News: NYAG calls Bitfinex out, Bitfunder founder off to jail, Roubini pissed at Bitmex

A few people asked me where I’ve been lately. I’ve been working! I recently started a full time job. I’m the editor of a website about ATM machines. I recently wrote Spanish authorities: bitcoin ATMs expose hole in AML laws” and Bitcoin ATMs: Why Vancouver doesn’t want them.” (By the way, if you are curious how criminals use bitcoin ATMs to clean money, this moneylaunder.com article does a nice job of explaining the process.) 

I also write a newsletter on money. You should sign up for it

On to the news — 

Much ado about exchanges

Crypto exchange Bitfinex is doing a lot more business in New York than it’s led us all to believe. The NYAG’s recent court filings — a Memorandum of Law and an affirmation from assistant Attorney General Brian Whitehurst, along with 28 pieces of evidence — reveal a full picture of the company’s dealings in the state.  

Why does it matter? Because his means NYAG has jurisdiction to push ahead with its investigation into Bitfinex and Tether’s ongoing shenanigans. Decrypt’s Ben Munster also points out that Bitfinex “loaned tethers to a New York trading firm.” There’s an open question as to whether the funds were ever paid back.  

Also, Bennet Tomlin had a good thread on the NYAG’s filing.

By the way, there are now nearly $3.9 billion tether sloshing around in the markets, pushing up the price of bitcoin, which briefly crested $13,000 on July 10. 

I nearly missed this bit of news from a few weeks ago: Ireland-based cryptocurrency exchange Bitsane went poof!, leaving its 246,000 users high and dry. Users began having issues withdrawing crypto from the exchange in May. And on June 17, the exchange’s website along with its twitter and facebook accounts vanished.  

Bitmarket, the second largest Polish crypto exchange, has shut down citing a loss of liquidity. Approximately 1,300 bitcoin are stuck on the exchange, and users are rightfully pissed off. They have formed a Facebook group and are planning a class-action lawsuit. The exchange was acting goofy before the shutdown. Reddit user u/OdoBanks says users were asked to change passwords and provide additional KYC for withdrawals.

Founder of bitcoin stock exchange Bitfunder will be spending 14 months behind bars for lying to the SEC about a hack that cost clients 6,000 BTC. Instead of telling his customers the truth in 2013, operator Jon Montroll misappropriated funds to hide the losses.  

Cryptocurrency exchange hacks don’t happen too often — only once every few weeks. Japan’s Bitpoint is the latest to make headlines. The exchange’s hot wallets were hacked to the tune of $32 million worth of crypto, most of which were customer funds. On Monday, the exchange found another $2.3 million missing on exchanges “that use the trading system provided by Bitpoint Japan,” according to Japan Today

(Update, July 15, 11:30 a.m. EST — previously, I indicated Bitpoint located $2.3 of the missing funds, but actually the exchange found more money missing.)

Speaking of Japan, the country’s top regulator says 110 crypto exchanges are waiting for licenses right now. Under Japanese law, crypto exchanges need to register with the Financial Services Agency to operate in the country. As of now, there are only 19 licensed exchanges in Japan. The FSA has been slow to license after the Coincheck hack

Binance burned 808,888 of its native BNB tokens — about $24 million worth. This is the eighth burn of BNB coins, which are totally not a security. The price of the remaining BNB goes up every time there is a burn. Keep in mind, until any crypto is converted to fiat, its value is completely theoretical. 

Screen Shot 2019-07-14 at 11.26.10 PMBitMEX, the Hong Kong-based bitcoin derivatives exchange, has finally released the tapes (round 1 and 2) from its “Tangle In Taipei,” a July 3 debate between Bitmex CEO Arthur Hayes and NYU professor Nouriel Roubini. The two have been going at it online.

A man is suing Gemini — the NY exchange operated by the Winklevoss twins — after $240,000 was stolen from his money market account and wired to Gemini, where it was used to to purchase crypto on the exchange.  

Due to heightened oversight on online crypto exchanges, users are increasingly asked to fork over their IDs and addresses. The shift is giving peer-to-peer exchanges, which typically don’t impose such KYC checks, a boost, according to Bloomberg

Other interesting stuff

Founders of the Tezos crypto platform object to sharing emails between them regarding the Tezos “fundraiser” because they are married. Steven Palley has the full story

New York City’s Monroe College was hit with a ransomware attack that shutdown the college’s computer systems. The attackers want the college to fork over $2 million worth of bitcoin to free up the computers.  

