NY Attorney General’s Lawsuit Against Bitfinex Highlights Unprecedented Levels of Crypto Collusion

And the fallout is likely to be felt across the stablecoin and broader crypto markets.

By Rakesh Sharma


Scandals and scams are par for the course in the rough and tumble world of cryptocurrency markets. The most recent one, however, is unprecedented even by crypto standards. It involves Bitfinex, one of the world’s biggest cryptocurrency exchanges by trading volume, and Tether, the world’s biggest stablecoin.

The Office of the Attorney General in New York filed a lawsuit against Bitfinex last week charging it with “a cover-up to hide the apparent loss of $850 million of co-mingled client and corporate funds.”  The agency claims that Bitfinex used Tether’s money — the fiat currency used to back its coins in the market — to create a “corporate slush fund” to hide its “massive, undisclosed losses and inability to handle customer withdrawals.”

When news of the lawsuit broke on April 25, Bitcoin’s price fell by 8% in approximately four hours. The effect of that evening’s losses was especially pronounced as it nullified gains made by the cryptocurrency in the past week, following a long period of mostly sideways movement. Tether’s price also briefly dipped before recovering. As of this writing, Bitcoin is trading at $5,428.15, still down 4.4% from its pre-crash price.

The Beginning of a Complicated Relationship

Rumors about Bitfinex’s business practices and its relationship with Tether have been swirling around since Bitcoin’s bull market run in 2017. The exchange is a pivotal part of the cryptocurrency ecosystem because it is among a handful of venues where investors can trade cryptocurrencies using fiat money. To facilitate the transaction, Bitfinex introduced Tether, a stablecoin that supposedly traded at parity with the U.S. dollar.

Traders purchase Tether using dollars and convert it to any cryptocurrency available on Bitfinex. Each Tether coin is backed by an equivalent U.S. dollar, the exchange claimed. Over the years, critics have cast doubt on Bitfinex’s assurances, pointing to the absence of a verifiable third-party audit. (While the New York Attorney General’s filing avoids any suggestion of an audit to verify Tether’s backing, the chain of events described in the document presents a challenge to the credibility of its claim.)

The businesses of Bitfinex and Tether are deeply intertwined. Both share senior management, and Tether, which is the world’s eighth-most valuable cryptocurrency as of this writing, derives a majority of its trading volume from Bitfinex.

Based on the New York Attorney General’s filing, there are three main charges outlined against Bitfinex and Tether: Commingling of customer and corporate funds, fudging of accounts, and misleading information provided to the public by Bitfinex about its finances.

Questionable dealings can be traced back to 2014, when Bitfinex began using the services of Switzerland-based payment processor Crypto Capital to clear customer withdrawals. On its website, Crypto Capital, which was founded in Panama, claims to be “a financial institution for the crypto economy enabling instant deposit and withdrawal of fiat funds to any exchange around the world.” Several prominent exchanges, including recently bankrupted QuadrigaCX, are listed as customers.

This relationship has especially favored Bitfinex. The Hong Kong-based exchange is often referred to as one of the world’s largest by volume. While the scandal-prone reputation of crypto markets, coupled with SEC crackdowns, has kept mainstream financial services institutions from actively participating in the industry, Bitfinex itself has careened between banks and payment processors for its business. In 2017, Wells Fargo terminated its role in clearing funds for Bitfinex’s U.S.-based customers, citing the failure of a Taiwanese bank that processed payments for the exchange to conduct its due diligence.

Over time, Crypto Capital became increasingly critical to Bitfinex’s business. By the middle of 2018, it held “all or almost all of Bitfinex’s funds”. The two parties never signed an agreement or contract to this effect, however. The Attorney General’s document further states that the exchange placed over one billion dollars of commingled customer and corporate funds with the payment processor.

Crypto Capital subsequently lost $851 million to a series of fund seizures by the governments of Portugal, the United States and Poland. Regulatory authorities cited suspected schemes involving the firm, including suspicion of money laundering for Colombian drug cartels.

Faced with a liquidity crunch, Crypto Capital refused to honor Bitfinex’s customer withdrawal requests or return its funds. Pleas from Bitfinex executives went unanswered or were met with obfuscation, and the future looked bleak for Bitfinex.

To make up for the shortfall, Bitfinex and Tether engaged in a series of elaborate accounting maneuvers. First, Tether transferred money from its reserve fund, which consisted of fiat currency holdings to stabilize price fluctuations, to Bitfinex’s accounts. Bitfinex then transferred funds from its Crypto Capital account to Tether’s account with the firm. The latter transfer was done for bookkeeping purposes as the actual amount did not exist in Bitfinex’s account. To add to the complexity, both companies established a line of credit for $900 million between themselves using their parent holding company’s shares as collateral.

Through all this, Bitfinex allegedly misled investors, according to the Attorney General’s suit. Amid news reports about its insolvency in October 2018, the exchange issued a notice to investors denying the charge and claiming that all customer withdrawals were being processed regularly. But the report identifies “severe problems processing client withdrawals” at the exchange.

The Lawsuit’s Implications Could Be Felt Broadly

The Attorney General’s court order is not expected to have a major impact on Hong Kong-based Bitfinex’s operations. Although the suit orders the exchange to “cease further dissipation” of Tether’s U.S. dollar assets, the stablecoin had already made provisions for such an eventuality earlier this year, when it changed the wording on its website to indicate that the stablecoin is “backed by other assets and receivables from loans made by Tether to third parties.”

The investigation could, however, have a spillover effect on the stablecoin market. Per last December, Tether was responsible for 75% of all stablecoin transactions. That share fell below 70% a month later as other stablecoins, such as Circle’s USDT, continued to gain market share. Regulatory action against Tether could provide further opportunity for other stablecoins to eat into its market share.  

There are likely to be far broader implications in store for the cryptocurrency markets. The relationship between Bitfinex and Tether has been riddled with conflicts of interest. Experts and commentators within the cryptocurrency ecosystem are already drawing parallels with the 1933 Glass Steagall Act, which demarcated lines of operation between the trading and banking functions of financial services institutions. Could this debacle result in attempts to lay down similarly sweeping crypto legislation? Perhaps.

That simple parallel, however, does not adequately account for the incredibly complex and often incestuous nature of the fledgling cryptocurrency ecosystem. Stablecoins can be collateralized in a number of different ways, including with other cryptocurrencies and gold. Crypto-collateralized coins involve webs of relationships so complex and tangled, they may yet present a serious challenge to even the most determined regulators of the future.





This website is for information and illustrative purposes only. It is not, and should not be regarded as "investment advice" or as a "recommendation" regarding a course of action, including without limitation as those terms are used in any applicable law or regulation. See Disclaimer.