An Introduction to the Tether/Bitfinex Controversy

Bitfinex is one of the historically largest Bitcoin exchanges and Tether is by far the largest stablecoin. Each potentially has significant influence over the industry on their own, and their interconnectedness makes this more of a concern. However, since both were founded years ago and many of the events have happened and been in revealed in bits and spurts it can be difficult to understand their place in the cryptocurrency environment. This will hopefully serve as a basic introductory document that will then prompt further research.

Bitfinex was founded by Raphael Nicolle, a helpdesk technician( best I can do for an archive is a screenshot), in 2012. It quickly grew in popularity in part due to its ability to serve as a meta-exchange where you could trade on Bitfinex, Mt. Gox, or Bitstamp from the same interface, and later their lending features. However, even from the founding there were issues that plagued Bitfinex. Not the least of which being that the source code for Bitfinex was stolen from Bitcoinica ( archive), an earlier hacked and failed exchange created by a 17 year old. Furthermore, the nature of the meta-exchange meant that they also frequently had large amounts of funds on other exchanges including Mt. Gox. As late as April 21st of 2013 you can see in the leaked email below that they had half of their funds on Mt. Gox. Mt. Gox was famously hacked for three years and had approximately 650,000 Bitcoin stolen, culminating in ending withdrawals on February 24, 2014 ( archive). It is unknown if Bitfinex had funds on Mt. Gox when it became impossible to withdraw.

The early history of Tether is complicated. The precursor to Tether, RealCoin was started in July ( archive) of 2014 by Brock Pierce (who was arrested in Spain with a fugitive child sexual offender ( archive)[released with no charges] and was once sued for child sexual abuse [he was voluntarily dismissed of all charges])( who once DMed me), Reeve Collins, and Craig Sellars. It was going to be the first dollar backed stablecoin, where each token on the blockchain would represent a dollar in the bank. This was possible thanks to a new protocol built on top of Bitcoin called Omni that allowed for these tokens to be minted easily. On September 5th 2014 Tether Holdings Limited ( archive) was founded by Phil Potter (CSO of Bitfinex at the time) and Giancarlo Devasini (CFO of Bitfinex)[ once ordered to pay 100 Million Italian Lira to Microsoft over his sale of pirated software( archive)]. On October 6th 2014 ( archive) [Bitcoin/Omni transaction id: ce36efda15bc6cf99ba6a010e71b47b00a5ea2071a392839effe7ed392cf690f] the very first Tether tokens were minted. At some point during this process Tether and Bitfinex ended up having the same leadership team and the same ownership (though they would deny this fact for a while).

Bitfinex was first hacked in May 2015 ( archive). It was just 1500 Bitcoins from their hot wallet and they covered it out of their corporate funds. This did little to affect the general confidence in Bitfinex and it retained its position as one of the largest exchanges. Bitfinex’s position became more complicated when in June of 2016 the CFTC ordered Bitfinex to pay a $75,000 fine for “ offering illegal off-exchange financed retail commodity transactions in bitcoin and other cryptocurrencies”. Part of the issue was that the Bitcoins were not “physically delivered” from the perspective of the CFTC. This may have been a motivating factor for Bitfinex’s switchover to BitGo for their wallet security. BitGo would have allowed for them to segregate each user’s balance ( archive). It was also supposed to provide them with significantly improved multi-signature security. Then they were hacked again in August 2016. This was one of the largest Bitcoin hacks of all time totally 119,756 BTC. In response to this hack, Bitfinex gave the majority of their clients a 30.67% haircut (at least one customer was excluded, Coinbase[ archive]). They credited each customer with a BFX token that represented $1 of the haircut. They said they would pay back all BFX tokens eventually or would offer equity in exchange for them. Bitfinex promised to provide a security audit and a financial audit ( archive). They did not. Many of these BFX tokens were converted to equity in Bitfinex, and these users became passionate advocates for Bitfinex. Eventually all tokens were paid off or converted.

Tether was hacked once as well. In November 2017, $30,950,010 ( archive) Tethers were removed from their wallet. In order to respond to this Tether forced ( archive) a hard fork of the Omni Protocol to mark those Tethers as no longer valid. Eventually Omni added a feature that allowed for transactions to be frozen by the issuer, an ability that Tether maintains to this day.