President Trump blasted bitcoin on Twitter. He is no fan of Facebook’s Libra either. There’s only room in this country for one currency, and that’s the almighty dollar.

The Federal Trade Commission has fined Facebook a gobsmacking $5 billion for privacy violations. It’s the biggest fine in FTC’s history. Surprise, surprise, Facebook’s stock went up on the news. 

An angry mob burned down the home of a man behind bitcoin ponzi scheme in South Africa after he admitted all the money was gone. 

Finally, police in China cracked down on a cartel of illicit bitcoin miners who stole nearly $3 million worth of electricity. A local power company tipped off authorities after they noticed a peculiar surge in power use.  

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Turns out, you can make money on horse manure, and tethers are worth just that

Screen Shot 2019-05-23 at 9.22.35 AM

Did you know, there is an actual business for horse manure?  

“It’s wild,” one horse farmer told Stable Management. “You can take this stuff that nobody wants and turn it into something of value.”  

You can do something similar in the crypto word. Shitexpress was a service that delivered horse poop anywhere in the world for bitcoin. Now, instead of sending actually poop, you can send tethers, a stablecoin issued by a company of the same name, Tether Limited.  

Tethers are a major source of liquidity in crypto markets. In lieu of the US dollar, you can use them to enter and exit positions in times of volatility. As such, tethers are responsible for the health and wellness of dozens of crypto exchanges, including Binance, Huobi, Bittrex, OKEx, Poloniex and others, that don’t have direct banking.

Inner workings

When Tether first entered the world in 2015, tethers were promised as an I.O.U. For years, Tether assured us that every tether was worth $1—as in, one actual US dollar that Tether had on hand that you could redeem your tethers for.  

Tether and its sister company Bitfinex, one of the largest crypto trading platforms by volume, are now being sued by the New York Attorney General. As court documents reveal more of the companies’ inner workings, people are asking: What are tethers worth? Is one tether worth a dollar? Less than a dollar? What can I get for my tethers?

For a while, the thinking was, well, maybe one tether is worth 74 cents, because in his first affidavit, filed on April 30, Stuart Hoegner, Bitfinex and Tether’s general counsel, said tethers were only 74% backed. In other words, Tether was operating a fractional reserve, kind of like a bank, but sans regulatory oversight or deposit insurance.

Tether updated its terms of service on February 26, to let you know tethers weren’t fully backed, but if you weren’t paying close attention—i.e., checking the Tether website every single day—you may have missed it. Tether says it can amend, change, or update its terms of service “at any time and without prior notice to you.”

Now, it’s looking like one tether is worth whatever someone gives you for it. If someone gives you bitcoin for a pile of tethers, hurray for you, that is the value of your tethers. If the person who got your tethers can pass them off to someone else for bitcoin, or another crypto of value, then yay for them! It’s called the greater fool theory, and, so far, it seems to be working—Tether is still trading on par with the dollar.   

But if you take those tethers to Tether, the company that, so far, has shoveled $3 billion worth of them onto the markets, and say, “Hey, can I redeem these for dollars, like you have been promising me all these years?,” they will most certainly tell you, “Sorry, no.”

Are you verified?

You can only redeem tethers under certain conditions, such as you bought loads of them directly from Tether—and you are not a US citizen.

In Hoegner’s recent affirmation, filed on May 21, he says you have to be a “verified” Tether customer to redeem tethers. 

“Only verified Tether customers are entitled to redeem tether from Tether for fiat on a 1:1 basis. There is no right of redemption from Tether on a 1:1 basis for any holders of tether who obtained the tokens on a secondary market platform and who are not verified Tether customers; on the contrary, such holders of tether have no relationship with Tether and are expressly precluded from redeeming tether on a 1:1 basis for Tether.”

In that paragraph, Hoegner reminds us three times—just to make sure we understand his point—that whoever you are and however you ended up with your tethers, the company is under no obligation to give you cash back for those tethers.

Per Tether’s terms of service, only those who bought tethers directly from Tether Limited—aka “validated users”—can redeem tethers. Anyone who got tethers on the “secondary market,” meaning, an exchange, is not able to redeem those tethers.

As court docs reveal, from November 2017 to December 2018, you could only buy tethers for cash directly from Bitfinex. Per Tether’s website, as of November 27, 2018, you could once again buy tethers directly from Tether. However, you have to buy a minimum of $100,0000 worth. According to Tether’s definition, Bitfinex is a secondary market.

Also, if you want to redeem tethers on Tether, you have to redeem a minimum of $100,000 worth at a time, and you can’t redeem more than once a week.

