Behind the Bitcoin Bubble – WSJ

To figure out if you’re in a bubble, you need to find the source of the hot air. Obvious for


but for bitcoin, not so much.

In July 2018, we wrote about the cryptocurrency company Tether, which issues tokens called tethers that trade under the symbol USDT and should be valued at $1—making the currency a “stablecoin.� Tether’s creators might have manipulated bitcoin, a University of Texas paper suggests, by issuing tokens willy-nilly unbacked by real dollars and then buying bitcoin to jack up its price. (The company claims the research is flawed.)

At the time, Tether’s total value was some $2.7 billion, and its website claimed: “Every tether is always backed 1-to-1 by traditional currency held in our reserves.� So somewhere there should have been $2.7 billion in real money—that’s how a stablecoin is supposed to work. In November 2018, New York state Attorney General

Letitia James

invoked the Martin Act to begin an investigation into iFinex, which owns Tether and the Bitfinex cryptocurrency exchange, “in connection with ongoing activities that may have defrauded New York investors.� The company has disputed the attorney general’s claims, denied it misled customers, and said it will fight any action. An appellate court last year rejected its challenge to the probe.

Bitcoin peaked at the end of 2017 at $19,000 and over the next year collapsed to $3,200. Well—they’re baaack! On Friday

Elon Musk

was the latest to pump Bitcoin, which briefly reached almost $38,000. And there are now some $26.4 billion of USDT tokens, $18 billion of which were created since March 2020. Why the increase? No one has a good explanation.

All that glitters is not gold. In 2019 Tether subtly updated its claim to say reserves “may include other assets and receivables from loans made by Tether to third parties.� Tether has even admitted it only has 74% of the cash or cash equivalents to back its stablecoin. Hmmm. Basically unbacked.

In October 2019, a separate lawsuit was filed against Bitfinex claiming the exchange’s alleged market manipulation “likely surpasses $1.4 trillion,� which Bitfinex denies. Yes, that’s trillion with a T. Bahamas-based Deltec Bank & Trust, where Tether has an account, recently claimed “every tether is backed by a reserve and their reserve is more than what is in circulation.� OK, but it turns out “reserves� may include an $850 million loan to Bitfinex. Is that the hot air? Oh, and reserves may include bitcoin too. Audit, anyone?

Pay no mind: “Momo� momentum investors dived in anyway. Bitcoin ran from $7,000 in January 2020 to almost $42,000 this Jan. 8. But the bitcoin bulls and bears are brawling. On Medium a few weeks ago, a poster named Crypto Anonymous (for what it’s worth, know your customer) did some digging and found that as much as two-thirds of bitcoin buys on any given day were purchased with tether, though crypto bulls insist that Chinese crypto investors use tether as a way to buy bitcoin. Try verifying that! The chart of bitcoin vs. tether issuance sure looks correlated, but a study published at the Center for Economic and Policy Research found no correlation. And I should note that wallet provider Coinbase, the largest holder of Bitcoin, says it “does not support USDT.� Do they know something?

Meanwhile, more than two years later, the New York attorney general’s office may get the documents it needs. I hope that includes an audit of Tether looking for the now $24.5 billion in cash, or even $19 billion if it’s 74% backed. I doubt all that cash exists. The attorney general claimed in a press release that some fishy money, maybe $850 million now part of Tether’s reserves, was taken from Tether to cover losses at Bitfinex. Yikes.

I contacted the attorney general’s office asking for the status of the investigation and what information it has received. I was pointed to the original filing for the scope of the investigation. It includes an accounting of all of Tether’s transactions. On Jan. 19, a letter from iFinex’s counsel said it had “largely completed the document production� and would “contact the Court in approximately 30 days� with a status update. So we’ll know something soon.

Meanwhile, lo and behold, around the same time as that letter, Tether temporarily stopped creating any more currency. That might explain bitcoin’s quick mid-January price drop from $42,000 to under $30,000. If fraud is uncovered, look out below.

Normally I wouldn’t care. Bitcoin is nothing, it’s vapor, a concept of an idea. Transactions using bitcoin are few and far between. It’s not a store of value—anything that drops 30% in a week can’t play that role. But we get Bloomberg Wealth stories saying: “Newbie Bitcoin investors tell us what inspired them to buy at record prices.� A lot of folks who can’t afford it may get hurt badly. Robinhood curbed some crypto purchases on Friday.

So all crypto eyes are on mid-February. The power of the subpoena is strong. I have no insight into what New York’s attorney general will find. She might close the investigation and go on her merry way because there’s no crime, or uncover a fraud that could make

Bernie Madoff

look like he was stealing from a lemonade stand. We know what happens to bubbles when the hot air runs out.

Write to [email protected].

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