DEVELOPMENT
Let’s look in two parts at manipulators and manipulation in the crypto market in 2017-2018.
In the first part, we looked at the Manipulators (participants of the Scheme).
In the second/concluding part, we will look at the manipulation of USDT itself.
Part 2. Manipulation
Tether’s dominance in the stabelcoin market
From 2014 to 2016, the price of Bitcoin fluctuated between $200 and $800, but from the end of 2016, the price began to rise sharply:
By March 2017, Bitcoin’s price was $1,200.
By July 2017, it had surpassed $2,000.
From July 2017 to December 2017, the price of Bitcoin increased tenfold.
On December 17, 2017, the price of Bitcoin reached its peak of $20,000. At that time, Bitcoin had a market capitalization of nearly $327 billion.
Soon after, the market began to fall, and:
By February 2018, Bitcoin’s price had fallen to $6,200.
By December 2018, Bitcoin’s price was $3,500 and its market capitalization was $62 billion.
USDT not backed by U.S. dollars
From Tether’s founding in 2014 through 2018, in order to maintain the value of USDT, Tether has, repeatedly and publicly, stated that:
- Each USDT will be backed by one U.S. dollar. The dollar is held in Tether’s reserves.
- Tether will only issue new USDTs in response to legitimate market demand, i.e., “customers willing to exchange dollars one-for-one for USDTs.”
- Customers can exchange USDT for USDT at any time (a process called “burning” USDT).
“Treasury” Tether is an account, fully controlled by Tether, from which and on which all USDT are issued and burned. Although customers could buy USDT directly from Tether, the “vast majority” of USDT issued by Tether was issued to accounts on the Bitfinex exchange, and direct purchases from Tether “were a tiny fraction of all USDT issued.”
Importantly, Bitfinex “was the only exchange to which Tether directly transferred USDT,” and because of the exclusive relationship between Tether and Bitfinex, Bitfinex was the only way through which USDT could enter the “crypto economy.”
This exclusive power over the distribution of USDT gave Bitfinex economic power in the cryptocurrency markets, as Tether held nearly 100% of the Stablecoin market during the relevant period.
USDT distribution across exchanges
DigFinex, which controlled Tether and Bitfinex issued between $2 billion and $3 billion worth of USDT, which was 72 percent of all USDT issued during that period. USDT was supposed to be collateralized by an equivalent amount of USDT reserves, but in fact was not fully collateralized and was essentially “printed out of thin air.”
The chart below shows the growth of Tether issuance over time to better explain the economic scale of Tether.
Shown below is the cumulative USDT flow among major market participants in the Tether blockchain from its inception on October 6, 2014 to March 31, 2018:
The sample size is proportional to the sum of the inflow and outflow of coins per node, i.e. the thickness is proportional to the size of the streams, and all the movements of the stream are clockwise.
USDT movement pattern: Tether was authorized (issuing USDT tokens), moved to Bitfinex, and then slowly spread to other exchanges, mostly Poloniex and Bittrex.
Almost no Tether went back to the Tether issuer for redemption, and the main exchange where Tether can be exchanged for dollars, Kraken, accounted for only a small portion of the transactions.
Tether also flowed to other exchanges and institutions and became an increasingly common medium of exchange over time.
A similar analysis of Bitcoin blockchain coin flow shows that the three major exchanges throughout most of 2017 (Bitfinex, Poloniex, and Bittrex) also facilitated significant cross-exchange flows of Bitcoin among themselves.
In addition, Bitcoin’s cross-exchange flows in the Bitcoin blockchain closely match those of Tether in the Tether blockchain.
It is also observed that one major player is associated with more than 50% of the USDT to Bitcoin exchanges on Bitfinex, suggesting that the spread of Tether in the market came from a major player rather than from many different investors who deposited cash into Bitfinex to buy USDT.
Scheme of transfers to exchanges
The entire volume of issued USDT went to the Bitfinex exchange. Bitfinex would then transfer almost all of the USDT received to two corresponding addresses, one on the Poloniex exchange and one on the Bittrex exchange.
Most of the USDT transfers from Tether’s treasury to Bitfinex were in “large round numbers” and “in amounts that are unlikely to reflect genuine consumer demand.”
Panel A shows that 81%* of USDT receipts from Bitfinex to Poloniex and Bittrex were distributed on these exchanges through two deposit addresses – those being 1J1d for Poloniex and 1AA6 for Bittrex.
*The remaining 19% of the arrivals of USDT from Bitfinex to Poloniex and Bittrex were distributed on these exchanges through other deposit addresses. We will not consider them.
These two addresses (1J1d for Poloniex and 1AA6 for Bittrex) accounted for 47% of all USDT proceeds from Bitfinex to all exchanges combined.
Panel B shows 52% of Bitcoin receipts back to Bitfinex from all exchanges were sent to a single deposit address on Bitfinex – 1LSg.