Further, if you live in the US, you have zero chance of ever redeeming your tethers for cash. Hoegner says that as of November 23, 2017, Tether ceased servicing customers in the US, and at this time, “no longer provides issues or redemption to any US customers.”

To summarize, if you are a US citizen holding a bag of tethers, Tether will give you nothing for them. If you acquired tether on Bitfinex or some other exchange, Tether owes you nothing. And if you don’t like that, too bad, because Tether also says in its terms that when you buy tethers, you waive any rights to “trial by jury or proceeding of any kind whatsoever.”

Wait, this doesn’t look like a dollar!

If you are one of the lucky few who purchased $100,000 or more worth of tethers via Tether’s website—and you are not a US citizen—and would like to redeem 100,000 or more of them, you may or may not get actual dollars back any time soon.

In its terms of service, Tether says it “reserves the right to delay redemption or withdrawal” of tether in the event of illiquidity—meaning, if they don’t happen to have cash on hand today. The company also says that it reserves the right to pay you “in-kind redemption of securities and other assets” held in its reserves.

Screen Shot 2019-05-27 at 12.06.21 PMBasically, that equates to, you could get shares of iFinex (Bitfinex and Tether’s parent company) or LEO tokens (a new token Bitfinex recently created) or whatever is in the soup bowl that day. And you may end up with something that has as much real world value as horse manure—just not as good for the roses.

Update (May 27): This story has been updated to reflect that if you buy or redeem tethers from Tether, you have to buy or redeem a minimum of $100,000 worth.

 

 

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New York Supreme Court: Bitfinex may not touch Tether’s reserves for 90 days

Screen Shot 2019-05-16 at 8.30.44 PMBitfinex will not be able to dip into Tether’s reserves for 90 days, except to maintain normal business activities, according to a New York judge. The crypto exchange must also “promptly” hand over documents to the New York Attorney General (NYAG).

On May 16, New York Supreme court judge Joel M. Cohen granted Bitfinex’s motion to modify a preliminary injunction obtained by the NYAG. The judge called the original ruling vague, over broad, and not preliminary, meaning it lacked a specified time limit. He also held that the Martin Act—New York’s powerful anti-fraud law—“does not provide a roving mandate to regulate commercial activity.”

Decision and order

NYAG’s original petition consisted of two parts: a directive to Bitfinex and Tether to “produce evidence,” and a preliminary injunction to ensure that the respondents maintain a status quo while the NYAG’s investigation is ongoing.

In his 18-page decision and order, the judge granted the directive—Bitfinex and Tether still have to surrender documents—and agreed to modify the preliminary injunction, so as not to restrict the companies’ “ordinary business activities” any more than necessary.

The modified injunction spells out the following:

Tether cannot loan, extend credit or transfer assets—outside of its ordinary course of business—that would result in Bitfinex having claims on its reserves.  

(In an earlier letter to the court, iFinex, the parent company of Bitfinex and Tether, claims that Tether’s business model depends on it “making investments and asset purchases with the proceeds it derives from selling tethers.” Presumably, since this is an ordinary part of the company’s business, Tether can continue to invest its reserves, though it is not clear how it is investing the funds.)

Tether and Bitfinex cannot distribute or dividend any funds from Tether’s reserves to executives, employees, or agents of Bitfinex—except for payroll and normal payments to contractors and vendors.  

The companies are barred from destroying or altering any documents and communications, including material called for by the NYAG’s 2018 investigative subpoenas.  

If the NYAG wants to extend the 90-day injunction, two weeks before the injunction expires, it must submit a letter to the court. Bitfinex will then have seven days to submit a response. Based on that, the judge will decide whether to hold a hearing.

Victory, for now…

In a post on its website, Bitfinex revels in its victory. The exchange claims the NYAG sought the April 24 order “in bad faith” and vows to “vigorously defend” against the agency’s actions. Bitfinex adds that it remains committed to protecting its customers, its business, and its community against the NYAG’s “meritless claims.”

Most tether holders (the NYAG calls them “investors”) entered into their contracts under the assumption that tethers were fully backed. Each tether was supposedly worth $1—until late February, when Tether changed its terms without actually telling anyone.

Around the same time, Tether made a questionable loan to Bitfinex for $900 million. (Both companies are run by the same individuals, and the same people signed the agreement on either side.) Bitfinex has already dissipated $750 million of those funds. The remaining $150 million appear to be safe—at least for now.

