Blog Articles

Bitfinex Saga: iFinex Inc., Tether, Crypto Capital, IEO – COIN360
SUMMARY
May 23  |  13 min read

Bitfinex Saga: What Have You Missed?

The COIN360 Editorial Team

In Bitfinex’s six years of existence and Tether’s five, the sister companies have suffered multiple million-dollar hacks, been the targets of loaded online allegations, and faced serious scrutiny from financial authorities. But they have also succeeded, with one becoming a household name in cryptocurrency exchanges and the other launching the biggest stablecoin in the crypto market.

The story connecting these two industry giants reached a boiling point last month when the New York Attorney General decided to sue iFinex, Bitfinex and Tether’s parent company, over a missing $851M. The money was apparently lost through a deal with the Panama-based payment processor Crypto Capital, whom iFinex chose to handle their payments after Wells Fargo froze their accounts in 2017.

Below, we briefly discuss the events that led up to the Attorney General’s filings last month, and present all the info that you may have missed from this saga, including Monday’s latest developments.

iFinex’s Tumultuous Past

The Tether Secret and the Initial Hacks

Bitfinex was founded in 2013 under its parent company iFinex Inc., by CSO Phil Potter, CEO Jan Ludovicus van der Velde and CFO Giancarlo Devasini. By September 2014, the team had founded Tether Limited, a sister stablecoin company — but this development was deliberately hidden from the public for 3 years. The team swore that Tether was nothing more than a partner to Bitfinex.

Bitfinex CSO Phil Potter

Bitfinex CSO Phil Potter is often regarded as the leader of the company.

Bitfinex lost $400K the first time it was hacked in May 2015, and suffered its first legal troubles just over a year later, with the CFTC demanding $75K from them (press release here). When an unfortunate second hack on Aug 2. 2016 cost them a total of 119,756 BTC —57% of their BTC deposits, around $70M at the time— Bitcoin shed 15% of its value on the cryptocurrency markets.

By now, the exchange was in danger of becoming another Mt. Gox. But rather than shut down for good, management decided to “socialize the loss” with a 36.067% tax on all users; including those who were not hacked. The exchange then distributed Bitfinex tokens (BFX) to make up for the haircut. Eventually, Bitfinex declared all customers repaid (here), and Potter stated proudly that they had “demonstrated an alternative to bankruptcy.”

First Accusations

This is when the earliest accusations regarding iFinex surfaced. When iFinex’s connection to Tether was revealed months later, some users cried foul and claimed (thread here) that the BFX repayment was just an elaborate gimmick, in which iFinex used USD collected from Tether to pay for BFX and atone for the impact of the hack.

Thread on Reddit about Bitfinex token and Tether

Thread on Reddit claiming the BFX repayment was a gimmick involving Tether.

In November 2017, Tether’s overlapping management with Bitfinex was revealed in the leaked Paradise Papers (available here). That’s around the time when Tether was hacked for nearly $31M in tokens and forced a “temporary hard fork” to make the stolen tokens unusable (press release here).

Critics everywhere began to wonder whether the iFinex platforms actually had the money they claimed it did (NYT and Bloomberg).

Bitfinex’ed (and Other) Theories

Leading the controversy train has been Bitfinex’s most infamous internet detractor: a user called Bitfinex’ed. In a series of Medium essays, the author argues that Bitfinex had been freely minting Tether coins to buy Bitcoin with them and artificially boost the latter’s price. Bitfinex’ed estimates that between January and April of 2017, the amount of available Tether went from 10M to 55M.

He also claims (here) Bitfinex uses market manipulation techniques such as spoofing (placing a large bid or ask order to make the price of Bitcoin go up or down before canceling the order) and wash trading (buying and selling an asset simultaneously to give the impression it is in higher demand than it actually is).

Charlie Lee: Tether (USDT) does not possess funds

Charlie Lee of Litecoin chimes in on accusations that Tether does not possess sufficient funds to back its stablecoin.

There are also allegations that the exchange was founded on stolen “swiss cheese” code, and that the founder has a history of supporting Ponzi schemes (thread here).

Bitfinex and Tether’s Effect on the Market

There is research to suggest that as much as half of Bitcoin’s price surge in late 2017 could have been a consequence of Bitfinex’s influence (Bloomberg).

By 2018, Tether’s strange behavior had caught everybody’s attention — including academics’. Market manipulation experts at New York University studied Kraken’s public order books, bewildered by how the stablecoin seemed to ignore the rules of economics: huge trades moved prices about the same as small ones—that is, very little—, and specific order sizes (going out to five decimal points) appeared to have frequently been repeated (Bloomberg).

In June that year, a University of Texas professor known for flagging suspicious activity on Wall Street, released research that concluded that transactions elevating Bitcoin’s price on Bitfinex were “consistent with a manipulation hypothesis.” Bitfinex disputed his findings (Bloomberg).

