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News of Justice investigation of Tether and Bitfinex comes as no surprise to Modern Consensus readers

Hear that sound? That’s us tooting our own horn

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Tuesday’s big story that the Department of Justice is probing Tether in Bitcoin price manipulation shouldn’t be a shock to one group of people—Modern Consensus readers.

“While federal prosecutors opened a broad criminal probe into cryptocurrencies months ago, they’ve recently homed in on suspicions that a tangled web involving Bitcoin, Tether and crypto exchange Bitfinex might have been used to illegally move prices, said three people familiar with the matter,” wrote Bloomberg’s Matt Robinson and Tom Schoenberg. However, we connected the dots months ago when news of a DoJ investigation began surfacing.

Modern Consensus began publishing at the start of the year, while crypto prices were stratospheric. Still, back in February, when bitcoins were trading at half their December all-time highs of $19,000, we were paying attention to critics who speculated that Bitcoin’s skyrocketing prices were tied to Tether. As our own Dylan Love wrote:

“But watchful eyes noticed that gobs of new Tether were created at times when other cryptocurrency prices were crashing. This new Tether was then believed to have been used on Bitfinex’s exchange to buy lots of bitcoin and other currencies, sending their prices back up.”

The following day, Love also sounded the alarm on a massive spike in tether issuances, noting that it followed CFTC subpoenas of Bitfinex and Tether. He closed with this ominous warning:

“If a cryptocurrency that’s purportedly backed by the dollar proves to be fraudulent, it will have lasting negative impacts on the cryptocurrency market at large.”

We kept track of Tether and Bitfinex for some time after. This editor caught wind that its then-spokesperson, Ronn Torossian of 5W PR, had left the account. That was news because Torossian had vehemently defended the company on social media for months.

On May 25, we noted that two stories in crypto-land that seemed to be separate were likely linked. On that day, Bloomberg reported first that the Department of Justice was investigating price manipulation in Bitcoin (without naming any specific entity). One hour later, the same news organization’s Matt Leising published a piece on how Tether and Bitfinex had moved their banking to Noble Bank in Puerto Rico. As we wrote in our lead paragraph:

“Two Bloomberg stories about bitcoin published within an hour of each other on Thursday seemed barely related. But to those who follow the space closely, they are really the same story—and it’s perhaps the biggest story in crypto, one that may yet turn out to be the Enron of the cryptocurrency world, if not worse.”

In June, Tether—which notoriously has avoided an auditor since losing Friedman LP at the start of the year—tried to assuage fears that it didn’t have fiat money backing its tokens. They did so by issuing a letter from Freeh, Sporkin & Sullivan LLP (FSS). Former FBI director Louis Freeh was once involved in a business deal with Noble Bank’s founder, John Betts, to try to obtain Mt. Gox’s assets after that exchange collapsed.

While some people focused on the background of the partner who actually signed the letter (former judge Eugene R. Sullivan, an advisor to one of Tether’s banks), we had another concern—the date when Tether’s books were examined. It was June 1, 2018. A study published just one week before by University of Texas’ John M. Griffin and Amin Shams made a striking observation:

“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). Interestingly, we find a significant negative EOM abnormal return of 6% in the months with strong Tether issuance. The EOM Bitcoin returns are highly correlated with the magnitude of Tether issuance, and no abnormal returns are observed in months when Tether is not issued.”

In other words, they suspected bitcoins bought by unbacked tethers were sold by the month-end to shore up Tether’s books to its investors. For that reason, it made sense to us that Tether’s books would appear to have dollars backing them if the date examined was the one immediately after a month-end.

As pressure mounted from some in the crypto to have the SEC approve a Bitcoin ETF, we came out against it on July 23, 2018, citing the influence of Tether on the overall market when there was a distinct possibility it could be a fraudulent enterprise. As we wrote then:

“Over the past 30 days, tether’s daily transaction volume has averaged the equivalent of its total supply. In other words, on average, every tether changes hands once per day. Though the ratio of trades to supply is half of what it was in December around bitcoin’s peak, the velocity is double what it was when Wells Fargo walked away from Tether. But recall that the supply is now 54 times what it was in April 2017.

“Backing most of those tethers may be nothing more than the warm Caribbean air.”

And Bitfinex may not have been the only entity that may have used Tether’s tokens for its own gains. Bitforex, we noted, was suspected of putting in a bunch of wash trades to gain prominence on CoinMarketCap.

We were the first organization to break the big story that precipitated the latest phase in Bitcoin price declines. On September 30, 2018, we reported that Noble Bank was going through severe financial problems and that some big traders looking to get out of large Tether positions were having trouble doing so.

Ten days later, we posted about a decline in tether circulation of 100 million tokens and how some linked it to Tether’s move to Bahaman bank Deltec. Since then, circulation has declined by about 1 billion tokens.

One month ago, on October 17, 2018, we conducted a long (6,000 words) interview with Bitfinex’ed, Tether and Bitfinex’s leading critic for well over a year. She (or he) gave us insight on what raised red flags and what she/he suspects happened.

Bitfinex and/or Tether—or else some of their more rabid supporters—appear to have begun targeting journalists, possibly with harassment. Two of them, David Floyd of CoinDesk and Larry Cermak of The Block, reported a significant amount of spam in their email boxes. We wrote the story that others didn’t want to—or couldn’t—write.

Just a couple of weeks ago, Deltec published a letter saying Tether had enough dollar assets in the bank to back it, we pointed out that, once again, the date of the letter was just after a month-end, a time that the University of Texas researchers warned was suspect.

And while just about everyone else started this week blaming Bitcoin Cash for the selloff in cryptocurrencies, we reported that volume on the Bitfinex exchange, controlled by the same management as Tether, had extraordinarily high volume relative to other exchanges. On Sunday, Bitfinex informed customers it would charge a 3 percent fee for those who cashed out with fiat currency (that is, if they could do so). Our sources explained the drop in Bitcoin came from traders essentially liquidating their tethers by using them to buy bitcoins, then transferring those bitcoins to other exchanges where they were then sold for fiat currency. Among other things, it would explain the large premium for bitcoin on the Bitfinex exchange relative to the rest of the market and the spike in volume.

What we have to say 

We cannot say whether or not anything will come of the Department of Justice investigation on Bitfinex and Tether. Perhaps they will find that this is an innocent misunderstanding and everything is hunky-dory.

The market right now thinks otherwise.

At Modern Consensus, we believe it is our responsibility to get to the truth as best as we can and to explain facts as well as analyze what it all means.

For months, we’ve been all over this and we haven’t relented. It’s not what we set out to do when we began this publication. Instead, we wanted to tell the big story of the technology and how all the interesting things that are coming from it.

But we couldn’t tell that story and ignore what was driving up prices. At first, we believed that there was legitimate enthusiasm for distributed ledger technology and cryptocurrencies—and, indeed, there was and still is. As we trudged more into it and as we slogged through the data, we came to realize something was fishy.

Again, it may be a nothingburger, as Tether fans and shills insist. Yet our decades of experience trading in financial markets before covering them led us to conclude that this nothingburger isn’t kosher.

What comes next may be worse for crypto investors than the astounding drop from all-time highs of a year ago. Nonetheless, our readers have been forewarned and to be forewarned is to be forearmed.

Go forth with vigilance, dear readers!

Lawrence Lewitinn, CFA is editor in chief of Modern Consensus. Disclosure: Lewitinn owns no cryptocurrencies in his portfolio.

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