To note, the investigation into whether Bitfinex violated the Martin Act is still ongoing. As a result of today’s ruling, Bitfinex still has to hand over documents and communications about its “business operations, relationships, customers, tax filings, and more.” The NYAG has been requesting those documents since November.

A transcript of the hearing is available here, courtesy of The Block. 

Update (May 19): I updated this story to clarify that there were two parts to NYAG’s original order. Additionally, I noted that Tether can still invest its reserves.

Update (May 21): I added a link to the full transcript of the hearing.

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Related stories:
Bitfinex to NYAG: You have no authority! We did nothing wrong!
NYAG: Bitfinex needs to submit docs and stop dipping into Tether’s reserves
The curious case of Tether: a complete timeline of events

 

Reginald Fowler, man tied to missing Bitfinex funds, out on $5 million bail

Screen Shot 2019-05-02 at 1.33.58 PMReginald Fowler, the ex-NFL owner arrested in connection with operating a “shadow bank” that processed hundreds of millions of dollars of unregulated transactions on behalf of crypto exchanges, is out on $5 million bail.  

The US Government previously argued that Fowler should be detained without bail. The government thought he was too much of a flight risk due to his overseas connections and access to bank accounts around the world. But for the time being, at least, Fowler is a free man, albeit, with restrictions.

Order and letter

The order setting conditions of release was filed with the District Court for the District of Arizona on May 9. A letter of motion, submitted by U.S. Attorney Geoffrey Berman and addressed to Judge Andrew Carter of the District Court of Southern New York, was entered on May 8.

Copies of the letter went to James McGovern and Michael Hefter, partners at law firm Hogan Lovells in New York. Presumably, these are Fowler’s defense attorneys. Fowler’s arraignment is set for 4:30 p.m. on May 15 at the Southern District Court of New York. 

Fowler was arrested in Arizona on April 30. The bond is being posted in New York, because the District of Arizona does not include secured bonds in bail packages. 

According to conditions set forth in the bond, Fowler cannot travel outside of the Southern District of New York, the Eastern District of New York, and Arizona. He also had to surrender his travel documents and his passport. 

The properties and the wealthy friends

Fowler’s $5 million personal recognizance bond is secured by two unnamed “financially responsible” co-signers and the following properties: 

  • 3965 Bayamon Street, Las Vegas, Nevada
  • 8337 Brittany Harbor Drive, Las Vegas, Nevada
  • 4670 Slippery Rock Drive, Fort Worth, Texas
  • 4417 Chaparral Creek Drive, Fort Worth, Texas
  • 8821 Friendswood Drive, Fort Worth, Texas

A quick look on Zillow indicates the properties are cheap investment houses, worth perhaps $1.5 million in total, if that. This would mean that the additional $3.5 million is secured by Fowler’s wealthy friends, whoever they are.

The LLC on the five properties is Eligibility LLC, 4939 Ray Road, #4-349 Chandler, Arizona 85226. The mailing address points to a UPS store, so it is basically a P.O. Box.

Global Trading Solutions LLC, a company linked to Fowler’s shadow banking operation, had the same mailing address for a time, but the address was later changed.

Indictment

On April 11, Fowler and Ravid Yosef, an Israeli woman who lived in Los Angeles and is still at large, were indicted on charges of bank fraud. Fowler was also charged with operating an unlicensed money services business. 

Fowler’s company—or one of his companies—was Global Trading Solutions LLC, which provided services for Global Trade Solutions AG, the Switzerland-based parent company of Crypto Capital Corp

Cryptocurrency exchanges used Crypto Capital as an intermediary to wire cash to their customers. The firm is allegedly withholding $851 million on behalf of Bitfinex, a crypto exchange that is currently being sued by the New York Attorney General.  

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Thanks to Nic Weaver for locating the court documents. He spends his beer money on PACER, so you don’t have to.

News: Money laundering in real time, Binance has you covered, maybe, and Bitfinex ready to IEO with LEO

A lot is going on in cryptoland right now—most of it involves investigations, a New York Attorney General (NYAG) lawsuit and missing funds, but I don’t want to sound negative.

The destiny of all crypto exchanges is to be hacked, apparently. Last year, thieves stole $950 million worth of cryptocurrency from exchanges. So, in many ways, it’s not surprising to hear that Binance, the largest crypto exchange by volume, got hacked a second time.