It turns out that one Bitfinex address transferred all received USDT to a Bitfinex controlled address, Poloniex (“1J1d”).
At the same time, another Bitfinex address was transferring all received USDT to a Bitfinex controlled address on Bittrex (“1AA6”).
The unusual USDT distribution pattern demonstrates that Tether was not simply issuing USDT in response to consumer demand, which involved distributing relatively small amounts to many accounts. Instead, it was secretly making large issuances to its Bitfinex subsidiary.
In effect, Tether and Bitfinex were issuing USDT for themselves. Although Tether could have received USDT from Bitfinex in exchange for each USDT it issued to Bitfinex, and thus could have maintained a sufficient reserve of USDT to support each outstanding USDT, as promised. But that was “economically impossible.”
For example, Tether issued $605 million in December 2017 to Bitfinex, but iFinex, the parent company of Bitfinex, received only $333.5 million for all of 2017.
This figure suggests that Bitfinex did not have $605 million to pay Tether for the 605 million USDT issued to it in December 2017, hence Tether did not have enough cash reserves to support all of the USDT issued to Bitfinex.
Access to the banking system.
In addition, Tether had difficulty obtaining and maintaining access to the U.S. financial system through correspondent banks – supporting the allegations that Tether had issued itself unsecured USDTs. In order to maintain its one-to-one dollar reserve to support the outstanding USDTs, Tether required access to the banking systems necessary to maintain such a reserve.
Between October 2014 and March 2017, Tether issued about $42 million in USDT. However, in early 2017, U.S. banks Bitfinex and Tether cut off access to banking services, and they did not restore access to U.S. correspondent banks for another six months.
During those six months, Tether somehow issued 409 million new USDT – nearly ten times the total USDT issued over the previous two and a half years – and thus, to maintain the one-to-one USDT rate, Tether would have needed access to correspondent banking operations in the US to deposit the 409 million dollars received in exchange for this new USDT issue.
As an example, in April 2018, Tether issued $130 million USDT and had to add the corresponding $130 million USDT to its cash reserves, but that same month Bitfinex had “difficulty fulfilling its customers’ requests to withdraw their money from the trading platform.”
Similarly, in October 2018, when Giancarlo Devasini begged Crypto Capital to send Bitfinex cash (“transfer at least $100 million”) to meet customer requests to exit USDT into USDT.
The money from Crypto Capital never arrived. To solve the problem, Tether “delisted” 1.04 billion USDT, reducing the amount of outstanding USDT by nearly 40%. Tether’s protocol was to send 1.04 billion USDT to “burn” and then send 1.04 billion USDT to customers (on exchanges).
Analysis of the blockchain showed no massive transfers of $1.04 billion in October 2018; instead, the blockchain shows a net transfer of only $72 million back to Bitfinex.
Giancarlo Devasini at Crypto Capital, Tether and Bitfinex did not have $1 billion in cash to meet customer requests. It is likely that the $1.04 billion that was delisted was “easily withdrawn from Bitfinex and destroyed without having to pay USDT in return” because Tether “issued those USDT directly to Bitfinex without receiving USDT in return.”
As Tether and Bitfinex lost access to the US banking system, they became increasingly dependent on Crypto Capital to “bypass correspondent bank monitoring and facilitate access to the US banking system.
It was necessary to gain access to cash and thus maintain the illusion that USDT was backed by U.S. dollars. Specifically, Crypto Capital. gave Bitfinex and Tether access to the U.S. banking system by creating bank accounts in the names of shell corporations that allowed Bitfinex and Tether to access the U.S. banking system to perform exchanges with customers.
These “shadow accounts” were shut down when banks determined that the accounts were being used by Bitfinex and Tether, forcing Crypto Capital and Reginald Fowler to create new accounts in what Philip Potter called a game of cat and mouse.
Crypto Capital’s behavior was “important to Bitfinex and Tether’s scheme to manipulate USDT purchases” because “without the illegal access to the US financial system provided by Reginald Fowler and Crypto Capital, Bitfinex and Tether would have been unable to fulfill any withdrawal requests, quickly revealing that USDT could not be redeemed or fully secured.”
Reginald Fowler and Crypto Capital knew that:
- “Bitfinex and Tether relied on Crypto Capital accounts for fiat currency transactions.
- “These transactions confirmed the market’s belief that USDT is fully backed.”
- the illusion of USDT being fully backed “contributed to the manipulation of cryptocurrency prices.”
As evidence, there was a series of exchanges on October 15, 2018 between Giancarlo Devasini – CFO of Tether and Bitfinex, director and shareholder of DigFinex and iFinex – and a Crypto Capital employee on the Telegram messaging app, in which Giancarlo Devasini begs Crypto Capital to “transfer at least 100 million” to Bitfinex to meet customer requests to exit USDT into USDT.
