S.D. has been batting 1000 this week, because he found this disturbing article on some trouble in the crypto-currency world, and in a nutshell, one trading platform might be resorting to some questionable accounting practices:
Now I've been trying to warn of the dangers of crypto-currencies since the whole fad started with the mysterious Satoshi Nakamoto, allegedly a Japanese man who invented the blockchain concept, but a man who proved to be difficult to track down, and whom some in the alternative research community believe might just be a cover for the world of intelligence and spookdom. In any case, it always struck me as an intensely dubious proposition that people would regard putting real money into chasing computer blips, because the whole cyber world is ultimately not secure, and hiding behind blockchains seemed to me to be an open door for all sorts of mischief. After all, the whole system is behind a one-way mirror, to draw upon Catherine Fitts' analogy.
But the allegations in this article are breathtaking, and if true, profoundly disturbing; beginning by noting that a platform called Tether accounts for 80% of Bitcoin trading volume, the article goes on to note the following:
- The crypto exchange ecosystem has major problems getting access to normal banking. So enter Tether or USDT, a surrogate crypto dollar that theoretically has the same value as a dollar, but can be traded without following regulation on dollars.
- The model is simple, you give the company a real dollar, they store that real dollar and give you one tether. You trade that tether for whatever you want, and at any point you can redeem that tether back for one dollar. Simple enough.
- It's a simple pitch: Have dollars, buy tether, do shady things, redeem tether, get dollars. "The virtual dollar for regulatory arbitrage."
- What is clear is that the company has allegedly issued $59 billion virtual dollars. At that scale, it is highly unlikely any bank in the entire world would those reserves on behalf of a crypto company. Not even the dodgiest banks would take on that insane level of risk.
- Now the company that issues these products is notoriously opaque and set up shop in the tax haven of British Virgin Islands to avoid any regulation and reporting obligations. So we really don't know much. What we do know comes from lawsuits and investigative journalists.
- Last Wednesday [May 12], we finally got the court-mandated disclosures of what's actually in the reserves. And not surprisingly when the vault is opened, the money isn't actually there.
- What we see is a lot of "commercial paper". Which is a form of short-term debt, a company-to-company unsecured loan. It's put on the books for the face value of the loan, but in reality that value depends on the credit risk of the other counterparty to the loan.
- If the counterparty isn't good for the value of the paper then it's worthless, just an accounting trick. And we don't know who the other parties are. Every Tether is backed by a giant pile of IOUs to strangers. And that's worth exactly what you think it is.
Now, at this point, after picking up my jaw off the floor, I had to pause and marvel at the scheme, because what in effect is being done is a classic Prime Minister Tanaka "paper swap": bad bonds, for real dollars, and the crypto-currency blockchain is being used to hide the owners of the "giant pile of IOUs."
In short, we have a vast money laundering operation, one of the possibilities I mentioned when I first blogged about cryto-currencies. In fact, the article says as much:
It's widely suspected that many exchanges are receiving large deliveries of unbacked tethers, using them to wash trade with themselves for bitcoin to drive up demand, and thus the synthetically inflate the price. This is illegal in other markets.
But wait, there's more: because Tether represents such a massive trader in Bitcoin, we end with a massive case of under-capitalization (in other words, a huge bubble that would make the 18th century "Tulip" and "South Seas Bubbles" look mild:
- A significant portion of bitcoin price formation is therefore quoted in dollars, but paid for in USDT dollars that are only actually backed by three cents. Which would make most of the price formation of bitcoin completely synthetic.
- Which leads to the obvious inconvenient truth that most people who look at the crypto space come to understand. Most exchanges are *vastly* undercapitalised and will never be able to pay out even a tiny fraction of their customers in real dollars.
- Crypto markets are not significantly different than Ponzi schemes. Short-term dollar inflows are used to pay-out short-term outflows and the whole thing stays afloat so long as there's not too many withdrawals. When that day comes, it implodes.
The rest of the article continues with other issues including the author's rejection of the characterization that all crypto-currencies share the danger, but I want to concentrate on one: when bitcoin (and hence, the whole crypto-currency phenomenon) was rolled out, it was touted as being impervious to manipulation from central banks.
And here we are - as predicted - years later, with clear prima facie evidence that there is massive manipulation, laundering, and fraud occurring and - surprise surprise - in involves bad commercial paper and real dollars.
...and wonder of wonders, it's all taking place in a British tax haven...
The banksters of the Rialto would have loved this...
...oh, wait, I forgot, the current head of the house of Medici wants to reopen the Medici bank, headquarter it in the Caribbean, and specialize in cryptos....
See you on the flip side...