Tether Lawsuit

Full Rundown

On January 15th 2021 Tether is due to produce documents for the lawsuit brought forth by New York Attorney General Letitia James. This lawsuit is attacking the very legitimacy of Tether, the number #3 ranked cryptocurrency by market cap. This lawsuit could have extreme consequences for the entire cryptocurrency market so I thought it would be worthwhile to take a look.

The Allegations

In April 2019 Attorney General Letitia James filed a lawsuit against iFinex ( Bitfinex - a cryptocurrency exchange) claiming they used Tether ( a stablecoin created by Bitfinex) to cover up a loss of $850 million dollars.

“Our investigation has determined that the operators of the ‘Bitfinex’ trading platform, who also control the ‘tether’ virtual currency, have engaged in a cover-up to hide the apparent loss of $850 million dollars of co-mingled client and corporate funds,” said Attorney General James.  “New York state has led the way in requiring virtual currency businesses to operate according to the law.  And we will continue to stand-up for investors and seek justice on their behalf when misled or cheated by any of these companies.

The filings explain how Bitfinex no longer has access to over $850 million dollars of co-mingled client and corporate funds that it handed over, without any written contract or assurance, to a Panamanian entity called “Crypto Capital Corp.,” a loss Bitfinex never disclosed to investors.  In order to fill the gap, executives of Bitfinex and Tether engaged in a series of conflicted corporate transactions whereby Bitfinex gave itself access to up to $900 million of Tether’s cash reserves, which Tether for years repeatedly told investors fully backed the tether virtual currency “1-to-1.”   

The NY AG is claiming iFinex handed $850 million dollars to a Panamanian shadow bank. iFinex then accessed Tether reserve funds to cover up this $850 million dollar loss. iFinex has told investors that their Tether will always be redeemable for U.S. Dollars at a 1:1 rate of conversion. If iFinex did in fact access Tether funds and use them for any purpose other than printing Tether, there is no way they could honor the 1:1 conversion rate.

Furthermore, this lawsuit has spun off a few more lawsuits. A few months after the NY AG filed suit, a paper was written titled Is Bitcoin Really Un-Tethered? This paper claims the Tether was printed to manipulate the cryptocurrency markets by pumping the price of Bitcoin. This research in turn resulted in a lawsuit found here which heavily references the paper. It should be noted that this paper is published on a “social sciences” platform which does not require peer review. The papers accusations have been questioned by many. Perhaps there judgement that Tether being printed after a Bitcoin dump is the result of investors “buying the dip” rather than manipulation.

However, let’s focus on the NY AG lawsuit.

The original suit was filed in April 2019. The deadline for documents to be presented was December 2020 however the NY AG requested an extension until January 15th 2021 which was granted. The extension was requested because , “Ifinex has cooperated in producing the requested documents since the Sep. 17 hearing, predicting that the process will be finalized in the coming weeks.”

The September 17th hearing was for an appeal issued by iFinex claiming the case was outside the NY AG jurisdiction because Bitfinex does not operate in New York. The appeal was dismissed for whatever reason, the deadline was set, and here we are.

I can’t really speculate on the outcome if the case because it would be foolish for me to do so. I will say however that the bank, Crypto Capital, that iFinex is dealing with seems to be shoddy at best. The bank was run by Daniel Barrs who has been indicted for failure to follow anti-money laundering laws.

Crypto Capital - Money Laundering

At some point in time Bitfinex said they were told by Crypto Capital the $850 million given to them was seized by government officials

Representatives for Bitfinex and Tether told the AG’s office that a Bitfinex official was told the reason the $851 million couldn’t be access was because Portuguese, Polish and American government officials had “seized” the funds.

It should be noted that I have yet to find the reason the $850 million was given to Crypto Capital in the first place.

To add even more concern, Tether recently changed the wording for their reserve funds policy. The new policy reads :

Every tether is always 100% backed by our reserves, which include traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties, which may include affiliated entities (collectively, “reserves”).

Previously, the policy stated :

“Every tether is always backed 1-to-1, by traditional currency held in our reserves. So 1 USD₮ is always equivalent to 1 USD.”

Suddenly, Tether is including assets other than traditional currency in its reserves.

To Tethers credit they have previously issued a letter from their new bank, Deltec, proving their reserve balance.

To show proof of its bank balance, Tether released a letter dated November 1 that appeared to come from Deltec, confirming “the portfolio cash value of your account with our bank was US$1,831,322,828” as of October 31.

But, yet again, there is serious cause for concern,

Yet there is no person’s name attached to the letter, and the signature is a simple cubic curve. Further, the letter contained two notable caveats: it was provided “without liability, however arising, on the part of” the bank, its shareholders, directors, employees or officers; and the letter is “solely based on the information currently in our possession.”

Furthermore, Tether has never produced an official audit of their reserves. They produced a “report” which was done by a law firm rather than an accounting firm. Their explanation is that an audit simply is not possible and they chose “ the next best thing”. You can read about the incident here but it seems to me that Tether is clearly being a bit dodgy.

Why Do We Care?

It is important to understand what is at stake with Tether. Currently, Tether is ranked number #3 with a market cap of 21 billion dollars. Tether is a stable coin which people depend on to maintain its peg at $1.00. If they own Bitcoin and want to sell some because they think the price of Bitcoin may drop, Tether can be used to “lock in” your funds and escape the volatility of Bitcoin or other cryptocurrencies. The problem arises when people begin to question if Tether can really be redeemed at a 1:1 ratio. If the documents obtained by the NY AG show that Tether only has half of the reserves they claim, the real value of Tether would be 50 cents. This would mean anyone holding Tether ( at 21 billion mcap there are ALOT of people holding Tether) the value of their coins would immediately be cut in half. This would cause a major panic and a flood of people out of Tether (likely dropping the price and breaking the 1 dollar peg) and into other cryptocurrencies and/or other stablecoins.

I have no reason to believe they only have half the required amount of reserves, I simply chose that number as an example.

The make things even more confusing a lot of people borrow Tether when they deposit funds as collateral. If I deposit $10,000 dollars of LINK into Aave and then withdraw $1,000 dollars of Tether, and while I have my loan out the price of Tether tanks because of the lawsuit, would Aave even want the Tether back? Would they double the amount of Tether requested back if the price went to 50 cents? Most likely not but who really knows? The incident would be unprecedented.

Additionally, if someone is holding Tether there is a good chance they would try to sell it for another stable coin like USDC. If 21 billion Tether try to flood into USDC in a short time period this could then cause the USDC $1.00 peg to break towards the upside. This would again wreak havoc on depositors as their loan value goes up and their collateral value drops likely causing cascading liquidations.

I say collateral value may drop because if Tether were to collapse you can bet on a market wide pullback.

These cascading liquidations would cause a downward price action spiral.

The truth is I have no idea what a Tether collapse would look like except I would expect to see a lot of red straight across the board. It would certainly leave a bad taste in retail investors mouths. Additionally, I would expect government officials from around the world but especially within the U.S. to very loudly proclaim we need additional regulations.

I certainly hope Tether kept up they’re end of the bargain…

-Matt