Binance, all funds SAFU

Thieves looted more than 7,000 BTC from Binance in a single transaction. The hackers, however, are not free yet! They still need to move that $41 million worth of BTC into fiat,  a feat that typically requires layering funds into smaller and smaller amounts (generally using a script of some sort), moving it through coin mixers, and then funneling it through various exchanges until they can exit into cash. 

Thanks to blockchain, we can watch this money laundering happen real time. The first transaction out of Binance consisted of of 44 outputs. The hackers have since consolidated the bitcoin into seven addresses of mostly amounts. Now we wait.

After the hack, Binance suspended all deposits and withdrawals for seven days. Traders on the platform can’t dump their bitcoin—or their tether. If bitcoin were to crash, they would be trapped. Fortunately, bitcoin is not crashing—it’s pumping. As I write, bitcoin is now at $6,800, having shot up $1,000 within a week.

According to one expert, the boost is partially due to “a rare alignment of celestial bodies forged in an ancient supernova”—thus, number go up. Makes total sense to me.

Binance says it has an insurance policy—its SAFU fund—to cover losses on the exchange. Nobody knows for certain what is in that fund, because there has never been an outside audit, but Binance’s CEO CZ says they have enough bitcoin to cover the losses. Phew!

In a recent blog post, CZ also said the exchange is revamping its security measures, including its 2FA, API and withdrawal validation processes. Also, withdrawals and deposits should resume “early next week.”

Bitfinex’s legal woes

If you need to get up to speed with the Bitfinex and Tether saga, I covered the NYAG lawsuit in my previous newsletter. Robert-Jan den Haan also wrote a complete timeline of Bitfinex’s history with its third-party payment processor Crypto Capital.

We have podcasts, too. I discuss the Bitfinex drama with Sasha Hodder on HodlCast, and Robert talks about it with Laura Shin on her Unconfirmed podcast.

In response to the NYAG’s court order, Bitfinex submitted a motion to vacate. The NYAG filed an opposition, and Bitfinex responded. At a hearing on May 6, New York Supreme Court judge Joel M. Cohen called the preliminary injunction “amorphous and endless.” The prelim will stand, but he is giving both parties a week to sort it out.

Bitcoin was selling at a 6% premium on Bitfinex—a sign that traders are willing to pay more to get rid of their tether and get their funds off the exchange. The price of bitcoin on the exchange was so off-kilter that CoinMarketCap, a website that aggregates bitcoin pricing from top exchanges, stopped pulling from Bitfinex.

The Bitfinex premium disappeared when Binance halted withdrawals on its platform, Larry Cermak doubts it has anything to do with Binance though. He thinks it’s because Bitfinex started processing cash withdrawals again.

Twitter user “Bitfinex’ed,” disagrees. When bitcoins and tethers are stuck on Binance,  that effectively reduces the supply and makes it that much easier to pump the market, he told me. He think prices will crash when Binance reopens withdrawals.

“I am lion, hear me roar”

Screen Shot 2019-05-10 at 9.39.37 PMBitfinex has a $851 million shortfall due to issues with Crypto Capital. How is it going to fix that? Here is an idea: Why not just print more money?

The exchange’s latest plan is a token sale, or exchange traded offering (ETO), on its own platform. It will be selling a new token LEO—as in lion.

Earlier this week, iFinex, the parent company of Bitfinex, released a white paper outlining the business proposition behind the token offering. Each LEO is worth 1 USDT, which is worth $1 USD. This is not the first time Bitfinex has issued a new token to pull itself out of a financial mess. (It created a BFX token after it was hacked in 2016.)

Bitfinex shareholder Dong Zhao told CoinDesk that iFinex has received hard and soft commitments of $1 billion for the token sale. Perfect. That should definitely eleviate all of Bitfinex’s money problems.

QuadrigaCX

Ernst & Young, the trustee for failed Canadian crypto exchange QuadrigaCX, released a preliminary report describing the company’s assets and liabilities. In a nut, Quadriga has US$21 million in assets, but owes creditors US$160 million.

Elsewhere

Recently, Negocie Coins, a crypto exchange that you probably have never heard of, rose to number three on CoinMarketCap’s top exchange’s list sorted by volume. How is this even possible? Clay Collins, founder of market data company Nomics, made a video, explaining how crypto exchanges use ticker stuffing and volume spamming to game the system.

FinCEN has released a new “interpretive  guidance” for money services businesses using cryptocurrency. If you are not sure if you are a money transmitter, David Gerard breaks it down for you. Sasha Hodder also covers the new guidance in Bitcoin Magazine. And there were several tweet storms—here, here, and here.

