Defying logic, Kraken raises more red flags after attacking Bloomberg piece on Tether manipulation

The second most interesting thing to happen in crypto this past weekend was the Bloomberg article dissecting thousands of tether trades on Kraken. Even more fascinating, however, was Kraken’s puerile response to that serious accusation made by one of the world’s largest financial news and data organizations. For those who don’t have time to dive into it (and we suspect that’s most of our audience), here’s the deal:

On June 29, Bloomberg reporter Matthew Leising, along with Mira Rojanasakul, Demetrios Pogkas, and Brandon Kochkodin, published an analysis they performed on 56,000 tether trades conducted on the Kraken exchange between May 1 and June 22. Kraken is pretty much the only place where one could trade tether tokens for U.S. dollars. Bloomberg’s two big takeaways were:

On some large orders to buy or sell tether, prices barely budged but on smaller orders, the price movement was more.
There were an inexplicably frequent amount of orders (7.9 percent of the total during the examined period) for precisely 13,076.389 tethers.

The Bloomberg team noted that they shared “the information with New York University Professor Rosa Abrantes-Metz and former Federal Reserve bank examiner Mark Williams. Both agreed that they’d never seen a market behave like Kraken, where large Tether orders fail to sway prices much.”

What could it mean?

“One possible explanation: The software would look for orders with a unique size, and trade against that. Taking both sides of a transaction is known as wash trading, something banned in regulated markets like stocks because it can give a false impression of market supply and demand. Kraken isn’t similarly regulated by the government.”

Tether tokens are marketed as being backed 1-to-1 by U.S. dollars. In other words, every tether token is meant to represent a single buck. Its ticker symbol is even USDT, to remind traders of this. This comes in handy for people who don’t want to divulge their identities when buying crypto for whatever reason, such as not wanting to deal with the hassle of KYC (know your customer) paperwork or else some nefarious purpose.

However, there are a lot of questions. For one, the token’s issuer, Tether, shares the same management as Bitfinex, one of the world’s largest bitcoin exchanges. However, they insist they are separate companies.

Another—and this is big—is that Tether hasn’t been audited. It had an auditor—Friedman LLP—but they parted ways in January. A couple of weeks ago, Tether published a report from a law firm run by former FBI director Louis Freeh. It claimed Tether had around $2.5 billion in the bank to back up an equal amount of tethers outstanding. That report analyzed balances on June 1.

A few days before Tether boasted it was fully backed by assets, another report—this time, an analysis by University of Texas at Austin professors John M. Griffin and Amin Shams—found (among other things):

“If Tether is pushed out to other crypto exchanges rather than demanded by investors with dollars in hand, Tether may not be fully backed by dollars when issued. However, if the issuers wished to post monthly bank statements to shore up dollar reserves and appear fully backed, this would necessitate the liquidation of the purchased Bitcoins at the end-of-the-month (EOM).”

Thus, in theory, the process is supposed to go something like, take U.S. dollars to buy tethers and then use tethers to buy bitcoins. But in practice, it may be that Bitfinex/Tether is issuing unbacked tether tokens and using those to buy bitcoins that are then sold for U.S. dollars. Without an audit, one cannot know for certain what’s really going on. What we do know is that the feds are investigating bitcoin price manipulation and the CFTC subpoenaed Tether and Bitfinex back in December.

Which brings us to Kraken’s defense of its business, an insult-and-expletive-laden diatribe attacking Bloomberg posted on July 1. The language and tone used was not in keeping with what one expects of an exchange handling millions of dollars every day. Alas, this is the crypto world, where bros rule the day.

Signed by “KRAKENFX”, the post started off by questioning Matthew Leising’s ability to comprehend arbitrage, order books, and currency pegs (followed by calling other respectable journalists “lemmings”). Kraken then claimed Leising’s story was “handily dismantled by the community” by which they mean a few posts by Tether and Kraken fans on Reddit.

