The Cryptocurrency MF Global
It’s amazing how the crypto industry manages to re-create the frauds and scams of the traditional financial industry. Remember MF Global, the brokerage firm that went down in 2011 taking over $1bn of its customers’ money with it? Well, now the crypto industry has its own MF Global – the cryptocurrency exchange Bitfinex. It is being investigated for fraud after losing $850m of its customers’ money.
According to the New York Attorney General’s office (NYAG), Bitfinex placed over $1bn of “co-mingled customer and corporate funds” with an unregulated payment processor, Crypto Capital. $850m of those funds – most of which are customer money – have disappeared.
But Bitfinex is not being investigated for the loss of the funds placed with Crypto Capital: after all, if anyone has embezzled those funds, it is Crypto Capital, not Bitfinex. No, what has attracted the NYAG’s attention is the fact that Bitfinex is still trading despite their loss – and the role played by Bitfinex’s sister company, Tether.
It appears that Bitfinex had to use unregulated payment processors to make dollar payments because regulated banks, fearful of the increasingly long arm of U.S. regulators regarding money laundering regulations, wouldn’t deal with the offshore cryptocurrency exchange. Crypto Capital wasn’t the only unregulated processor it used:
Bitfinex and Tether have also used a number of other third party “payment processors” to handle client withdrawal requests, including various companies owned by Bitfinex/Tether executives, as well as other “friends” of Bitfinex – meaning, human being friends of Bitfinex employees that were willing to use their bank accounts to transfer money to Bitfinex clients who had requested withdrawals.
The picture is one of a business which, denied access to traditional banks, tried to meet its payment obligations by any means available. Bitfinex even attempted to sue Wells Fargo for terminating its correspondent banking relationship in 2017, claiming that the decision “presented an existential threat to their business.” and that if Bitfinex and Tether “could not remit to customers U.S. dollars that belong to their customers. [their] business would be crippled.” Although the lawsuit collapsed, Bitfinex’s comments proved prescient.
In the latter half of 2018, Crypto Capital failed to make customer payments and refused (or was unable) to release the funds placed with it. In its desperation, Bitfinex had placed the funds without entering into any legally enforceable contract, so had no means of recovering the money. Deprived of funds, Bitfinex found it more and more difficult to meet customer withdrawal requests. Increasingly frantic emails from Bitfinex officials to Crypto Capital during this time reveal that Bitfinex was in serious trouble. And this is when Tether got involved.
Tether is the sole issuer of the stablecoin USDT. Until this year, Tether had always insisted that every USDT was backed by an actual dollar. But in March, Tether admitted that it did not have sufficient dollar cash reserves to back all the USDT in issue and was, in effect, acting as an unregulated (and unusually risky) fractional reserve bank. Why it changed its stance was shrouded in mystery – until now.
It seems Tether transferred funds from its own reserves to Bitfinex. This, of course, destroyed its one-for-one reserve holdings. From that moment on, Tether was no longer a full-reserve token issuer. And according to the NYAG, from that moment on it was also involved in a fraud.
Bitfinex and Tether set up the transfer as an arms-length revolving credit agreement collateralized by shares owned by Bitfinex’s parent company:
Bitfinex immediately undertook negotiations with Tether on an agreement under which Tether extended a secured, revolving line of credit of up to $900 million on commercially reasonable terms (including a term of three years and an interest rate of 6.5% in outstanding loans under the facility). documented in a loan facility negotiated between the two companies at arm’s length with the benefit of separate counsel and approved as required by each company’s corporate governance processes. Under this transaction, the line of credit is secured by a share charge over 60.000,000 iFinex Inc. shares owned by DigFinex. which DigFinex agreed not to otherwise encumber. That transaction closed on or about March 19. 20I9. The total accessed under the loan facility as of today’s date is equal to $700 million.
But Tether is owned by iFinex, which is owned by DigFinex, which also owns Bitfinex. These companies are all owned and managed by the same people. The conflict of interest is blatant:
The transaction documents were signed on behalf of Bitfinex and Tether by the same two individuals. Those two individuals are also directors and owners of Digfinex. Bitfinex and Tether.
Arms-length, this is not.
Tether also transferred $625m to Bitfinex in a separate transaction. Bitfinex seems to have drawn rather more than the missing $850m from its sister company.
This wouldn’t matter if Tether was lending its own capital. But it isn’t. Tether’s reserves belong to its customers. Customers buy USDT tokens from Tether for dollars on the understanding that those dollars are held in reserve so that customers can exchange the USDT for dollars one-for one whenever they want.
The NYAG alleges that neither Tether nor Bitfinex told customers that the reserves backing USDT had been lent out, nor that they might not be recoverable:
Counsel’s disclosures at the February 2I meeting raised serious questions about the viability of Bitfinex as an ongoing concern… the possibility that Tether’s cash reserves would be dissipated and unrecoverable. and whether Bitfinex and Tether have misled their clients (including both clients of the Bitfinex trading platform. and holders of tethers) regarding the matters described above.
Drawing on client money, without the knowledge of those clients, to prop up an insolvent sister company is fraud. The same fraud, in fact, for which Jim Corzine, former CEO of MF Global, paid a $5m penalty. During its collapse into bankruptcy, MF Global used its clients’ money to meet its own proprietary obligations. Similarly, Bitfinex seems to have drawn on client money at Tether to keep itself afloat.
Most of the money belonging to MF Global’s clients was eventually recovered. But Tether’s clients may not be so fortunate. Bitfinex insists that the funds transferred to Crypto Capital are not lost but “seized and safeguarded.” But we only have Bitfinex’s word for this – and its own counsel told the NYAG that they did not believe it. A letter quoted by the NYAG says that Bitfinex management suspected Crypto Capital of fraud. Fraud begets fraud…
But underlying these layers of shady financial deals is a deeper question. Why is the New York Attorney General investigating an offshore cryptocurrency exchange which officially bans New York-based people and businesses from trading on its platform?
It seems the NYAG does not think the ban is effective, so New York residents could be among those being ripped off:
OAG’s ongoing investigation seeks to determine. among other things, the extent to which New York investors are exposed to ongoing fraud being carried out by Bitfinex and Tether.
And because it doesn’t trust Bitfinex and Tether not to lose even more of New Yorkers’ money, the NYAG gave no advance warning of its application for an injunction to prevent any more money being transferred from Tether to Bitfinex.
But it is already too late. The money is gone, and Bitcoiners are rapidly learning to love fractional reserve banking. USDT is so important to the Bitcoin ecosystem that they dare not reject it. Bitcoiners, like everyone else, are only to ready to abandon their principles to preserve their wealth. And so the cryptocurrency world becomes ever more like traditional finance.
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