Last week's injunction by the New York Attorney General (NYAG) to prevent further money transfers from Tether to Bitfinex exemplifies a fundamental obstacle to mainstreaming cryptocurrency:
Lack of regulation leads to risky actions and potential fraud, which in turn reduces investor confidence in the future of cryptocurrency.
Here are the details of the investigation:
- Bitfinex, one of the largest cryptocurrency exchanges in the world, is being investigated by the NYAG over potentially fraudulent transactions they entered into with their sister company, Tether, the issuer of a virtual currency called "tether" (symbol: USDT).
- Since regulated banks wouldn't deal with the offshore cryptocurrency exchange, Bitfinex was forced to use an unregulated payment processor, Crypto Capital, and placed over $1 billion of funds in their hands.
- However, when $850 million of mostly customer funds disappeared (seized by governments in Portugal, Poland and the United States according to Crypto Capital), and Bitfinex was left unable to meet its customer withdrawal request obligations, Tether transferred funds from its own reserves to Bitfinex, and agreed to a revolving line of credit of up to $900 million at an interest rate of 6.5%.
So why does that matter?
- Tether and Bitfinex are owned and operated by the same group of executives and employees, and the NYAG alleges that customers were not told about this arrangement.
- Tether, is what's called a "stablecoin," which means that every USDT is backed by an actual dollar. By loaning money, Tether was "in effect, acting as an unregulated (and unusually risky) fractional reserve bank."
Read on to to see how this author compares these events in the cryptocurrency world to a traditional financial fraud like MF Global.
Drawing on client money, without the knowledge of those clients, to prop up an insolvent sister company is fraud. The same fraud, in fact, for which Jim Corzine, former CEO of MF Global, paid a $5m penalty. During its collapse into bankruptcy, MF Global used its clients’ money to meet its own proprietary obligations. Similarly, Bitfinex seems to have drawn on client money at Tether to keep itself afloat.