NY Attorney General accuses Bitfinex of using Tether’s reserves to hide $850 million loss

Controversial cryptocurrency exchange Bitfinex is alleged to have tapped into reserves of the stablecoin issued by sister company Tether to cover up $851 million in losses last year, New York Attorney General Letitia James charged on Thursday.

In a filing in New York Supreme Court on April 25, James alleges that Bitfinex’s owner, Hong Kong-based iFinex Inc., pulled at least $700 million out of Tether’s dollar reserves. Until a little more than a month ago, Tether claimed dollars were backing its token on a one-to-one basis, with those greenbacks said to be safely held in banks. James said her office received a court order to stop Bitfinex from commingling its own funds and the Tether reserves, turn over documents, and stop any distribution of funds to its executives.

Some 73% of all Bitcoin trades are done with Tether’s tokens, according to research site CryptoCompare.

James’s filing traces the source of Tether’s current woes to the March 2017 decision by Wells Fargo Bank to cut ties with Bitfinex, which the company alleged in a lawsuit “presented an existential threat to its business,” by cutting off its ability to transfer dollars to its U.S. clients, James’ filing noted. By September 2017, they were doing business with Noble Bank.

News of Bitfinex’s troubles came to light in a story first broken by Modern Consensus on September 30, 2018, noting that the bank holding most of Tether’s reserves, Noble Bank International of Puerto Rico, was on the verge of insolvency. The following day, Bloomberg reported that Noble was trying to put itself up for sale.  Tether moves its reserve of dollars from Noble to the Bahamian Deltec Bank & Trust Limited in October, James’ filing said.

By early October 2018, stories—starting with Modern Consensus’ reporting—”began circulating online that Bitfinex was close to insolvency, as numerous clients reported that they had been unable to withdraw their money from the Bitfinex trading platform,” James’ filing said. “On October 7, 2018, Bitfinex published a notice to investors ensuring them that the company was not insolvent. and that rumors to that effect were ‘a targeted campaign based on nothing but fiction … Stories and allegations circulating mentioning an entity called Noble Bank have no impact on our operations, survivability, or solvency.’”

On October 9, Modern Consensus reported that $100 million of Tether’s stablecoin tokens had disappeared, and that one Tether critic believed Deltec was letting Bitfinex and Tether pull reserve dollars out, indicating that the company had lost banking for a period.

Forced to work with questionable institutions like Noble and Deltec—both of which now appear to have ceased operations—because major banks increasingly avoided working with cryptocurrency exchanges, by mid-2018, Bitfinex found itself in a severe cash crunch and unable to meet withdrawals from its trading platform. That’s when it turned to a Panamanian bank called Crypto Capital, which James said held about $1 billion in an account mingling Tether reserve funds with Bitfinex’s own money.

In October, while Bitfinex was publicly saying that withdrawals were being processed normally, they were desperately begging Crypto Capital to release their funds, James said, citing a conversation in which a senior Bitfinex executive told a contact at Crypto Capital, “please understand this could be extremely dangerous for everybody, the entire crypto community. BTC could tank to below 1k [$1,000] if we don’t act quickly.”

In November, the U.S. Department of Justice was probing Tether for involvement in Bitcoin price manipulation.

That month, Tether had transferred $625 million from its account at Deltec to the Bitfinex account at Deltec, and Bitfinex then transferred the same amount from its account at Crypto Capital to Tether’s account there, the company’s lawyers eventually admitted to James’ office. By December, Bitfinex was starting to have concerns about their ability to access funds at Crypto Capital.

Crypto Capital eventually told Bitfinex that $851 million had been seized by authorities in Poland, Portugal, and the U.S., James said, noting that Bitfinex said they did not believe this.

On February 21, 2019 Bitfinex’s counsel had informed attorneys for the Office of the Attorney General that it intended to, “take a ‘line of credit’ of $600 to $700 million on the reserve funds backing tethers,” according to James’ filing. “Counsel did not suggest what, if any, benefit would accrue to Tether, or holders of tethers, from this transaction. Nor did counsel suggest that this transaction would be disclosed to the public, including investors trading on the Bitfinex platform or holders of tether.”

On March 14, Modern Consensus reported that Tether had changed the description of its dollar reserves from “always backed 1-to-1, by traditional currency” to “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”). Every tether is also 1-to-1 pegged to the dollar, so 1 USD₮ is always valued by Tether at 1 USD.”

As we noted, this translated to: “Every tether is also 1-to-1 pegged to the dollar” solely because Tether claims it is, not because—as they once advertised—one tether token had an equivalent dollar in the bank.”

Tether has retained it position as the top source of liquidity in the Bitcoin exchange market despite the addition of stablecoins issued by Gemini and Paxos under the supervision of the New York State Department of Financial Services, widely considered the gold standard of regulatory oversight in the cryptocurrency market.

“The news today reinforces our belief that regulation and oversight create confidence and stability for the industry and Paxos is proud of its NYDFS-granted Trust charter, the highest form of regulation in the space,” Chad Cascarillo, CEO and co-founder of Paxos, said in a press statement an hour after New York’s court filings were publicized. “The industry is trading billions of dollars worth of cryptocurrencies daily and relying on exchanges and stablecoins that have no licensing, no registration, no oversight, is bad for business and reckless in the long term. We knew this was coming—and we’ve been expecting the tide to turn. That’s why we built Paxos within the framework of regulation and oversight for both our PAX stablecoin and itBit exchange.”