He warned that failure to comply with the requests would show that USDT has no collateral and “could be extremely dangerous for everyone in the crypto community” because “BTC (i.e. Bitcoin) could fall below 1k if we don’t act quickly.”
Crypto Capital participated in and benefited from the scheme because:
- Invested heavily in the continued success of the crypto-asset market because the entire business model depended on its continued existence.
- Received commissions and interest on Bitfinex trades.
- The value of his own cryptocurrency stocks was inflated by the scheme, which allowed him to “take advantage of the bubble he helped create.”
Using USDT to Manipulate
While the scheme to hide the unsecured nature of USDT was quite complex, the scheme to use this unsecured USDT to manipulate the cryptocurrency market was relatively simple.
After convincing the market that the value of each USDT was equivalent to one U.S. dollar, Tether then used USDT, signaling to the market that the purchases they made with USDT “reflect massive and measurable consumer demand for… cryptocurrencies. Thus, these purchases naturally raised the price of cryptocurrency.”
As noted above, between October 2014 and December 2018, Tether issued between 2 and 3 billion USDT – 72% of all USDT issued during that time – to the Bitfinex exchange, then Bitfinex transferred USDT to two Bitfinex-controlled accounts, Poloniex and Bittrex.
Once the USDTs were deposited into Bitfinex accounts (on the Bittrex and Poloniex exchanges), Bitfinex used them to buy cryptocurrencies. These cryptocurrencies were then sent back to the Bitfinex exchange, where Bitfinex sold them to its customers for USD.
Supposedly Bitfinex may have secretly sold these illegally acquired cryptocurrencies using so-called “hidden” orders, in which the “hidden” order does not appear in the publicly available order book.” These hidden orders are a mechanism for an opaque channel to sell Bitcoin without a price drop – these are so-called OTC deals.
The fraudulent scheme was not just about converting unsecured USDT into valuable assets such as fiat currency and cryptocurrencies – the entire scheme was designed to artificially inflate the price of Bitcoin and other cryptocurrencies and had an effect.
Because the market mistakenly viewed USDT as equivalent to U.S. dollars, the large influx of this crypto-asset into the cryptocurrency market had a huge impact. The market saw the influx of USDT as a sign of new cash inflows and therefore an increase in demand for the cryptocurrency market.
Bitfinex made carefully calculated strategic cryptocurrency purchases using their unsecured USDT when cryptocurrency prices began to fall in order to:
- stop prices from falling;
- push cryptocurrency prices back up;
- hold prices above certain “round number thresholds” that created a false impression of “lows” below which cryptocurrency prices would not fall.
In turn, this price manipulation was self-perpetuating because it led the market to mistakenly believe that:
– Organic demand for cryptocurrencies increased;
– the value of cryptocurrencies would remain stable and not fall below a certain price threshold, which would encourage further investment in cryptocurrencies and further inflate prices.
For example, when cryptocurrency prices were down 5% or more, Bitfinex transferred an average of ten times more USDT to Poloniex and Bittrex than when prices were up.
Bitfinex sent large flows of USDT to its Poloniex and Bittrex accounts, causing cryptocurrency prices to rise. There was a correlation between unsecured USDT, large USDT transfers from Bitfinex to Poloniex and Bittrex, and the rise of Bitcoin and other cryptocurrencies from March 2017 to March 2018.
The collusion “created the biggest asset bubble” – as noted earlier, at its peak Bitcoin was trading at $20,000 in December 2017, and a year later fell to $3,500.
Poloniex and Bittrex
DigFinex needed to use other crypto exchanges to exchange its unsecured USDT into more valuable cryptocurrencies because if Tether deposited huge amounts of USDT directly into Bitfinex accounts on the Bitfinex exchange and then immediately tried to buy Bitcoin – it would cause too many red flags.
As a consequence, Bitfinex transferred USDT to Poloniex and Bittrex – direct competitors – and from these accounts it was possible to buy cryptocurrencies anonymously and in large quantities, thereby artificially creating demand for cryptocurrencies and manipulating their price.
Poloniex and Bittrex were more than just unwitting facilitators of the scheme. For much of the relevant time period, these exchanges did not accept fiat-based deposits, did not offer fiat-based exchanges, and therefore, for example, users could not exchange Bitcoin for USD on Poloniex or Bittrex.
Thus, USDT was the most important crypto-asset to support both exchanges because it was supposed to “combine the best aspects of fiat currency and crypto-assets: it was as stable and secure as the US dollar, but also, like other crypto-assets, easily transferable to various crypto-exchanges and not subject to many government regulations.”
Both Poloniex and Bittrex accepted and promoted Tether’s guarantee that each USDT was backed by a U.S. dollar, and both worked closely with Tether to list USDT. Poloniex and Bittrex quickly became large and successful crypto exchanges, in part as a result of their early adoption of USDT.