“It’s scary to think that our lawmakers are reading this stuff,” whined Kraken. “If we are to take up our pitchforks against market manipulation, guide your torches toward this illumination: the Bloomberg News piece was published on June 29th, the last business day of trading for Q2, and expiration date of numerous futures contracts.”

Kraken then listed reasons why they want people to dismiss the Bloomberg story. First, it claimed, tether “enjoys price stability due to arbitrage and design.” Why is that? “However, Tether is unique in that each USDT is (according to the issuer) collateralized with $1 US dollar.” [Emphasis ours.]

The standard definition of “arbitrage” in trading parlance is riskless profit. If the price of one tether falls below $1, a trader merely has to buy as many tether tokens until the price climbs back up to a buck even (transaction costs for USDT/USD on Kraken are 0.2 percent at the highest). Then, conceivably, one can go to the issuer, Tether, and redeem those tokens for a dollar.

Except Tether has been accused of making it difficult—if not impossible—for holders to redeem those tokens for greenbacks. And if there aren’t enough dollars at any given moment to back those tethers, then it’s not a riskless profit. Again, that would be assured were there an audit.

Kraken’s second argument was that “USDT on Kraken is a miniscule market” (that word should be “minuscule,” but let’s not be petty). And, indeed, that is the case. As of this writing, $769,145 worth of tethers traded against U.S. dollars in the past 24 hours, according to CoinMarketCap.com. In total, some $2.722 billion in tethers changed hands during that time frame (the largest single tether market, versus bitcoin on Binance, was worth $233 million).

Yet there was one small detail not discussed: USDT versus U.S. dollars on Kraken is pretty much the entire market for that pair. In other words, it’s the only game in crypto for someone to buy and sell tether against the dollar directly.

Kraken then took aim at Bloomberg’s suggestion of manipulation. “After reading the Bloomberg article, we scratched our heads, questioning just what type of manipulation was being claimed,” Kraken kvetched. “Price manipulation? Is it so hard to believe that an asset-backed stablecoin could trade, well… with so much stability?”

Again, that would assume all tether tokens are in fact backed 1-to-1 with U.S. dollars. But if it’s not and someone is trying to keep prices stable through manipulation, as noted above about those odd but frequent orders, “The software would look for orders with a unique size, and trade against that.”

Still, such accusations may not bother Kraken’s CEO, Jesse Powell, argued the New York Times’ crypto reporter, Nathaniel Popper:

This is quite a deep dive into suspicious trading patterns on the crypto exchange Kraken, from @mattleising . The CEO of Kraken has, in the past, mocked the idea that market manipulation should be policed. https://t.co/D1BpxYXqxr

— Nathaniel Popper (@nathanielpopper) June 29, 2018

A fourth argument by Kraken is that tether doesn’t threaten a solvency risk to exchanges. Here’s how they put it:

“Unless an exchange has made promises to the contrary, they are not accountable to clients for the loss of value of any particular asset. USDT is no different than bitcoin or ether or any publicly traded stock. If an asset’s value goes to $0, the exchange will simply allow you to withdraw your full balance of worthless assets. When you deposit USDT with Kraken, it remains in our wallet as USDT to cover our liability to you. We do not make any conversions on your behalf. If Tether loses its peg – no matter if it rises or falls in value – we still owe you the same number of tokens.”

This is an enormous assumption on the part of Kraken. A collapse of Tether would mean $2.7 billion in perceived value destroyed or else cut down to some fraction of it. But it could also mean catastrophe for the world’s second-largest exchange—Bitfinex—that is also essentially Tether’s issuer. That could have a MtGox-level of shock for the rest of the cryptocurrency market.

The final argument Kraken made was really a defense of Tether. Kraken argued that the increase in their fiat deposits had a correlation coefficient of 0.78 with Tether issuances and an R-square of 61 percent. Kraken interprets that as, “USDT supply increase seems reasonable given our own fiat deposits”.

Or, it could be more good money is chasing more bad money and vice versa.

Kraken closed the post with this line, expecting it to be a zinger (they even included a .gif from the film “Anchorman” of “Ron Burgundy” saying, “It’s science”):