., a Panamanian payments processor that handled funds from retail investors, fits into the picture. According to the suit by New York Attorney General Letitia James, Bitfinex customers sent more than $1 billion to Crypto Capital last year.

Bitfinex executives eventually came to suspect that Crypto Capital had “lost, stolen or absconded with the money,” according to the suit. That means it’s likely that Bitfinex’s retail customers are most exposed to that loss, while institutional investors aren’t.

Bitfinex and Tether have struggled to maintain a banking relationship since at least 2017, when they were dropped by their Taiwanese lenders. The issue has been most acute on the retail side of their business, which is why they used Crypto Capital, a private firm with banking connections around the world.

It was through Crypto Capital that the retail customers were told to direct deposits to Poland, Portugal and other locales, said the people, who asked not to be named discussing private business.

These accounts would usually work for a time, then get shut down, leading to customer frustration and confusion. On the retail side, Bitfinex used Crytpo Capital as its bank account and left customer money there, according to one of the people. Tether never used Crypto Capital, the person said.

If you were an institutional investor with millions to spend, Bitfinex established accounts in 2017 at Puerto Rico’s Noble Bank and then, in 2018, at Deltec Bank & Trust Ltd. in the Bahamas. Noble, in fact, didn’t actually hold the money. Bank of New York Mellon Corp. acted as custodian for a time, adding to the protection sophisticated investors received when dealing with Bitfinex.

“We have been informed that these Crypto Capital amounts are not lost but have been, in fact, seized and safeguarded,” Bitfinex said Friday in a statement. That position is contradicted by the attorney general’s suit, which said Bitfinex attorneys “do not believe Crypto Capital’s representations that the funds have been seized.”

An email to Crypto Capital seeking comment wasn’t immediately answered.

Tether is one of the world’s most popular cryptocurrencies because of its claim that it holds one dollar in reserve for every digital token it creates. Tether has said it holds $2.9 billion, according to its website. The allegations against Tether and Bitfinex have revived doubts about Tether’s one-for-one assertions.

A loss of faith in Tether would be a major blow to traders who rely on it as a substitute for dollars. Virtual currencies tracked by CoinMarketCap.com lost $10 billion of value within an hour of the attorney general’s statement Thursday. Tether slid 1.4 percent.

State officials focused on the “loan” made by Tether to Bitfinex to cover the Crypto Capital loss. Bitfinex executives transferred $625 million “out of Tether’s legitimate bank account” in November 2018, the case alleges. In return, Bitfinex credited $625 million to Tether’s accounts with Crypto Capital.

“That ‘credit’ was illusory,” the attorney general wrote, because Bitfinex knew that Crypto Capital was unwilling or unable to process withdrawals or return funds. In effect, executives “fraudulently shifted most or all of Bitfinex’s risk of loss of several hundred million dollars onto Tether’s balance sheet, but continued to represent to the market that Tethers were fully ‘backed’ by U.S. dollars sitting safely in a bank account. They were not.”

The case is In the Matter of the Inquiry by Letitia James, Attorney General of the State of New York v. Ifinex Inc., 450545/2019, New York Supreme Court, County of New York
(Manhattan).

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