NY attorney lasers Bitcoin’s key funding mechanism

It’s been a volatile and stressful week in cryptoland.

First Elon Musk, the electric boss of eccentric car company Tesla (or was it the other way round) and one of bitcoin’s most high-profile supporters, tweeted on Saturday that the cryptocurrency’s price “seems high”.

Then, after bitcoin hit a record high of $58,354 on Sunday, US Treasury secretary and former Fed chair Janet Yellen dismissed bitcoin as an “extremely inefficient way of conducting transactions”, as she lamented its staggering energy consumption, a comment that helped bitcoin fall more than 22 per cent from its peak. At pixel time, Bitcoin was trading around $47,500.

And then on Tuesday, the New York District Attorney’s office moved to suspend Bitfinex and Tether’s “illegal activity” in the state.

The connected entities will now be prohibited from servicing New Yorkers, on the basis that they deceived the market by overstating reserves and by covering up approximately $850m in losses around the globe.

The move could be a major blow for the value of bitcoin, due to the role that Tether, a dollar-tracking crypto stablecoin, plays in supporting dollar-denominated inflows into the bitcoin ecosystem.

Tether’s transparency page puts its current dollar assets at $34bn. But regulators and critics have always worried about the shape and liquidity of the underlying assets used to peg Tether’s tokens to the dollar. Many believe a huge chunk of bitcoin’s value may as a result have been synthesised by overly depending on this only partially funded asset pool.

In her findings, NY Attorney Letitia James dubbed Tether a “stablecoin without stability” with tokens that were “never fully backed at all times”. In some cases, she noted, Tether’s declarations of holdings came only as a result of temporary cosmetic cash injections (usually described as window dressing in the finance sector).

From the AG’s statement (our emphasis):

The OAG’s investigation found that, starting no later than mid-2017, Tether had no access to banking, anywhere in the world, and so for periods of time held no reserves to back tethers in circulation at the rate of one dollar for every tether, contrary to its representations. In the face of persistent questions about whether the company actually held sufficient funds, Tether published a self-proclaimed ‘verification’ of its cash reserves, in 2017, that it characterized as “a good faith effort on our behalf to provide an interim analysis of our cash position.” In reality, however, the cash ostensibly backing tethers had only been placed in Tether’s account as of the very morning of the company’s ‘verification.’

On November 1, 2018, Tether publicized another self-proclaimed ‘verification’ of its cash reserve; this time at Deltec Bank & Trust Ltd. of the Bahamas. The announcement linked to a letter dated November 1, 2018, which stated that tethers were fully backed by cash, at one dollar for every one tether. However, the very next day, on November 2, 2018, Tether began to transfer funds out of its account, ultimately moving hundreds of millions of dollars from Tether’s bank accounts to Bitfinex’s accounts. And so, as of November 2, 2018 — one day after their latest ‘verification’ — tethers were again no longer backed one-to-one by U.S. dollars in a Tether bank account. 

The full report is worth a read, not least because of the scale of the purported misdirection by Tether regarding its under-funded assets. As an example, in 2017 Tether repeatedly denied insolvency rumours in press reports, despite at the same time pleading with Panama-based Crypto Capital to have almost $1bn of its assets returned.

Bitfinex and Tether are now being required by the New York Attorney to pay $18.5m in penalties.

To what degree the news will set the crypto system back, however, is unknown. In theory, the Tether and Bitfinex revelations suggest that, despite being designed to resolve the core financial sector’s vulnerability to centralised control, money printing and capital shortfalls, the supposedly impossible-to-hack-or-manipulate crypto monetary system has still managed to fall victim to the very same forces Satoshi Nakamoto (bitcoin’s pseudonymous creator) critiqued in core finance.

And yet, faith in the “currency” system among its enthusiasts is such — especially among its HODLer class (those who buy and hold the currency against the odds) — that it is possible the system could defy the Tether setback. Bitcoin, after all, has proved resilient in the face of reputation issues, from exchange hacks and capital losses, before. Many, such as the MtGox debacle, would arguably have rendered a more conventional financial system bankrupt. But bitcoin continues to prevail.

Collectivist meme power

This is perhaps because in its current incarnation, the HODLer class constitutes a type of long-term patient capital that is remarkably rare in more traditional markets. If HODLers can regulate themselves in the style of an Opec cartel and defy the temptation to sell, the presence of such capital arguably gives bitcoin an edge over competing systems.

The bad news is that Opec’s compliance to its targets and selling quotas was shaky at the best of times. But then, Opec never had meme culture — mutually supporting “laser eye” signifiers being the latest fad — to support its HODLer base in its most trying moments.

Nor did it benefit from the de facto leadership of a wacky Elon Musk type, who was more than happy to adopt unconventional signals like laser eyes to cryptically signal his intentions. Not only is the meme king increasingly gearing up to become bitcoin’s Saudi Arabia by piling Tesla’s reserves into the crypto asset, but some even think his ultimate plan may be to send bitcoin miners to space where they can earn endless crypto fortunes thanks to being powered by cheap and limitless solar energy.

The analogies are already forthcoming.

Being the lowest-cost producer and most abundant oil-reserve member, Saudi Arabia was considered the ultimate swing producer — meaning that regardless of who was officially head of the cartel, the kingdom had the power to single-handedly influence the balance of marginal supply. In the heyday of Opec’s power, the oil market would obsessively deconstruct every utterance the Saudi Arabian minister of petroleum and mineral resources made for clues about the country’s oil producing intentions.

Elon might not have fields of cheap abundant energy at his disposal just yet, but his Twitter utterances do seem to be enough to influence the HODLers, or at least to boost their morale. Deciphering the true meaning of his tweets, meanwhile, is as sophisticated an art as reading runes or coded wartime messages.

Related links:
Bitcoin Opec favours 8MB blocksize increase – FT Alphaville
OpecCoin – FT Alphaville
Let them eat Bitcoin mining rigs – FT Alphaville