In October 2018, numerous clients were unable to withdraw fiat from Bitfinex. The company had to explicitly assure the public that they were not insolvent: “Verified Bitfinex users can freely withdraw Euros, Yen, Pounds Sterling and U.S. Dollars,” the statement read (Bloomberg). We will see in the following section that this was possibly the moment at which the trouble with Crypto Capital began and the $851M went missing.

Bitcoin Price Chart on COIN360

Bitcoin saw a spike in price in October 2018 that may be attributed to Tether holders dumping the stablecoin.

As Alex Michaelis, co-founder of CoinSchedule, told Bloomberg, many investors who bought Tether through Bitfinex began to dump their holdings in exchange for Bitcoin, which spiked its price. At the time, Bitcoin was trading at around $6,440 on most other exchanges, while trading for $6,778 on Bitfinex.

2019: The Attorney General’s Injunction

This all brings us to this year’s chapter in iFinex’s story. On Apr. 25, the New York Attorney General (NYAG), Letitia James, sued Bitfinex on claims that the company hid a missing $851M through illicit transactions involving Tether, and that several New York-based traders are illegally transacting on Bitfinex. You can access the full legal filing here.

So, what happened before and after?

Bitfinex and Crypto Capital

In April 2017, iFinex had several Taiwanese bank accounts frozen by Wells Fargo. These were accounts that operated with US customer money, and the blockade meant, in theory, that Bitfinex would not take on US clients anymore. However, James has said the exchange was still taking on several New York-based clients.

According to the NYAG, Bitfinex hired Panama-based payment processor Crypto Capital to handle customer withdrawals, and handed them “over one billion dollars of co-mingled customer and corporate funds”. From that money, Crypto Capital may have lost or stolen the $851M that are now missing. In fact, the attorney general attributes Bitfinex’s problems with withdrawals from last October to this very issue.

In addition, James believes Bitfinex drained at least $700M from Tether’s reserves to cover their loss. On Apr. 25, the news caused Bitcoin to fall nearly 6%, to around $5,130.

Bitcoin price and market capitalization. April, 25. COIN360

The news of the NYAG's injunction made Bitcoin take a dip on Apr. 25 2019. Price chart by Coin360.

The filing quotes messages from August 2018, in which a Bitfinex executive (going by the name “Merlin”) begs for money from Crypto Capital. In the excerpts, Merlin grows increasingly more desperate, telling his contact, “Oz,” that they are “seeing massive withdrawals and are not able to face them anymore unless (they) can transfer some money out of Crypto Capital,” and that “BTC could tank below 1K” if they did not get the money quick. The following are excerpts from the messages, available in the NYAG’s report (here).

iFinex contacts Crypto Capital

Merlin, from iFinex, contacts Crypto Capital with a pressing situation.

iFinex contacts Crypto Capital

Merlin claiming that “dozens of people are waiting for a withdrawal out of Crypto Capital”

iFinex contacts Crypto Capital

Merlin tells Crypto Capital that “BTC could tank below 1K” is the situation is not resolved.

According to the NYAG, Crypto Capital failed to return the $851M to iFinex, claiming that the money was seized by Portuguese authorities; a story that the attorney does not believe to be true. If the AG manages to prove fraud was involved, criminal charges could be placed on the iFinex team.

On Apr 30, Reggie Fowler, who is said to have connections with Crypto Capital, was indicted for running an unlicensed money transmitting business for crypto traders. Some have speculated this is directly linked to the iFinex case.

The Politics Behind the Probe

Attorney General Letitia James’s inquiry into Bitfinex is part of her office’s larger probe into crypto. Although the crypto community has no political affiliations per se, and many holders would rather remain apolitical, it is nonetheless noteworthy to point out that within the US government there is a tendency for officials who favor crypto to be republicans and Trump supporters (take Mick Mulvaney for example, or Peter Thiel), while officials who take a stricter stance towards it tend to be democrats.

The iFinex saga is no exception— James came to office through a no-nonsense campaign that unapologetically targeted president Trump. She has promised to investigate the US President's finances, real estate holdings, and business dealings. In his own style, Trump tweeted to denounce what he calls James's open campaign on a "GET TRUMP agenda." In turn, during her campaign, James called Trump incompetent, ill-equipped and "an embarrassment to all that we stand for" (here).

Donald Trump voices his dislike for Letitia James, New York Attorney General suing iFInex.

Donald Trump voices his dislike for Letitia James, New York Attorney General suing iFInex.

Bitfinex’s reaction

Bitfinex responded with outrage, stating “New York Attorney General’s court filings were written in bad faith and are riddled with false assertions”. The company’s official stance is to defend that the $851M “are not lost but have been, in fact, seized and safeguarded,” calling the AG’s actions a “gross overreach”. Moreover, Bitfinex further warns that the AG’s actions are undermining their constant efforts to regain the money, acting in detriment to the interests of their customers.

Immediately following the AG’s report, some 17,250 BTC (around $89 million) and 633,300 ETH (around $96 million) were withdrawn from Bitfinex's cold wallets; about 20% of Bitfinex's holdings rests in these coins. It appears as if these movements could have been customer withdrawals, but it is not clear.

