NY prosecutor alleges fraud by Bitfinex

The owners of cryptocurrency exchange Bitfinex have been defrauding clients by engaging in secret, conflicted transactions with related parties, according to a court order published on April 25 by the New York Office of the Attorney General (NY OAG).

The NY OAG said it is requiring Bitfinex and Tether, a related company and the issuer of a virtual currency called ‘tether’, to stop depleting the US dollar assets which back tether tokens, with immediate effect.

The OAG said it is also ordering the companies to produce additional documents and to refrain from destroying information.

Tether is owned and operated by senior Bitfinex employees, according to a 23-page affirmation from the NY OAG, which also accompanies yesterday’s court order.

“Our investigation has determined that the operators of the Bitfinex trading platform, who also control the tether virtual currency, have engaged in a cover-up to hide the apparent loss of $850m of commingled client and corporate funds,” said Attorney General Letitia James.

“New York state has led the way in requiring virtual currency businesses to operate according to the law.  And we will continue to stand up for investors and seek justice on their behalf when misled or cheated by any of these companies.”

Bitfinex says it is the world’s most advanced cryptocurrency exchange

Bitfinex, launched in 2012, is owned by a company called iFinex, based in the British Virgin Islands.

On its website, Bitfinex says it is the world’s most advanced cryptocurrency exchange, and the world’s largest exchange by volume for trading bitcoin against the US dollar.

However, cryptocurrency exchange volumes are self-reported and notoriously unreliable. According to coinmarketcap.com, Bitfinex’s 30-day trading volumes as at April 25 were $6.7bn, placing the exchange 40th in a ranking of global cryptocurrency exchanges.

The bitcoin/US dollar price fell by up to 10 percent in response to the publication of the NY OAG court order late on Thursday 25 April, though it has since recovered around half this loss. The dollar price of tether is around $0.99 in lunchtime New York trading on Friday 26 April, a modest discount to the target $1 value.

From banking constraints to an $851m shortfall

According to the NY OAG, which says it started its investigation last year, the problems facing Bitfinex and Tether are at least partially due to past difficulties with banking relationships.

Before 2017, the NY OAG says, Bitfinex and Tether serviced clients wishing to make US dollar wire transfers by using Taiwan-based banks. In turn, US bank giant Wells Fargo acted as the correspondent bank for these Taiwanese banks.

However, in 2017 Wells Fargo decided to stop acting in this role, says the NY OAG, prompting Bitfinex and Tether to seek alternative dollar payment facilities.

Bitfinex and Tether could not find reliable banking partners

First, they used a Puerto Rico-based bank called Noble Bank International, says the NY OAG. This relationship ended in October 2018. Then in November 2018, Tether announced publicly that it had established a relationship with a Bahamas-based bank, Deltec.

However, the NY OAG says in its court statement, Bitfinex and Tether declined to disclose that they had also started using the services of a so-called ‘payment processor’ called Crypto Capital, based in Panama.

Crypto Capital’s website says the firm is owned by Global Trade Solutions AG of Zug, Switzerland. The website also says Crypto Capital worked with Quadriga CX, the now-bankrupt Canadian cryptocurrency exchange.

In February this year it emerged that Quadriga had lost $140m in client assets following the reported death of its chief executive in India.

Bitfinex has failed to disclose an $851m loss

According to the NY OAG, although Bitfinex and Tether ended up placing over $1bn in a mixture of client and company funds with Crypto Capital, no written agreement ever existed between Crypto Capital and either Bitfinex or Tether.

The NY OAG says it believes Bitfinex and Tether were forced to use the services of payment processors like Crypto Capital because they could not find reliable banking partners.

According to transcripts of electronic messages between Bitfinex and Crypto Capital, published by the NY OAG, in October and November 2018 Bitfinex was making increasingly desperate requests to Crypto Capital to help process withdrawal requests by clients. This period coincided with heavy falls in cryptocurrency prices.

At the same time, the NY OAG says, Bitfinex was making deliberately misleading public statements, alleging that withdrawals were being processed as normal.