The FinCEN document has far reaching implications, such as, it appears Lightning Network (LN) operators qualify as money transmitters. Emin Gün Sirer says he is not surprised “given how similar LN is to hawala networks, and given the role hawala networks played in financing terrorism pre-9/11.”

The US banking committee is concerned about Facebook’s attempt at a cryptocurrency—Facebook coin—and how the social media giant is treating people’s’ financial information. It’s published an open letter with questions for Facebook.

Redditor u/BioBiro, who needed to acquire bitcoin for a totally legal purchase, complains about the rigamarole he had to go through. Among other things, “Now there’s two pictures of me and my driving license on their server for the rest of time, I guess.”

Consensus, CoinDesk’s big money maker conference, kicks off in New York next week. Last year it had 8,500 attendees, pulling in ~$17 million in ticket sales—and that’s before sponsorships. Arthur Hayes, CEO of bitcoin derivative exchange BitMEX, was one of several who rolled up to New York Hilton Midtown in a lambo.

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Bitfinex to NYAG: You have no authority! We did nothing wrong!

Screen Shot 2019-05-06 at 5.42.29 PMBitfinex has filed yet another rebuke to the New York Attorney General’s ex parte court order.

The April 24 order basically tells Bitfinex to submit documents and stop dipping into Tether’s reserves, which it has done, so far, to the tune of $750 million.

Bitfinex filed a motion to vacate or modify the order on May 3. On Friday, the Office of the Attorney General (OAG) opposed the motion. And on Sunday, Bitfinex filed a response to the opposition. The reply memorandum in further support of the motion to vacate or modify the order was filed by law firms Morgan, Lewis & Bockius LLP and Steptoe & Johnson LLP.

In the memo, Bitfinex argues that “nothing in the Attorney General’s opposition papers justifies the ex parte order having been issued in the first place.” It lists a bunch of reasons for this—essentially, a lot of “buts,” which equate to Bitfinex saying, “It wasn’t me, you can’t prove it, and anyway, nobody was harmed by the thing I totally didn’t do.”

Here is a summary—also, I am not a lawyer. 

But, tethers are not a securities!

The OAG claims Bitfinex violated the Martin Act, New York’s anti-fraud law, which grants the agency expansive powers to conduct investigations of securities fraud.

Bitfinex argues that the OAG did not even try to explain how tethers (the dollar-backed coins issued by Bitfinex’s affiliate Tether) qualify as securities or commodities in the first place. In its opposition, this is what the OAG did say, in a footnote:

“The Motion to Vacate wrongly suggests that an eventual Martin Act claim stands or falls on whether ‘tethers’ are securities or commodities. It does not. The Bitfinex trading platform transacts in both securities and commodities (like bitcoin), and is of course at the core of the fraudulent conduct set forth in OAG’s application.”

This looks like an attempt by Bitfinex to pull the OAG into the weeds, and the OAG is not going there. The fact that Bitfinex does trade in securities and commodities (the CFTC considers bitcoin a commodity, and the SEC considers most ICO tokens to be securities) is enough to bring Bitfinex under the OAG’s purview. ‘Nuff said. 

But, this is so disruptive!

The ex parte order is “hugely disruptive,” says Bitfinex, because it freezes $2.1 billion of Tether reserves—what’s currently left to back the 2.8 billion tethers in circulation—prohibiting any investment of any kind, for the indefinite future. 

In other words, Bitfinex feels like it can do whatever it wants with the cash that tether holders gave it for safe keeping. Tether works like an I.O.U., which means Bitfinex is supposed to hold onto that money for redemptions only.  

The big reason Bitfinex wants to bend the rules here is that it is desperate for cash to stay in operation. If it can’t get that cash from somewhere, the exchange is potentially in danger of running aground, or getting into even more trouble with regulators. At this point, Bitfinex is even trying to raise $1 billion in a token offering. 

But, we didn’t do anything wrong!

Bitfinex argues it has not committed fraud. It has taken hundreds of millions out of Tether’s reserves, but that is okay, because it updated Tether’s terms of service to make it clear that reserves could include loans to affiliates. What’s more, Bitfinex says it updated the terms before it drew a line of credit from Tether for $900 million.

(It has so far dissipated $750 million of that loan—which was signed by the same people on either side of the transaction—with access to another $150 million.)

In its memo, Bitfinex says:

“This disclosure gave anyone holding or considering buying tether the opportunity to take their money elsewhere if they chose, defeating any allegations of fraud.” 