On May 13, after attorneys on both sides failed to come to a consensus, iFinex’s attorneys wrote a letter to confirm they would, without waiving their previous motion to vacate NYAG’s Ex Parte order entirely, agree to certain changes to the preliminary injunction that could allow Bitfinex to use Tether reserve funds, including for investment purposes. Basically, they asked the court to loosen the NYAG’s restrictions on them. Surprising many, the strategy worked (more on this below).

The Law on iFinex’s Side?

On May 16, Justice Joel Cohen granted Bitfinex’s motion to modify the AG’s injunction. The order allowed Bitfinex and Tether to continue their normal business, but required them to turn over information regarding a loan and line of credit. In addition, Tether has been forbidden from loaning assets to Bitfinex or other parties, distributing reserve funds to employees, or modifying documents subpoenaed by the NYAG.

The Initial Exchange Offering (IEO)

In a surprising turn, Bitfinex announced that in order to cover for the missing or frozen $851M, they would conduct a private initial exchange offering (IEO). The company managed to sell $1B worth of its very own LEO token — official ticker UNUS SED LEO (whitepaper here).

The new tokens will be bought back on a monthly basis at market price, with at least 27% of Bifinex’s profit from the previous month, and the exchange has reserved the right to buy back the tokens within 18 months after the funds are unfrozen. And if the $851M are never retrieved? The plan is to use Bitfinex’s 2017 and 2018 profits to buy back all of the tokens within 4 years.

LEO was listed on Bitfinex on May 20. The coin traded within a $1.04 to $1.08 corridor in its first two days. On May 22 at 16:00 GMT, the price of LEO shot from 1.08 to $1.14 within just 3 hours. At press time, LEO is trading at $1.14.

In three months time, holders will have access to benefits including: a taker fee reduction of 15% over all crypto-to-crypto pairs, a lending fee reduction, and a crypto and fiat withdrawals and deposits fee discount of up to a 25% depending on the amount of LEO held.

Tether’s Reaction

Tether’s website famously used to assure its readers that every single Tether was backed 1-to-1 by a US dollar— “every tether is always backed 1-to-1 by traditional currency held in our reserves.” — in addition to claiming that each Tether could be redeemed for $1 (even though its terms of service actually state “There is no contractual right or other right or legal claim against us to redeem or exchange your tethers for money. We do not guarantee any right of redemption or exchange of tethers by us for money”).

In a quiet but extremely telling move, on Mar. 14, Tether modified this text to say that their coins may not just be backed by traditional currency and cash equivalents, but, “from time to time, (by) other assets and receivables from loans made by Tether to third parties, which may include affiliated entities.”

Tether (USDT) may not be backed by cash

Analysts like Tuur Deemster have taken to social media to comment on the development and on Tether’s particular use of language.

Analyst Tuur Deemster criticizes Tether’s language when referring to its funds.

Analyst Tuur Deemster criticizes Tether’s language when referring to its funds.

You can find a synthesis of further analyses here.

What’s Blockstream Got to Do with This?

An accusation going round for a few months now is that Blockstream has been colluding with Bitfinex to raise Bitcoin prices through Tether (discussed here and here). It is interesting that, although there are no official public mentions of this, Ex Bitfinex Director of Community & Product Development, Zane Tackett, let slip in a Whalepool call back in 2016 that the exchange has investments in Blockstream. Knowing this, it is not surprising that Blockstream employees have been actively defending Bitfinex and Tether in their 2019 scandal.

Blockstream has been colluding with Bitfinex to raise Bitcoin prices through Tether

Latest Developments

With the LEO IEO a success, the state of token trading on Bitfinex as of this Monday (May 20), the new Bitfinex-native IEO platform Tokinex ready to announce its first sale on May 23, and Justice Cohen granting a modification to loosen the NYAG’s injunction, it seems like iFinex might, against all odds, swim rather than sink—at least for the time being.

In court filings from May 21 (available here), Bitfinex and Tether asked Judge Cohen to stay the NYAG’s request for documents from Bitfinex and Tether while he considers the motion. iFinex attorneys Jason Weinstein and David Miller are claiming that Bitfinex and Tether have “nothing to do with New York investors — the businesses do not allow New Yorkers on their platforms and do not advertise or otherwise do business here.”

Of course, Miller did surprise the court last week by (perhaps accidentally) admitting that Tether had invested part of its reserves in Bitcoin. Judge Cohen was quoted as telling Miller, “Tether sounded to me like sort of the calm in the storm of cryptocurrency trading… And so if tether is backed by bitcoin, how is that consistent?”

The company has had its fair share of storms. If they prevail in the current one, managing to explain the $625M loan and $900M line of credit that Tether offered Bitfinex to cover for the missing $851M, it will be an impressive feat. One that Tether’s customers will have to decide whether to celebrate or, perhaps more likely, retract their patronage for in outrage.

As always, thanks for reading.
The COIN360 Editorial Team