NYAG/Tether, Bitfinex settlement reveals commingling of funds, years of shenanigans

I wrote a quick article this morning about the New York attorney general settlement, wherein Bitfinex and Tether agreed to pay $18.5 million in penalties, stop servicing New York customers, and submit quarterly transparency reports. 

But there are more details to highlight. Namely, the settlement agreement reveals the games Bitfinex and Tether have played over the years—games they will keep on playing until someone puts an end to their shenanigans. 

It also reveals how the firms have long misled the public about Tether’s reserves. From 2014 until late February 2019, Tether advertised that tethers were fully backed 1:1 by cash in some bank accounts somewhere—but that was not true. 

Tether now has 34 billion tethers in circulation—a number that is growing by leaps and bounds every day.

Here are my random thoughts and notes from the 17-page agreement.

Phil Potter

In the agreement, the office of the NY attorney general writes: “During the time period relevant to the OAG’s investigation, and as late as early-to-mid 2018, one of Bitfinex and Tether’s senior executives lived in, and conducted his work from, New York.”   

I’m assuming this is Phil Potter, Bitfinex and Tether’s chief strategy officer, and one of its three top execs. Potter allegedly stepped away from the company in mid-2018, about the time the NY attorney general started its investigation. Though the public did not learn of the investigation until April 2019.

The fact that Bitfinex and Tether had one executive and large customers in the state—and no BitLicense—opened the door to the NY attorney general’s probe. Per the terms of the settlement, Bitfinex and Tether can no longer do any business in the state, which means New York crypto firms can no longer use tethers. 

Previously, although Bitfinex and Tether claim to have barred New York residents (retail investors) in January 2017, they still served eligible contract participants, meaning individuals or trading firms with assets in the millions.

Commingled funds

Tether and Bitfinex lost their banking in March 2017 when they were cut off by Wells Fargo, a correspondent bank. Subsequently, their banks in Taiwan also dumped them.  

Two months later, when Tether had 108 million tethers in circulation, Bitfinex opened an account at Noble Bank in Puerto Rico. (Noble Bank, by the way, was co-founded by Brock Pierce, the child star who also created Tether.)

Tether, however, did not open an account at Noble—or at any bank—until September 2017, according to the office of the NY attorney general’s findings.

Instead, Tether deposited the “vast majority” of its cash into a trust account held by its general counsel, Stuart Hoegner, at the Bank of Montreal in Canada. The account never held more than $61.5 million dollars.

The rest of Tether’s money was mixed in with Bitfinex customer money at Bitfinex accounts at Noble Bank. Between June 1 and September 2017—Bitfinex held hundreds of millions of dollars in Tether’s funds in its accounts, the prosecutor said.

Commingling of funds is a terrible idea—legally and logistically. (Failed crypto exchange QuadrigaCX also commingled funds. And its now-allegedly-deceased CEO used customer money like his own personal slush fund.) 

Mystery NY trading firm

Because Tether had no bank account between March and September 2017, it could not directly take money for tethers. At the same time, according to the NY attorney general, “neither the Tether website or Bitfinex allowed for the direct purchase or exchange of tethers in exchange for any other virtual currency, including the two most popular virtual currencies, bitcoin and ether.”

Between June and September 2017, “Bitfinex’s Noble Bank account received USD deposits from only two institutional trading firms, one of which was located in New York. Neither of those firms purchased tethers directly from Bitfinex or Tether during this time period.”

This part of the NY attorney general’s findings puzzles. Why were these trading firms sending money to Bitfinex if they were not getting tethers in exchange? What were they getting instead? And who was the New York firm?

Mike Novogratz’s Galaxy Digital is based in New York. And we know it was onboarding as a Bitfinex customer in October 2018, based on court documents that point to letters Galaxy sent to Bitfinex. But it is not clear if Galaxy was a customer of Bitfinex or Tether in 2017. (In April 2019, Novogratz claimed Galaxy had “zero exposure” to Bitfinex and Tether.)

Staging the Friedman audit

According to the office of the NY attorney general, until September 15, 2017, the only U.S. dollars held by Tether backing 442 million tethers in circulation was $61 million at the Bank of Montreal. 

