A bitcoin fraud or billion-dollar opportunity?

Bitcoin is created by computer processing power – anyone can do it – and uses more energy than Denmark’s annual electricity output.

After a short-lived crash in the new year, it was recently trading around $US37,000. Ads on buses proclaim: “If you’re seeing bitcoin on a bus, it’s time to buy.”

The mysterious digital blockchain-based product, which appears to have no intrinsic value, may have created as many millionaires as sceptics.

Two weeks ago, Sydney fund manager John Hempton interviewed a job applicant, who suggested he short-sell (punt the price will fall) a blockchain payment-system called XRP that is owned by Ripple Labs.

There is a significant overlap between bitcoin investors and Trump supporters.

— Anne Stevenson-Yang, J Capital research director

Ripple’s investors include private equity firm Andreessen Horowitz and consulting firm Accenture. On December 22, the US Securities and Exchange Commission accused Ripple of selling about $US1.3 billion in XRP currency without filing the necessary paperwork, circumventing the need to disclose important financial and operational information.

Hempton, the founder of Bronte Capital, wasn’t impressed with the idea. Not because he didn’t think XRP would fall – he was worried about getting his money back from his bitcoin broker if the market dived.

“I can imagine it being a really bad trade whatever the market outcome,” Hempton wrote on his blog. “If I am wrong and crypto just keeps going up I will lose money. If I crypto collapses I can’t collect my winnings – indeed I just lose my collateral.”

The job applicant suggested Hempton trade on Plus500, a trading website he said was regulated by the Australian Securities and Investments Commission.

Hempton was unconvinced. Plus500 is based in Israel and Cyprus and listed on the London Stock Exchange. It isn’t an exchange. It buys and sells financial securities using its own capital, and doesn’t use financial contracts known as hedges to protect itself from big falls or rises in the securities, according to Hempton.

“I could just imagine the ASIC officer trying to get a holiday in Cyprus on the public purse because he wanted to do a site visit,” he wrote.

Bitcoin isn’t just for individual investors. Coinbase, a popular service for trading cryptocurrencies, received an investment from Westpac Banking Corp’s venture capital fund, Reinventure Group, six years ago.

Describing itself as the “most trusted brand in the crypto ecosystem”, Coinbase suffered outages last week after several weeks of problems in which some European customers couldn’t access their accounts.

The problem was caused, according to Coinbase, by the bitcoin rally, which attracted more traders, and new regulations requiring extra customer information. So a bitcoin business that was meant to be scaleable couldn’t handle the bitcoin boom.

Around the world, banks and institutional investors are starting to take cryptocurrencies seriously as an investment and an alternative means of payment.

In the US, PayPal and Square facilitate bitcoin payments, driving up demand. Growing interest from big custodians and some investment institutions buying it as an alternative asset is also providing a fillip for aficionados.

The interest has driven up the bitcoin price, which has triggered interest in listed bitcoin companies.

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Bit Digital was listed on the Nasdaq in 2018. It originally operated a peer-to-peer lending business in China and rented out cars. Last February, the company took up bitcoin mining and said it was operating thousands of computers in Xinjiang, Inner Mongolia and Sichuan provinces.

On December 23, a report on the Seeking Alpha website, which describes itself as the “world’s largest investing community”, said Bit Digital had delivered “impressive” profits.

“What’s interesting here is that the company’s current mining capacity and revenue are already above some more high-profile peers, even as the stock is trading at a discount highlighting attractive relative value,” the article said. “We are bullish on bitcoin and see BTBT [Bit Digital’s ticker code] as well-positioned to benefit from the ongoing momentum.”

A week later, J Capital began investigating. J Capital looks for dishonest companies, borrows their stock, sells it, and publishes reports designed to drive the price down for profit. It specialises in China, where managing partner Murray used to live. (Murray stood as a Labor candidate in the Sydney seat of Wentworth at the last federal election.)

A records search found that Chinese police had shut down Bit Digital’s lending business, which had cost investors $US42 million. Its bank accounts had been frozen by a Shanghai court. No cars belonging to its car rental business seemed to exist.

‘Simply a lie’

Bit Digital reported at the end of last year that it had 22,869 computers generating bitcoins in China.

“That is simply a lie,” J Capital wrote. “With no subsidiary in China, that would be illegal and the machines subject to confiscation.”

J Capital said the local Chinese authorities supposedly hosting the bitcoin miners didn’t know of them. Companies meant to have sold Bit Digital computers denied any contact.

“We think the company has simply stolen the $US19.8 million it claims to have spent on miners in the first nine months of 2020,” it wrote.

“Perhaps to avoid detection, the company modified its disclosures to provide only the names of huge provinces where they are supposedly mining bitcoin, deleting the names of towns.

“The executives who still secretly control the company are in jail or are fugitives from the law.

“This team not only stole from investors in Shanghai, but they even diverted cash into their personal bank accounts. Chinese legal cases against them allege that they diverted at least Â¥2.5 million into personal bank accounts. This is documented in numerous cases filed in Shanghai.

“And yet these are the executives US investors are being asked to believe run the biggest pureplay bitcoin mining operation now listed on a public market.”

In September 2020, Bit Digital replaced a director, Liu Xiaohui, because “the company was not able to reach” him.

Liu couldn’t be contacted because he was in jail, according to J Capital, along with the then CFO, Leng Jing. A new chief executive didn’t complete high school. The replacement CFO wasn’t an accountant. Three auditors had resigned in three years.

It is a testament to the size of the US capital markets that the fraud accusations against the $1 billion company didn’t warrant any mainstream news coverage, and was publicly ignored by the target.

The day after J Capital’s report was published, Bit Digital issued a press release stating it had received a bridging loan.

It also asserted that the company, which didn’t respond to a request for comment, had 40,865 computers that produced 291 bitcoins in December, which would be worth about $14 million at current prices.

The notice was riddled with spelling and grammatical errors: “Moreover, the miners in United States are fully intsalled [sic] in Nebraska and Texas. The Company will continue to exexute [sic] its stragety [sic] to rebalancing its utility cost structure and asset allocation in seek [sic] of the best utility use to produce more bitcoin. Management believes that our bitcoin mining business is performing well and the stragegy [sic] is correct.”

The share price rebounded, a little. “I thought it was pretty amusing the second day after it was issued they issued debt,” J Capital’s research director, Stevenson-Yang, said in an interview from her home in Connecticut.

“It’s a fraud and we feel that the surge in value is not going to last all that long and we probably need to get the word out.”

To magnify its findings’ impact, J Capital turned its report into a two-minute video, which Stevenson-Yang posted on her private Twitter account and that of J Capital.

Twitter froze Stevenson-Yang’s account until she deleted it. J Capital’s account was still frozen on Thursday, although it was back online on Friday after the video was deleted. Stevenson-Yang said they were accused of posting “intimate” material online, a category usually reserved for revenge porn.

“It’s so ridiculous,” she said. “I feel there is a significant overlap between bitcoin investors and Trump supporters and I suspect there was some kind of posse that got together to complain.”

Bit Digital is still valued at more than $1 billion. Stevenson-Yang wouldn’t say if J Capital had placed bets that the shares would fall further.