In the end, says the NY OAG, Bitfinex was left with an $851m shortfall as a result of the inability of Crypto Capital to return funds. Bitfinex has up to now failed to disclose this loss, says the NY OAG.

The double-dipping allegation

To help address the shortfall, says the NY OAG, in March 2019 Bitfinex arranged a loan facility from Tether totalling up to $900m. This loan facility drew on the funds held by Tether to provide backing for its tether tokens’ dollar peg, the NY OAG says.

The loan transaction documents were signed on behalf of Bitfinex and Tether by the same two individuals, who are directors and owners of both companies, the NY OAG says.

Prior to February 2019, Tether had said that its tokens were backed one-to-one by traditional currency held in reserve.

However, the NY OAG notes, in March 2019, Tether changed this disclosure, stating that henceforth tether tokens would be backed by reserves which would include ‘currency and cash equivalents, including from time to time other assets and receivables from loans made by Tether to third parties, which may include affiliated entities’.

However, Tether has up to now not disclosed the existence of a loan agreement with Bitfinex.

According to Tether’s website, over 2.6bn tether tokens ($2.6bn at the target exchange rate) are outstanding.

“Undisclosed transactions treat Tether’s reserves as Bitfinex’s slush fund”

The New York prosecutor says that Bitfinex’s use of the funds supposedly backing the dollar value of tether tokens was both undisclosed and against clients’ interests.

“In order to fill the [funding] gap, executives of Bitfinex and Tether engaged in a series of conflicted corporate transactions whereby Bitfinex gave itself access to up to $900m of Tether’s cash reserves, which Tether for years repeatedly told investors fully backed the tether virtual currency ‘1-to-1’,” the NY OAG said in its press release.

“According to the filings, Bitfinex has already taken at least $700m from Tether’s reserves,” the NY OAG said.

“Those transactions treat Tether’s cash reserves as Bitfinex’s corporate slush fund, and are being used to hide Bitfinex’s massive, undisclosed losses and inability to handle customer withdrawals,” the NY OAG said.

“Both Bitfinex and Tether are committed to fighting this gross overreach”

On April 26, both Bitfinex and Tether published an identical response, rebutting the Attorney General’s allegations.

“The New York Attorney General’s court filings were written in bad faith and are riddled with false assertions, including as to a purported $850m ‘loss’ at Crypto Capital,” Bitfinex and Tether said.

“On the contrary, we have been informed that these Crypto Capital amounts are not lost but have been, in fact, seized and safeguarded. We are and have been actively working to exercise our rights and remedies and get those funds released. Sadly, the New York Attorney General’s office seems to be intent on undermining those efforts to the detriment of our customers.”

In April 2018 Polish authorities seized $371m from two companies on suspicion of money laundering for the Colombian mafia. At the time, Polish news media drew attention to possible links with Bitfinex and Crypto Capital.

The New York Attorney General’s office has set a hearing date of 3 May, at which representatives of Bitfinex and Tether are supposed to deliver a series of additional documents under subpoena.

“Both Bitfinex and Tether are committed to fighting this gross overreach by the New York Attorney General’s office,” the two companies said.

“[We] will vigorously challenge this, and any and all other actions, by the New York Attorney General’s office.”

An echo of the 2016 Bitfinex hack

In April 2016 Bitfinex suffered one of the largest hacks in cryptocurrency history, when 120,000 bitcoins (worth around $72m at the time but $630m today) were stolen from client accounts as a result of a flaw in the exchange’s security procedures.

At the time, Bitfinex applied a blanket 36 percent ‘haircut’ on all client deposits on the exchange, offering clients a substitute token called BFX instead.

The following year, helped by the ongoing bull market in cryptocurrencies, Bitfinex was able to make clients whole (in fiat currency, if not in cryptocurrency terms), redeeming these tokens at their $1 face value.

The 120,000 bitcoins stolen from the exchange had never changed their location on the blockchain. However, this week that changed.

300 of the stolen coins were moved for the first time on the day the New York Attorney General released its report. The addresses to which the bitcoins moved were new, offering outside observers no help in tracing the hackers.

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