Whatever other money Tether had was held in Bitfinex accounts.

In the summer of 2017, rumors were afoot that tethers were not fully backed. To quash those rumors, Tether and Bitfinex arranged for accounting firm Friedman LLP to perform an attestation on September 15, 2017.

They had to move quickly to set things up though.

On that morning, Tether opened an account at Noble Bank. And Bitfinex transferred $382 million from Bitfinex’s account at Noble Bank into Tether’s account at Noble Bank. Friedman conducted its verification of Tether’s assets that evening.

“No one reviewing Tether’s representations would have reasonably understood that the $382,064,782 listed as cash reserves for tethers had only been placed in Tether’s account as of the very morning that Friedman verified the bank balance,” the NY attorney general wrote. The attestation included the money at the Bank of Montreal as well. 

Friedman’s relationship with Bitfinex ended a few months later. 

It’s never a good sign when your auditor quits. Worse, there was no official announcement—Friedman simply deleted all mention of Bitfinex from its website, including past press releases.

Massive loss of funds

In 2017 and 2018, Bitfinex began to increasingly rely on Crypto Capital to handle its customer deposits and withdrawals. Oz Yosef, was Bitfinex’s contact at the Panamanian payment processor.

By 2018, Crypto Capital held over $1 billion of Bitfinex funds. That’s when the real trouble started.

In April 2018, the government of Poland froze a Crypto Capital bank account holding $340 million. Adding to that, Oz told Bitfinex that a Crypto Capital account in Portugal containing $150 million of Bitfinex client funds also had been frozen. 

These events threw Bitfinex into a liquidity crisis. And in the summer of 2018, Bitfinex began dipping into Tether’s cash reserves to fund customer withdrawals. Bitfinex told customers that rumors of its insolvency were false, but behind the scenes, the crypto exchange was pleading with Oz to release the money. 

(Later we learn that another $350 million in missing Crypto Capital funds were linked to 60 accounts held by Arizona businessman Reginald Fowler, who was indicted in April 2019 for bank fraud. Some of these accounts were frozen in 2018. Oz’s sister, Ravid Yosef, was also indicted for her role in assisting Fowler set up those accounts. She is still at large.)

(And in October 2019, Crypto Capital President Molina Lee was arrested by Polish authorities in connection with laundering money for Columbian drug cartels via Bitfinex.)

Deltec Bank & Trust

In October 2018, Bitfinex and Tether ended their relationship with Noble bank. Soon after, they announced they were banking with Deltec in the Bahamas. 

In a letter dated Nov. 1, 2018, Deltec said Tether’s account held $1.8 billion, enough to back the tethers in circulation at the time. The letter was signed but had no name under the signature. The signature itself was illegible.

The following day, Tether began moving hundreds of millions of dollars out of its bank account at Deltec to Bitfinex’s bank account at Deltec. And as part of a “loan arrangement,” between the two closely related firms, Tether assumed Bitfinex’s losses on its own balance sheet. (We can’t be sure of the total loan amount, but an estimate is $750 million.) 

Tether’s misrepresentation that tethers were fully backed continued to Feb. 2019 when it updated its terms of service to say that tethers are backed by “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.”

Bitfinex says it paid off the loan to Tether in January, and the firms now claim tethers are fully backed—but the question is, backed by what? Loans? Bitcoins? We’ll find out in 90 days when Tether and Bitfinex publish their first transparency report. Per the terms of the settlement agreement, the firms will need to publish these reports quarterly for two years.

Also, $18.5 million—the amount of the settlement—is no small number. We have no idea how much cash Tether and Bitfinex actually have on hand.

The bitcoin community is calling the settlement a win for Tether and Bitfinex. They say the fine is nothing but a slap on the wrist. In reality, it’s another way for Tether and Bitfinex to buy time. The NY attorney general has set its trap; now we wait.

Updated Feb. 24 to note that Novogratz claimed zero exposure to Bitfinex and Tether in 2019.

Also read: NYAG to crypto companies: ‘Play by the rules or we will shut you down’

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