Crypto Market Roiled by New Allegations Against Tether, Bitfinex

(Bloomberg) -- One of the world’s most widely traded virtual currencies faces renewed doubts about its stability, after New York’s top cop accused the coin’s issuer of participating in a cover-up to hide the loss of about $850 million in client and corporate funds.

The allegations against Tether and the operator of cryptocurrency exchange Bitfinex, announced by the New York attorney general on Thursday, have revived doubts about Tether’s claim that each of its so-called stablecoins is backed by $1 of assets -- a feature that gives the coins a central role in crypto markets around the world.

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 and Tether slid 1.4 percent.

Crypto Market Roiled by New Allegations Against Tether, Bitfinex

This isn’t the first time that Tether and Bitfinex have faced scrutiny from U.S. authorities. The U.S. Justice Department is investigating whether traders used the stablecoin to manipulate the price of Bitcoin, Bloomberg reported in November, while the the U.S. Commodity Futures Trading Commission sent subpoenas to Bitfinex and Tether in late 2017. Heightened regulatory scrutiny is one reason why institutional investors have mostly steered clear of the industry.

Bitfinex, unable to find a bank that would work with it, entrusted more than $1 billion in co-mingled client and corporate deposits last year to a Panamanian firm, Crypto Capital Corp., according to the civil case brought by New York Attorney General Letitia James, a Democrat who took office in January. Bitfinex was allegedly using that firm as an intermediary to wire dollars to traders.

“Despite the sheer amount of money it handed over, Bitfinex never signed a contract or other agreement with Crypto Capital,” the attorney general wrote to the court. By mid- to late-2018, executives at Bitfinex and Tether suspected Crypto Capital had lost, stolen or absconded with the money, and they haven’t be able to find or recover roughly $850 million, she said. “None of that has been disclosed to investors.”

The attorney general’s court filings “were written in bad faith and riddled with false assertions,” Bitfinex said in a statement on its website. There was no loss of funds, Bitfinex and Tether are financially strong, and the firms are cooperating with the attorney general’s office, the company said.

Judge’s Order

Justice Debra James in Manhattan issued an order barring iFinex and Tether from any further violations of state law while the case proceeds. They must also retain all documents tied to the probe, court records show.

After the $850 million loss, executives at Bitfinex and Tether cooked up a series of “conflicted corporate transactions” in which Bitfinex gave itself access to up to $900 million of Tether’s cash reserves, which Tether repeatedly told investors fully backed its coin one-to-one, the attorney general said in a statement.

Correspondence between a senior Bitfinex executive and Crypto Capital included in the attorney general’s complaint suggests the exchange was under immense pressure in October to gain access to funds amid a spike in client withdrawal requests. “Please understand all this could be extremely dangerous for everybody, the entire crypto community,” the executive wrote, according to the attorney general. “BTC could tank to below 1k if we don’t act quickly.”

At the time of the correspondence, Bitcoin was trading at around $6,500. It dropped 4.7 percent to $5,236.03 at 12:10 p.m. in Hong Kong on Friday.

“It definitely brings Tether’s credibility into question,” said Eric Turner, director of research at Messari, which tracks cryptocurrencies. “It’s been well known that they have struggled to maintain banking relationships, but this is the first I have heard about them losing access to funds.”

Banks’ Reluctance

Major banks have been unwilling -- or at least reluctant -- to offer financial services to many cryptocurrency ventures because the market’s opacity makes it difficult to police the flow of funds and detect money laundering, as required by laws in the U.S. and elsewhere.

While that has helped make Tether attractive as a stand-in for the dollar, it’s also been a headache for operating its related platform, Bitfinex.

Bitfinex and Tether’s banking problems began in 2017 when they lost relationships with Taiwanese banks as well as a link to the U.S. through Wells Fargo & Co., which acted as a U.S. correspondent bank for the Asian lenders.

For people to buy into cryptocurrencies, their dollars, euros and yen must make it into the system somehow. In an article last year, Bloomberg described how Crypto Capital entered the equation: Through its president, a Canadian in Panama City named Ivan Manuel Molina Lee, Crypto Capital used links to banks in Poland and Portugal.

Crypto Capital and Lee offered no comment at the time, and there was no immediate response to a message sent to a representative for them on Thursday. Neither are named as defendants in New York’s case.

Alleged Cover-Up

To prop up Bitfinex after the loss, the executives transferred $625 million “out of Tether’s legitimate bank account” in November 2018, the case alleges, without naming that bank. 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 refusing 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.”

In 2015, New York created the BitLicense, a special permit that applies to virtual-currency exchanges that has sometimes drawn criticism from crypto ventures for being too burdensome.

“New York state has led the way in requiring virtual currency businesses to operate according to the law,” said James said in her statement Thursday. “We will continue to stand up for investors and seek justice on their behalf when misled or cheated by any of these companies.”

©2019 Bloomberg L.P.