The Great Tether Controversy, Part II

The crypto world seems to be fertile ground for more heated debates and virtual fistfights than any other high-tech sector in history. And among them, few are more serious than the great Tether controversy of 2017-’18.

In Part I of this series, I explained the primary issue: No evidence to back their claim that each Tether token is 100%-backed by U.S. dollars. Today, I dig deeper by analyzing a critical statistical study.

The Big Idea Behind Tether

The Tether concept, if executed properly, is both ingenious and practical. Here’s how it works:

  1. You send your fiat money to a company.
  2. The company gives you the equivalent value in a very stable cryptocurrency.
  3. You can then use that crypto to trade on any exchange that supports it.
  4. You can also cash out at any time and get your fiat back.

Sounds good, right? But researchers are now asking:

Did Tether and Bitfinex manipulate the 2017 Bitcoin price surge?

If they did, it has far-reaching consequences for investors.

The study concludes that up to 50% of the price appreciation we saw from Bitcoin in 2017 may have been due to:

• The printing of Tether coins, and

• Their use in bidding up the price of the cryptocurrency.

I said it in the previous report and I’ll say it again: Don’t use Tether-based pairs. And don’t store any crypto on exchanges that use Tether, as the liquidity mat could be swiped out from under them if anything were to happen to this token.

And even if it turns out not to be true, the mere suspicion can cause dislocations in the marketplace.

Here’s their theory about what might be happening:

First, the folks behind Tether issue more tokens. In other words, they effectively print money.

Second, they transfer them to the Bitfinex wallet.

Third, they convert them into Bitcoin — driving up its price, typically within about four hours.

In short, the researchers suspect that this so-called “Tether Effect,” whether intentional or not, could be a mechanism for a small group to artificially pump up the price of Bitcoin.

This is not new to us. We’ve written about it before. And back in January, an anonymous author put together a detailed report about correlations between Tether activity and Bitcoin price action.

Before I continue, though, let me point out two caveats.

Caveat #1. Correlation does not equal causation. Just because Tether printing and the Bitcoin price action occur in sync doesn’t prove intent or foul play.

Caveat #2. Nothing we say here should be interpreted as an allegation of fraud. Rather, my intent is strictly to analyze the study, add my comments and let users decide what to do with the information.

Here’s where we land on the controversy: At a minimum, the findings in these reports are more than enough to justify an outcry for one critical thing: more transparency by Bitfinex and Tether.

And even though we applaud recent attempts to do so, it simply isn’t enough. What’s required is a full certified audit by a reputable accounting firm, not a letter from a law firm whose potential conflicts of interest are not disclosed or entirely clear.

The risk to investors and the markets overall: Regulators may also conclude that Tether is being used to manipulate prices.

And even if they don’t, they may take the position that Tether can be used to skirt money-laundering and know-your-customer rules.

The world of fiat money and banking is heavily regulated, and Tether can be used to sidestep these regulations.

Here’s What the January Report
Is Trying to Demonstrate …

The study’s main objective is to establish a relationship between the timing of Tether printing and the price of Bitcoin by asking three basic questions:

Question 1
Is Tether printed primarily when the price of Bitcoin is declining?

I’ll spare you the statistical voodoo. The idea here is to mathematically determine whether Tether tokens are issued when the market is going down, implying an attempt to artificially support the market during corrections.

With most assets, whether digital or traditional, the majority of individual investors almost invariably rush to buy when prices are surging … and sell when prices are falling. So if money is regularly moving into the market in the opposite direction, it means that somebody — either institutional investors or market manipulators — are behind it.

We come from many years of experience in traditional financial markets. And we’ve seen these same patterns so often, we can recognize them a mile away:

• The telltale investor buying frenzy at the top, just before a crash …

• The panic-selling at the bottom, just before a new bull market …

• And big institutions using each as opportunities to cash out or load up.

Is the same true in crypto markets? Even more so!

The market is dominated by small, individual investors with little or no experience in financial markets or trading. Few institutions participate. And so, you typically see even more extreme buying frenzies and selling panics.

How would this impact Tether? No differently than any other cryptocurrency. Tether should see:

• A bigger influx of funds when Bitcoin has been going up,

• A smaller influx when prices have been stagnant, and

• An outflux when prices have been falling.

