Matt Stankiewicz, Managing Counsel at The Volkov Law Group, informs us about the NYAG case against Bitfinex and Tether.
In late February, the New York Attorney General (“NYAG”) resigned itself to Bitfinex and Tether on charges of financial mismanagement. NYAG claimed Bitfinex and Tether tried to cover around $ 850 million in lost customer funds. In addition, NYAG alleged that Tether had misrepresented that its stablecoin held adequate reserves of one US dollar for every single Tether coin. As part of the settlement, Bitfinex and Tether have agreed to pay $ 18.5 million, cease trading with New York-based companies and corporations, and provide NYAG with quarterly transparency reports. As part of the settlement, Bitfinex and Tether neither admit nor dispute any of NYAG’s results.
In a statement, New York Attorney General Leticia James stated:
Bitfinex and Tether have ruthlessly and illegally covered massive financial losses in order to keep their systems running and protect their bottom line. Tether’s claim that his virtual currency was fully backed by US dollars at all times was a lie. These companies masked the real risk investors were exposed to and were operated by unlicensed and unregulated individuals and companies operating in the darkest corners of the financial system.
Bitfinex is a cryptocurrency exchange that allows users to trade a wide variety of virtual currencies as well as a wide variety of related services. Tether is a stable coin pegged to the US dollar and traded under the acronym USDT. The two companies are closely related and share several directors and executives. This investigation revealed that agents were also frequently mixed between the two.
Tether expressly states that it maintains a corresponding reserve level so that a tether is always covered by one US dollar. A stable coin is generally a cryptocurrency that is designed to maintain its overall value despite the volatility in the crypto markets. Stable coins are important for cryptocurrency traders. It allows traders to hold money in the cryptocurrency ecosystem while switching between trades and allows a “safe haven” to park funds in the event of downward market volatility.
Tether’s reserve problems
During the first few years the company had banking relationships with several Taiwanese banks, with Wells Fargo acting as the correspondent bank. In March 2017, Wells Fargo declined to process further transfers in US dollars, forcing Tether to find a new banking partner. At this point there were approximately 51 million tethers in circulation and the company continued to “print” new tethers quickly. By the end of May 2017, the number of seat belts in circulation had more than doubled to over 108 million.
Even so, Tether had still not been able to find a new banking partner. In fact, Tether had no significant banking relationships until September 2017. During this hiatus, Tether kept much of his funds with the Bank of Montreal under the name of his General Counsel. Despite Tether’s surge in the market, that account never held more than $ 61.5 million. Regardless, Tether continued to “print” new coins during this period, reaching approximately 442 million Tether in the market in September 2017. On the other hand, Bitfinex told NYAG that it held approximately $ 382 million in Tether funds at the time, what appeared to be a mixed-up bank account at a Puerto Rican bank at best. Tether balanced these funds by posting a “claim” against Bitfinex.
During this period, rumors circulated in the market that Tether did not have sufficient reserves to support further pressure. In June 2017, Tether engaged Friedman LLP to review its reserves. The audit was never completed. In September, Tether and Bitfinex asked Friedman LLP, instead of an audit, to conduct an independent review to determine whether Tether has adequate reserve funds. On the morning of September 15, 2017, Bitfinex transferred nearly $ 382 million from its own bank account to an account on behalf of Tether. Later that day, Friedman LLP confirmed that Tether had approximately $ 442 million between this new account and the Bank of Montreal account. Tether posted this misleading review as a “Transparency Update” on its website.
Bitfinex banking problems
Bitfinex allowed users to exchange fiat currencies (e.g. US dollars, euros, etc.) for virtual currencies and vice versa. To do this, Bitfinex relied on third-party payment processors to make deposits and withdrawals easier. In 2017 and 2018, it was a difficult task to find banks willing to take on these activities as they were viewed as extremely risky, which was not surprising. As a result, Bitfinex relied on Crypto Capital Corp., a Panama-based institution, to process deposits and withdrawals for its users. As of May 2018, Crypto Capital held over $ 1 billion in funds from Bitfinex users.
In April 2018, reports surfaced that Crypto Capital was experiencing regulatory issues and countries had started to freeze their assets. Poland was one of the first countries to freeze around $ 340 million in funds. When Bitfinex inquired, Crypto Capital assured the exchange that the freeze was only temporary. Over the course of several months, Crypto Capital provided various reasons for its inability to return funds to Bitfinex. Portugal then frozen an additional $ 150 million in Crypto Capital’s assets. Bitfinex began internally discussing strategies to deal with a “temporary liquidity crisis” like the one that characterized it, but continued to use Crypto Capital despite its problems.
To address the “temporary liquidity crisis”, Bitfinex “borrowed” $ 400 million from Tether by transferring the money from Tether’s bank account to its own bank account. Bitfinex also instructed Crypto Capital to transfer funds between its Bitfinex account and the Tether account at Crypto Capital. If the money were frozen with Crypto Capital, Bitfinex could at least move it there to fund its internal books. During this time, reports surfaced that Bitfinex was insolvent. Bitfinex denied the allegations.
On November 1, 2018, Tether announced a partnership with a new bank in the Bahamas, Deltec Bank and Trust Ltd. With that announcement, Tether released a letter from the bank stating that Tether’s account was valued at $ 1,831,322,828, which is equivalent to the amount of Tether currently on the market. The next day after the announcement, Tether deposited nearly $ 500 million in Bitfinex’s account. Bitfinex also “bought” nearly $ 150 million in Tether. Just one day after Deltec’s presentation, Tether was no longer really supported one-to-one.
In November 2018, Bitfinex requested the release of its funds from Crypto Capital. Notifications to NYAG suggest Bitfinex complained to Crypto Capital that they didn’t produce “even $ 1 for the entire month.” According to records, Bitfinex may have had over $ 860 million in funds tied to Crypto Capital during this period. To further address the liquidity crisis caused by the frozen funds, Bitfinex negotiated a line of credit in March 2019 that enabled it to pull up to $ 900 million from Tether’s reserves. Despite the financial difficulties, Bitfinex apparently struggled to fulfill withdrawal requests for its customers during this period. Despite what was going on behind the scenes, both Bitfinex and Tether continued to publicly state that everything was in order and under control.
At the time of the settlement, Bitfinex has apparently still been unable to access its funds at Crypto Capital and has no evidence to suggest that Bitfinex will be able to access them in the near future. At the time of this writing, Tether’s supply exceeds $ 38 billion.