(Bloomberg Opinion) -- It’s tough being a cryptocurrency exchange. All you want to do is provide a valuable liquidity service to an emerging industry, while navigating a fine line between regulatory compliance and crypto anarchy. But maybe you step a little too far into the shady side and find yourself in trouble.
That could be the situation an exchange called Bitfinex finds itself in. Bitfinex issues the digital token Tether, a tradable asset on most major exchanges that has remained operational in spite of constant criticism and a New York attorney general investigation. More recently, a study from the University of Texas raises new allegations that a single account used Tethers to drive more than half of Bitcoin’s 2017 price surge. There’s a lot at stake — the research study is cited as key evidence in a $1.4 trillion class action lawsuit against Bitfinex and Tether.
Anyone who has access to cable news, social media, the outdoors, or any form of human contact probably remembers the relentless cryptocurrency hype of the past two years. Between 2017 and 2018, token hustlers sold over $20 billion in speculative new coins based on half-baked sales pitches that not even Masayoshi Son would entertain. Coinbase saw so much trading activity that the exchange “broke.” And the idea that a lone whale fueled this yearlong Bitcoin bull run is more than a little silly.
According to Jeremy Allaire, Co-founder and CEO of Circle, the Tether study makes the mistake of attributing a custodial account address to a single trader (although the authors maintain that this is an individual deposit address). Exchanges pool customer funds into a single wallet before netting and batching transactions with partner institutions; traditional banks do the same. A single Bitfinex wallet could easily represent the aggregate trades of many customers.
The authors also examine the top 1% of hours with the highest Tether issuances, and find that these issuances were typically preceded by a falling Bitcoin price. They suggest that Tethers were issued to provide artificial price support. While the issuances do seem auspiciously timed, it may simply be that Tethers are issued in response to user demand. Kraken, another cryptocurrency exchange, has previously noted that Tether issuances positively correlate with their own cash deposits. Every Tether issuance is publicly reported on the blockchain, and traders use bots to algorithmically trade on this information. No surprise that Tether issuance can amplify demand for Bitcoin.
There may be a confounding factor. In late 2017, the Chinese government imposed a ban on cryptocurrency exchanges. According to a report from research firm Chainalysis, traders in China exchanged large volumes of yuan for Bitcoin after learning of the impending ban. Once the ban was in effect, the traders had no way to trade crypto back to yuan, so they shifted to using Tethers on overseas exchanges as a substitute for fiat currency (after all, the yuan is roughly pegged to the dollar). A more recent study found that Tether was used in 99% of Bitcoin spot trades in China this year, accounting for 60% of all on-chain transaction value.
Tether may even have a use case beyond speculation. Chinese importers in Russia reportedly buy tens of millions worth of Tether each day to send remittances back to China. The U.S. has threatened to ban Russia from the Swift international payment network, and Tether offers a sanctions-resistant alternative without the volatility of Bitcoin.
That doesn’t mean there isn’t some cause for concern. A lot of activities that would be considered fraudulent in regulated financial markets are par for the course on crypto exchanges — Wash trades, spoofing, pump-and-dump schemes. It’s also entirely possible that Tethers are not, despite Bitfinex’s promises to the contrary, actually backed by U.S. dollar reserves, although adherents may not care. Our fiat dollars demonstrate that people are willing to use a currency backed by nothing at all, as long as it serves a useful purpose.
Those who can’t fathom that cryptocurrencies might see use beyond nefarious deeds find it easy to dismiss price gains as the machinations of a rogue trader.
Perhaps the takeaway is that when banks refuse to do business with crypto traders, or when a government bans trading altogether, it doesn’t stop traders from trading. It just forces them to find creative solutions. If it were easy for crypto exchanges to use the traditional banking system, there would be no need for Tether at all.
Another study using data from the same period finds that Tether issuance has no statistically significant impact on bitcoin price – the amount of Tether printed at any one time is dwarfed by amount being actively traded – although the data granularity is coarser than the University of Texas study.
From Kraken’s website: “We looked at our own inflows of fiat currency (deposits) between January 2017 and April 2018 and compared them to new USDT issuance. While our cumulative deposits are several multiples of the amount of USDT issued, we found a positive correlation of 0.78 with R^2 of 61%.”
To contact the editor responsible for this story: Sarah Green Carmichael at sgreencarmic@bloomberg.net
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Elaine Ou is a Bloomberg Opinion columnist. She is a blockchain engineer at Global Financial Access in San Francisco. Previously she was a lecturer in the electrical and information engineering department at the University of Sydney.
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