The result of the study, however, shows the opposite pattern:

• During the sample period studied, the price of Bitcoin has gone up by an average 0.84% per day, or 0.42% every 12 hours.

• But during the same period, new Tether tokens are issued after the price of Bitcoin has gone DOWN by an average of 0.43% in the 12 preceding hours.

In other words, even in a rising market, they typically issue new tokens only after the price of Bitcoin has fallen.

Does this mean crypto investors are very savvy? That they religiously buy the dips in Bitcoin and use Tether as their conduit?

Maybe. But the psychology of investors — especially crypto investors — tells us that’s not very likely … that something fishy may be going on.

Question 2
After Tether is printed and sent to the Bitfinex wallet, what happens to the price of Bitcoin?

OK. The study has established that Tether typically issues more tokens after a Bitcoin decline.

If the decline continued, it would not be as concerning. But the study finds that it does notcontinue. Quite to the contrary, nearly half (48.8%) of the entire 2017 price appreciation of Bitcoin was concentrated in the first two hours following new Tether issuance.

If validated, it would mean that the new Tether tokens landing in the Bitfinex exchange became one of the main drivers of the entire Bitcoin bull market of 2017.

That is a staggering finding.

It paints a picture of a persistent, pervasive market manipulation. One where Bitcoin prices fall when new Tethers are absent and surge as soon as new Tethers hit the market.

Question 3
Is there any unusual activity with the movement of funds between the Tether “treasury” wallet and the Bitfinex wallet?

This is the question that starts getting into the issue of intent and deliberate manipulation.

Essentially, the study asks: Is the flurry of Tether transactions at Bitfinex after a new grant the product of normal customer activity? Or is it something artificial in the vein of market manipulation?

In the quest for an answer, the study relies on an analysis based on “Benford’s Law.” This is a mathematical construct that establishes the normal pattern of naturally occurring variations or fluctuations in numbers — be it the length of a river, the population of a town or the movement of money.

If the transactions observed on the Bitfinex exchange are normal, they should conform to Benford’s Law. But if they do not conform to Benford’s Law, it’s a sign that something or someone may be causing an aberration.

To test whether Benford’s Law works with cryptocurrencies, the study tested it out in another place — on the Bittrex exchange. And sure enough, the transactions there do conform to the Benford Law. Their pattern of variation is in line with what the law predicts.

Not so on the Bitfinex exchange! The study covered several time periods and found that, in every single one, there was consistently a flurry of unusually large transactions when the freshly baked Tether was delivered to Bitfinex’s wallets.

This implies unusual movement of funds related to Bitfinex’s accounts when the new Tether hits the exchange.

My Thoughts

The study is quite revealing. It demonstrates …

• A pattern of unusual trading activity relating to Bitfinex and Tether, plus

• Unusual price activity in the Bitcoin market around the time that new Tether get issued.

Now, the University of Texas has recently conducted a similar study to arrive at basically the same conclusions. This lends further credibility to this theory that not all is as it seems when it comes to Bitfinex, Tether and BTC’s price.

The study makes two recommendations based on the findings, which I think are worth repeating here:

“1) Conduct an audit by a reputable auditor. Considering the scale of the operation it would be best to engage an organization of the highest reputation, such as one of the Big Four. Release a statement from Tether that this audit has been initiated and have the auditing firm confirm this.

“2) The audit does not solely include a snapshot of accounts on a single date. It should also confirm that each Tether is backed by a dollar now and was for all points in Tether’s history. More than confirming that accounts of the proper amount do and have existed, the nature of those accounts and the service agreement between the banks and Tether should be divulged to show that these accounts exist solely for the benefit of Tether holders.”

Please bear in mind this story is not over.

But it’s an important one. It could be one of the most-disruptive events for the cryptocurrency markets in the short term.

That said, also bear in mind that cryptocurrencies don’t need exchanges. And they certainly don’t need Tether in order to change the world.

None of this detracts — not by one iota — from the underlying technology or its promise to make the world a better place.



About the Editor

When econometrician and pro trader Juan M. Villaverde first applied his algorithms to Bitcoin years ago, he discovered a regular cyclical pattern. And he has since used it to build the world’s first crypto timing model based on cycles. Thanks to his analysis, the Weiss Ratings team has accurately picked the top and bottom of major crypto booms and busts.

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