These exchanges “knew that Bitfinex was the entity listing huge amounts of USDT to 1J1d and 1AA6 addresses because Bittrex and Poloniex worked specifically with Bitfinex to provide these transfers. This agreement is supported by the unusual practice with respect to the 1J1d and 1AA6 addresses, allowing Bitfinex to reuse these addresses multiple times when regular customers would normally be given a new deposit address to transfer USDT to their Bittrex or Poloniex account.”
Similarly, evidence of an unusual and deliberate arrangement between the exchanges and DigFinex is clear regarding the shares of USDT traded on the exchanges compared to other crypto exchanges: the combined net USDT flow on Bittrex and Poloniex is about half of all issued USDT, even despite cryptocurrency trading on Bittrex and Poloniex. Relative to Poloniex and Bittrex, USDT saturation was minimal on Binance, the largest cryptocurrency exchange in the world.
Poloniex and Bittrex knew that Bitfinex controlled 1J1d and 1AA6 addresses “because federal “know your customer…” requirements prohibit them from accepting such large transfers from an anonymous source,” and because both exchanges allegedly complied with such requirements and claimed to have systems in place to comply with those requirements. Thus, Poloniex and Bittrex had “direct access to the daily trading activity” of Bitfinex accounts, they necessarily knew that USDT was not released in response to organic customer demand.
Because it occurred on their exchanges, Bittrex and Poloniex also knew that Tether and Bitfinex were using this USDT to buy cryptocurrencies. They knew what assets Tether was buying and when, and that the cryptocurrencies they bought were going back to Bitfinex. They also knew how these purchases affected cryptocurrency prices on their own exchanges. Given the size and regularity of these transfers through a mechanism they created just for this purpose, and their perfect transaction visibility, Bittrex and Poloniex knew about the manipulative effect of transactions on their exchanges.
The exchanges did not report such transactions, but instead knowingly and voluntarily facilitated such transactions by creating “individual” accounts for Bitfinex. In addition, despite being direct competitors of Bitfinex, the exchanges allegedly agreed to participate in the DigFinex Defendants’ scheme because they benefited from:
- Increased trading volume caused by market manipulation.
- Increased commissions from increased trading.
- Increase in value of their cryptocurrency stocks due to artificial price increases.
- Preserving the viability of the cryptocurrency market on which their entire business model depended.
What’s the bottom line?
- The Scheme participants misrepresented to the market that USDT is fully collateralized with U.S. dollars.
- Hid the unsecured nature of USDT: for example, the exchanges broke the rules that would reveal the truth about USDT’s collateralization, and Crypto Capital facilitated access to U.S. banking operations.
- Voluntarily facilitated exchanges to distribute unsecured USDT from Bitfinex-controlled accounts on the Bitfinex exchange to Bitfinex-controlled accounts on Poloniex and Bittrex because, for example, exchanges could see every transaction on their platform and had to know basic information about their users under anti-money laundering rules, and therefore knew or should have known that Bitfinex controlled those accounts and that USDT was not fully secured.
- Used USDT to buy large quantities of cryptocurrencies in order to inflate their prices.
- Exchanging messages between Scheme members about the need to maintain the illusion of full support for USDT to maintain Bitcoin’s value.
- Close communication and coordination between DigFinex and exchanges regarding the use of USDT on their respective crypto exchanges.
- Philip Potter, Giancarlo Devasini and Ludovicus Jan van der Velde hid their simultaneous control of Bitfinex, Tether and DigFinex, a key element of the scheme to hide the unsecured nature of USDT and use USDT to inflate cryptocurrency prices and monopolize the cryptocurrency market.
- Reginald Fowler was a Crypto Capital employee and was at the center of Crypto Capital’s scheme to run a shadow bank on behalf of crypto exchanges, with hundreds of millions of dollars flowing through accounts he controlled in jurisdictions around the world. There is clear involvement of Reginald Fowler in the scheme, such as the fact that he set up certain shell companies and bank accounts to facilitate the DigFinex scheme.
Bottom line, Tether was issuing USDT and transferring to Bitfinex and then to Poloniex and Bittrex.
After USDT was transferred to Poloniex and Bittrex, the Exchanges used it for carefully timed cryptocurrency purchases when prices threatened to fall, thereby fraudulently creating the appearance of price “lows” in the market, artificially simulating organic demand and creating a cryptocurrency market bubble.
Crypto Capital helped cover up the fact that USDT was unsecured and the same Poloniex and Bittrex knew and wanted to participate in the scheme, despite the alleged competition with Bitfinex.
All had a clear intention to stop the fall of cryptocurrency prices and artificially increase prices in the cryptocurrency market, as the further viability of each participant in the scheme depended entirely on the continued growth of the cryptocurrency market and each of them profited significantly from the bubble in the cryptocurrency market.