In fact, Tether did update its terms of service on its website on February 26, 2019, but it did so silently. It was not until two weeks later, when someone inadvertently stumbled upon the change, that the news became public. In contrast, a bank would totally be expected to reveal such a move—at the very least, to its regulators.  

The OAG also claims that in mid-2018, Bitfinex failed to disclose the loss of $851 million related to Crypto Capital, an intermediary that the exchange was using to wire money to its customers. Bitfinex argues that, as a private company, it had “no duty to disclose its internal financial matters to customers.”

If Bitfinex were to go belly up all of a sudden, traders could potentially be out of their funds, but apparently, that is none of their business. Also, Bitfinex went beyond not disclosing the loss. It even lied about it, telling its customers that rumors of its insolvency were a “targeted campaign based on nothing but fiction.”  

The OAG’s opposition to Bitfinex’s move to vacate, literally has an entire section (see “Background”) that basically says, “We’ve caught these guys lying repeatedly, here are the lies,” which Bitfinex does not even address in its memo.

But, nobody has been harmed!

The OAG’s job is to protect the public, but Bitfinex says “there has been no harm to tether holders supposedly being defrauded, much less harm that is either ongoing or irreparable.” Particularly now, it says, after it made the details of its credit transaction—the one where it borrowed $900 million from Tether—fully public.  

“Holders of tether are doing so with eyes wide open,” Bitfinex says. “They may redeem at any time, and Tether has ample assets to honor those requests.”

Ample assets, that is, as long as everybody doesn’t ask for their money back all at once. Bitfinex’s general counsel Stuart Hoegner already stated in his affidavit, which accompanied the company’s move to vacate, that tethers are only 74% backed.  

Tether’s operation fits the definition of a fractional reserve system, which is what banks do, which is why banks have a lot of rules and also backing and deposit insurance.  

But, “the balance of equities favors Bitfinex and Tether!”

Bitfinex and Tether would be fine, if the OAG would just go away. The agency is doing more harm than good, Bitfinex argues. 

The exchange argues that a preliminary injunction would not protect anyone, but would instead cause “great disruption” to Bitfinex and Tether—”ultimately to the detriment of market participants on whose behalf the attorney general purports to be acting.”

It maintains that it needs access to Tether’s holdings because it needs the “liquidity for normal operations.” That is, Bitfinex admits it does not have enough cash on hand, without dipping into the reserves.

But, what’s good for Bitfinex is good for Tether. “For its part, Tether has a keen interest in ensuring that Bitfinex, as a dominant platform for Tether’s products and known affiliate, can operate as normal,” the company says. 

Besides, the OAG has no business “attempting to dictate how two private companies may deal with one another and deploy their funds,” says Bitfinex.

It maintains the OAG’s actions have actually done harm. In the weeks leading up the order, the crypto market was rallying after an extended downturn. In its court document, Bitfinex writes: 

“This rally was halted by this case, which resulted in an approximate loss of $10 billion across dozens of cryptocurrencies in one hour of the April 24, 2019 order becoming public.”

Not only that, but Bitfinex itself was harmed by the publicity brought on by the OAG’s lawsuit. The exchange says the balance of it cold wallets “have fallen sharply, an indication that customers have been drawing down their holdings.”

It is likely that Bitfinex is going to have to surrender the documents the OAG is asking for at some point—and that may be what it is trying to avoid. Its attempts to vacate the OAG’s order appears to be an effort to buy time, while it scrambles to figure out how to come up with the nearly $1 billion it needs to stay afloat—a token sale may be just the thing.

Update:

On May 6, New York Supreme Court judge Joel M. Cohen ruled that the OAG’s ex parte order should remain in effect, at least in part. However, he thinks the injunction is “amorphous and endless.” He gives the two parties a week to work out a compromise and submit new proposals for what the scope of the injunction should be.

On May 13, iFinex, the parent company of Bitfinex and Tether, submitted this letter and this proposed order to the court. Among other things, iFinex is asking for a 45-day limit on the injunction and to replace three paragraphs—one of which would allow Tether employees to get paid using Tether’s reserves.

For its part, the OAG submitted this letter and this proposed order. The OAG is not opposed to Tether’s employees being paid, but it wants Tether to to pay its employees using transaction fees—not reserves.

