I had intended to stop writing about crypto currency. Despite the massive buzz in 2016 and 2017, crypto has largely shown itself to be irrelevant to any serious discussion about finance or economics.
The same people who were screaming back then that bitcoins would be trading at $100,000 each are still “certain” that it will happen “soon”. The promised institutional investors never materialized and probably never will. The bitcoin ATMs promised for every street corner must still be on order.
The “un-hackable” online wallets and accounts still get hacked. People who invested good old fiat currency in more than 1000 “alt-coins” saw those coins disappear into thin air.
There were and still are people who favor crypto currency because they hate banks. Many have moved on to other battles against the establishment. Some, having fattened their own wallets as crypto currency consultants, now have very high limit American Express cards.
There are still people who defend crypto currency despite the fact that there have been so many scams and losses. A common argument is that the losses in crypto are not significant compared to consumer losses caused by banks. That follows the same logic as the sentence “Ted Bundy killed more than 30 people and I only killed one”.
Perhaps the most disappointed people in the crypto world will be the many who favor crypto currency because of what they see as a lack of transparency and over-concentration in the traditional banking system. I cannot imagine how they must feel when they realize that the future of crypto currency may be in the hands of Facebook.
Lawyers no longer have to lecture on the Howey test or lament that they cannot do what they do without more guidance from the government. The best lawyers work with the regulators to “tokenize” this project or that, even when those projects could likely raise money without tokens.
Whatever becomes of the crypto or token market it is a lot cleaner than it was because regulators became more and more active, not because crypto investors have gotten any smarter. But there is still a lot of crypto-trash to clean up.
The enforcement action of the month involves an action by the New York State Attorney General (NYAG) against iFinex Inc. which operates of the Bitfinex trading platform and Tether Limited, issuer of “Tether” a self–styled crypto currency. Both, apparently, are controlled by the same people.
Tether bills itself as a “stable coin”. Its original white paper claimed that “each issued into circulation will be backed in a one to one ratio with the equivalent amount of corresponding fiat currency held in reserves by Hong Kong based Tether Limited.”
On its website the company still claims “Every Tether is always 100% backed by our reserves, which include traditional currency and cash equivalents” and “Every Tether is also 1-to-1 pegged to the dollar, so 1 USD₮ is always valued by Tether Ltd. at 1 USD.”
IFinex Inc. says it issued more than $1 billion worth of Tether. The New York State Attorney General believes that the reserves may be short by $700 or $800 million or more and wants to see the books.
People have actually been questioning the accuracy of the reserve figure for some time. The company promised and then refused to provide any kind of audited financial information.
The original white paper notes that Tether, Ltd. “as the custodian of the backing asset we are acting as a trusted third party responsible for that asset. This risk is mitigated by a simple implementation that collectively reduces the complexity of conducting both fiat and crypto audits while increasing the security, provability, and transparency of these audits.”
It should be cheap and easy to prepare a certified audit because the company should be able to easily demonstrate how many coins it issued. The reserves are all held at banks and should be easy to prove. Instead of an audit the company offers a letter from their law firm that says that it looked at some account statements and it seems that there are adequate reserves. The letter did not satisfy the New York Attorney General.
The idea behind stable coins was intended to fix a problem created by other crypto currency like bitcoins which were susceptible to volatile shifts in their exchange rate with US dollars. Given that bitcoins were a intended to be “currency”, merchants take on a substantial risk every time transactions were denominated in bitcoins, instead of dollars. It is a problem best solved by eliminating the bitcoins rather than adding the Tether to the transactions.
Actually the only thing new about stable coins is the name. The financial markets already have a class of securities that are pegged one-to-one to the US dollar and backed by cash or cash equivalents. We call them money market funds.
Money market funds are registered with the SEC under the Investment Company Act and subject to specific disclosure and custody rules like other mutual funds. Issuing a stable coin on a blockchain is remarkably similar to buying a money market fund from a mutual fund company using a book entry system. Mutual funds are required to provide timely, accurate information to the public. The management at Tether does not believe that they should be required to do the same.
Bitfinex and Tether have had problems in the past. In early 2017, Bitfinex accounts were thrown out of Wells Fargo Bank. At the time, many people in crypto saw this as “retaliation” by a legacy bank against the brave new world of crypto currency. The bank no doubt looked at it as a refusal to assist or participate in an obvious scam.
In late 2017, Bitfinex announced that hackers had stolen $31 million worth of Tether from its own wallet. No investigation was ever reported. Management did not even raise a fuss.
Jordan Belfort, the infamous Wolf of Wall Street called Tether a massive scam. His comment got some press at the time. Most people in crypto just refused to see anything related to crypto as a scam in 2017. That is largely still true and unfortunate.
IFinex and the other defendants argued that the Judge should refuse to let the NYAG look at their books because they never did any business in the State of New York. The NYAG has presented the court with evidence that they did. Sooner or later the Judge will question everything the defendants tell her.
In the meantime, Bitfinex claims to have raised another $1 billion by selling a new crypto currency token called the LEO. As I said the best securities lawyers are now working with the regulators when they want to issue anything that purports to be a crypto currency. It does not seem that any regulator, anywhere, reviewed the LEO paperwork. The NYAG told the court that LEO offering “has every indicia of a securities issuance subject to the Martin Act, and there is reason to believe that the issuance is related to the matters under investigation.”
Sooner or later the Judge will want to see the records that prove that the reserves are indeed in the bank. No one, and I mean no one, should seriously expect that the reserves will be there unless the proceeds from the sale of the LEOs are meant to replenish them. That will not solve the problem because the people who bought the LEOs were not told the reserves were missing or that their funds would replenish them.
Over the years I have read thousands of prospectuses and other documents that are given to investors when they purchase any new security. Among other things, the documents disclose specific risks that may adversely affect the investors’ returns. I have seen those “risk factors” go on for pages and pages.
Still there is one “risk factor” disclosed in the original Tether white paper that I cannot recall ever having seen before. Management at Tether Ltd. deemed it necessary to disclose to the initial buyers of Tether stable coins that: “We could abscond with the reserve assets.” Perhaps they were already thinking about it.
I have written about investment scams before, and as I said, I really do not think crypto is worth writing about. What makes Tether interesting is the potential magnitude of the loss.
The NYAG says that as much as $850 million may be missing from the reserve account. After that money was allegedly already gone, the company may have raised another $1 billion with the LEOs. It is more than possible that a year from now the crypto industry will be staring at a $2 billion loss because the management of Tether just absconded with all of it.
I actually wonder if the crypto zealots will consider that to be a “significant” loss.
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The Troubling Tale of Tether