One of the most commonly voiced frustrations with Tether is that they have never provided a true and full financial audit to prove that they were backed. Tether for years promised that they would get an audit and have yet to follow through. Early on in their history they did have attestations from a Taiwanese accounting firm [ 12/16 ( archive), 1/17 ( archive), 2/17 ( archive), and 3/17 ( archive)]. Due to banking difficulties in Taiwan (we will get back to this) they stopped this relationship. They then hired Friedman LLP in New York for promised “comprehensive balance sheet audits on a quarterly basis going back to Dec. 31, 2016. We will share those results with you as they become available in the coming weeks or month.” ( Archive) This audit (like the promised Bitfinex audit) never arrived. Tether said the following in response to this relationship ending, “We confirm that the relationship with Friedman is dissolved. Given the excruciatingly detailed procedures Friedman was undertaking for the relatively simple balance sheet of Tether, it became clear that an audit would be unattainable in a reasonable time frame.” ( Archive) Tether did release a memo from Friedman that was explicitly not meant to be relied upon. ( Archive) This was for cash balances as of September 2017. The next update (which was still not an audit) came not from an accounting firm, but from a law firm. Tether engaged Freesh, Sporkin, and Sullivan LLP to review their bank accounts and provide a letter saying that the number of dollars in the bank was greater than the number of Tethers in circulation ( archive). It is important to note that again this document does not seem to have been meant for public release. Since this update there has been no more review of Tether’s backing (we’ll come back to this).

Against this backdrop both Bitfinex and Tether struggled with their banking. This started in April 2017 when Wells Fargo, the correspondent bank for Tether and Bitfinex’s Taiwanese banks, cut off their withdrawals. Since then Bitfinex and Tether have jumped from bank to bank. They briefly banked at Noble Bank International an international financial entity that was founded by Brock Pierce and John Betts (an investor most noted for trying to buyout Mt Gox). After Noble faced financial difficulties Tether landed at Deltec bank.

Due to Bitfinex’s difficulties in securing and maintaining banking they partnered with Crypto Capital Corp. Crypto Capital Corp was run by Reggie Fowler and Ravid Yosef ( archive). Reggie Fowler has been arrested on bank fraud charges, and Ravid Yosef is still on the run.

Shortly before the news broke about the charges and arrest of Reggie Fowler the New York Attorney General revealed that they were investigating Tether and Bitfinex for fraud ( archive). Several shocking details were revealed in this investigation (some of which I have covered here, here, here), including that Bitfinex had given $1 bn to Crypto Capital and had not even signed a contract. When Crypto Capital stopped serving Bitfinex’s withdrawal requests (which Bitfinex actively was lying about), Bitfinex exchanged $625 mn of their ‘book’ dollars in Crypto Capital for money that Tether had in their bank account in order to service withdrawals. This in effect made Tether insolvent. This happened before Tether changed their promise from fully backed by cash. After this Bitfinex entered into a credit agreement with Tether wherein Tether extended a loan of up to $900mn to Bitfinex. The loan was secured by iFinex shares which were owned by Digfinex the parent company for both Tether and Bitfinex. The NYAG report includes the following line, “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.” (See the postscript for some other things that were discovered when the NYAG released the order.)

When news of this effective insolvency broke, Bitfinex responded by creating a new token called UNUS SED LEO ( archive) or Leo from here on out. They intended to sell 1 billion tokens, each for a dollar, in order to help close out the loan facility. (All tokens were sold but the loan facility has not been paid off.) The token provided some discounts on Bitfinex’s platform to it’s holder. However, most of its potential value derviced from the other promises they made including that they would buy back an amount of LEO equal to 27% of their (unaudited) revenue each month, or their promise to use 95% of the net recovered funds from Crypto Capital to buy and burn LEO.

Since then Tether’s size has absolutely exploded with it growing to nearly $20,000,000,000. Bitfinex and Tether are still under investigation by the NYAG, but have had their appeal rejected and they will be moving to trial soon.

This is far from an exhaustive look at Tether (I’m working on a book with CasPiancey for that), but hopefully you have a better understanding of the context surrounding the claims of fraud that frequently follow Bitfinex and Tether.

POSTSCRIPT: Thanks to the NYAG investigation we have found out the following things:

1. Bitfinex commingled customer and corporate funds.
2. Tether commingled customer and corporate funds.
3. Tether executives would get irregular large payments from Tether.
4. The largest redemption of Tether was less than $30 million.
5. Tether reserves had been used to purchase Bitcoin.
6. Tethers had been loaned to trading firms.
7. Both Bitfinex and Tether had numerous ties to New York for years after claiming to have cut off business there.
8. Bitfinex does not (did not?) believe Crypto Capital when they claimed their funds were seized in Poland.

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Originally published at http://bennettftomlin.com on December 9, 2020.