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What happened next?
NY Supreme Court Judge: Bitfinex may not touch Tether’s reserves for 90 days

Related stories:
NYAG: Bitfinex needs to submit docs and stop dipping into Tether’s reserves
The curious case of Tether: a complete timeline of events

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NYAG: Bitfinex needs to submit docs and stop dipping into Tether’s reserves

Screen Shot 2019-05-05 at 1.09.10 PMBitfinex was not happy with the New York Attorney General’s April 24 ex parte court order, which demanded that the crypto exchange stop dipping into Tether’s cash reserves and hand over documents that were requested in November 2018. It struck back with a strongly worded motion to vacate, or overturn the order.

On May 3, the Office of the Attorney General (OAG) submitted an opposition to that motion. The agency argues that Bitfinex violated the Martin Act, New York’s anti-fraud law, widely considered the most severe blue sky law in the country.

Legally, Tether and Bitfinex are separate entities, but they are managed by the same individuals. To note, the OAG’s order does not prohibit Bitfinex from operating. Nor does it prohibit Tether from issuing or redeeming tethers (USDT) for U.S. dollars.

The order simply prohibits Bitfinex from helping itself to anymore of Tether’s funds. This, of course, poses a problem for Bitfinex, because it desperately needs cash to stay afloat. (It’s latest effort to fill the gap is a token sale, but that is another matter.)

There are currently 2.8 billion USDT in circulation, and each of them is supposed to be backed 1:1 with the dollar, but as of now, they are only 74% backed.

The alleged fraud

The OAG began investigating Bitfinex late last year. If there is any question as to how Bitfinex allegedly committed fraud and misled its customers, the OAG spells that out clearly in its memorandum. I’m paraphrasing some this. 

Bitfinex failed to disclose to its clients that it had lost $851 million of “wrongfully commingled” client and corporate funds to Crypto Capital, an overseas entity, which it used as an intermediary to wire US dollars to traders on its platform.

Bitfinex knew in mid-to-late 2018 that Crypto Capital’s inability—or unwillingness—to return the funds meant it would have problems filling out client requests to withdraw cash off the exchange. Nevertheless, it told the public that rumors of insolvency were a “targeted campaign based on nothing but fiction.”  

In November 2018, Bitfinex tried to cover up the loss by moving (at least) $625 million from Tether’s legitimate bank account into Bitfinex’s account. In return, Bitfinex “credited” $625 million to Tether’s accounts with Crypto Capital. OAG says the credit was “illusory,” because the money at Crypto Capital was lost or inaccessible.

(In its motion to vacate, the OAG notes that Bitfinex contradicted itself by saying the “credit” Bitfinex gave to Tether was $675 million—a $50 million discrepancy.)

Bitfinex later shifted to a new strategy. It engaged in “an undisclosed and conflicted transaction” to let Bitfinex dip even further into Tether’s reserves. The exchange took out a $900 million loan from Tether, secured by shares of iFinex—the parent company of both Tether and Bitfinex. OAG says there is little reason to believe the iFinex shares have any real value, especially in the event iFinex itself defaults.

In March 2019, $900 million represented almost half Tether’s available reserves at the time, but Bitfinex and Tether did not disclose this to its customers. In fact, up until February 2019, Tether telling its customers that USDT was fully backed. Bitfinex told the OAG that it has already dissipated $750 million of Tether’s funds.

Bitfinex demonstrates “a pattern of undisclosed, conflicted, and deceptive conduct” that its customers would “find material, and indeed, essential to buying tethers and trading assets, like bitcoin, on the Bitfinex platform,” the OAG said.

In its motion to vacate, Bitfinex argues that the Martin Act stands or falls on whether tethers are securities or commodities. It does not, the OAG says. In fact:

“The Bitfinex trading platform transacts in both securities and commodities (like bitcoin) and is of course at the core of the fraudulent conduct set forth in the OAG’s application.”

Related events

The OAG points to other events that underscore the need to maintain the status quo.

Since the original order, two individuals, Reginald Fowler and Ravid Yosef, were charged with bank fraud in connection with their operation of a “shadow bank.” Fowler was arrested on April 30, while Yosef is still at large.

The operation processed hundreds of millions of dollars of unregulated transactions on behalf of numerous cryptocurrency exchanges and associated entities—“several of which,” the OAG says, are at the center of its own investigation. 

This appears to indicate the OAG’s is looking into other exchanges, which makes sense, given it sent out a questionnaire to more than a dozen cryptocurrency exchanges in April 2018, requesting they disclose key information about their operations.

While the OAG does not specifically state that the “shadow bank” is Crypto Capital, it points to the Memorandum in Support of Detention of Fowler, which said that companies associated with Fowler “failed to return $851 million to a client of the Defendant’s shadow bank.” 

The OAG’s investigation is still ongoing.

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