One year ago exactly, I wrote my first piece about a stablecoin called Tether.

A year later, uh, wow:

From legal action introduced last month: Leibowitz et al. versus iFinex et al., US District Court.

A complaint is not the same thing as a conviction. But the complaints are mind-blowing. This is not just “we are upset that we lost our crypto money and we’d like to sue someone”. If these accusations are found by a jury to be true, or even approximately true, then it will immediately go straight to the Hall of Fame level of Largest Frauds of All Time. In terms of monetary evaporation, the accusations here are ten times the size of WeWork, and at least ten times as interesting.

In my opinion, this is the most interesting story in tech this year and nothing else comes close.

In this and next week’s newsletter, I’m going to walk you through the accusations being made in this complaint, along with context from others in the community who’ve been paying attention, so you can understand how truly shocking this all is. It’s a complex story, so I’ve broken down the allegations into three parts. The first two we’ll talk about today, and the third next week:

Allegation #1: The 2017 Bitcoin Bubble was market manipulation, and Tether was how they did it

Allegation #2: Tether became a systemically important, money laundering conduit for the crypto ecosystem

Allegation #3: They might’ve gotten away with it, too, if they hadn’t gotten robbed while busy scamming

To be clear: everything I’m about to talk about in the next two weeks are allegations. They have not been proven in a court of law. Many aspects of this story as I’m telling it may turn out to be misinterpreted or flat-out wrong. But it’s an important story, and I’m committed to sharing it with you accurately, to the best of my ability and understanding.

So, let’s begin:

Allegation #1: The 2017 Bitcoin Bubble was market manipulation, and Tether was how they did it

This is the part of the Tether story I wrote about most recently, back in June in All The Other Kids With The Pumped Up BTCs. Here’s a recap.

Unless you’re a crypto insider, the main lens through which you probably think about cryptocurrency and Bitcoin specifically is the price. The price of Bitcoin bounces around a lot, which makes sense: it is super speculative. Unlike something with intrinsic value, like a share of Apple stock or an actual apple, one Bitcoin is "worth" whatever the market feels it ought to be worth. And that feeling can change quickly.

In 2017, the price of Bitcoin rocketed up from around $1000 all the way up to 5, then 10, 15 and close to $20,000 in less than a year, and then in the next year fell most of the way back down. If you include the other cryptocurrencies that rose and fell along with it, and measure from peak to trough, the total amount of speculative value that got created and then destroyed was over 450 billion dollars.

Why did this happen? The simple explanation is human nature: this was a bubble. No one knows what a Bitcoin is really worth, but if other people get greedy we get greedy too, and if they get afraid, we get afraid too. That’s why bubbles happen, like with the dot coms in 1999. Now, Occam’s Razor is usually right: sometimes the simple explanation is the correct one. But not this time.

We now know that what happened in 2017 was not just a bubble. It was also a scam.

To understand what happened here, you need to appreciate that the price of Bitcoin isn’t “real” like the price of Apple stock is - not only because it’s more subjective, but also for more serious reasons. Apple stock trades at high volume, every day, on stock exchanges that have rigorous, transparent rules in place to prevent market manipulation and abuse. Not Bitcoin. Bitcoin trades in the dark, on exchanges whose rules you don’t know.

Bitfinex is one of those exchanges. At one point, it was the largest cryptocurrency exchange in the world. As you probably know by now, they worked with (and secretly owned) a Stablecoin called Tether that issued a cryptocurrency token pegged to a value of $1. Tether’s offering was essentially: approved customers could mail Tether a cheque for 100 US dollars, Tether would stick them in the bank for you, and then they’d issue you $100 worth of Tethers on a blockchain. You could go spend those Tethers on buying crypto, or doing whatever you want; when you’re done with them, send the Tethers back, and you get your 100 US Dollars back.

If Tether were acting honesty, and all Tethers in circulation were backed by genuinely invested dollars sitting in a genuine, safe bank account, then there’s nothing wrong with this. But that’s not what they did. Bitfinex and Tether, together with their business partners, figured out that they could use this money printing machine to their advantage. Here’s the basic playbook:

Print a whole bunch of Tethers into existence - not backed by real dollars, but instead collateralized by other stuff - cryptocurrency, their own equity, IOU receivables, sometimes nothing. But most importantly, Bitcoin. Bitfinex held a lot of Bitcoin, which makes sense given they were the world’s largest Bitcoin exchange. Working with partners, flood those Tethers onto crypto exchanges all around the world (who treated Tethers as equivalent to dollars, sometimes indistinguishably so - more on this in part 2) to buy Bitcoin, pumping and stabilizing the price, and therefore pumping up the value of Bitfinex’s own Bitcoin holdings. If anybody asks questions (“Where did all those Tethers come from? Prove to me they’re collateralized”), sell some of your inflated Bitcoins for real US Dollars at a profit, stick those dollars in your bank account, and then say "Look! Here they are! Just like we promised." Repeat.

Now here’s what I mean when I say that the price of Bitcoin isn’t “real”: when you see a Bitcoin price quoted on an exchange, you assume that the price reflects a bid/ask spread that’s genuine and deep. You assume that the bid and ask here represent actual investor interest, with real dollars - not an artifact of a thinly traded float, or from unbacked Tether dollars that were printed into thin air. Trading activity in the float makes it look like there’s demand to support the entire inflated “Market Cap” of Bitcoin and other cryptocurrencies, which is absolutely not true. But it looks true, temporarily.

However, because the price of Bitcoin is “whatever people want it to be”, and because humans are herd animals who get greedy when they see other people getting greedy, a surging price can bring in a new wave of retail investors, and turn the pump into a self-fulfilling prophecy. Even Bitcoin insiders, who may be more clued in to what’s going on, have no reason to be upset - they’re getting rich!

Once the price is successfully boosted, Tether is also useful for keeping things that way. If too many people try to cash out at once, Bitfinex can simply print more Tethers, buy Bitcoin with it, and keep the price up. Fortunately for them, many people who are actually investing into Bitcoin with real money are doing it because they believe it in over the long run. They’ll proudly carry their Bitcoin bags, and aren’t going to give up and sell on this week’s news.

Crypto markets can be too opaque and complex to accurately track as they move in real time. But for smart people who know what they’re looking at, you can create pretty good post-hoc reconstructions of what happened. After the bubble burst in early 2018, a lot of people were understandably upset that their paper gains had evaporated. So people started looking for what could be responsible, and that included the connection between Bitcoin and Tether.

John Griffin, a Texas researcher who is well known for uncovering fraud, published a landmark paper last year that asked the key question: was Tether used as a market manipulation tool in the Bitcoin bubble? They certainly thought so, concluding that Tether was overwhelmingly used as an instrument to “push” the crypto ecosystem, rather than being “pulled” by real market demand.

Is Bitcoin really Un-Tethered? | John M Griffin & Amin Shams

Did people know this at the time? Well, to varying degrees, yes and no. At the bottom of the crypto hierarchy, you have the typical bubble buyers: people who see their neighbours getting rich and want in too. They definitely didn’t know. Higher up, you have people who’ve spent time in the crypto ecosystem, have adopted some of the hubris and may have already gotten paper rich. They're now way out over their skis in convincing their peers, and especially themselves, that their paper gains aren’t from luck, but actually because they’re a sophisticated smart person. They’ve probably heard of Tether, but not the whole story.

At the top, you have the real insiders, who are probably aware that crypto prices are routinely manipulated, and may even know some of the people doing it. But here’s the thing: none of these people want the music to stop. Even the insiders’ insiders, at the very top of the pyramid, probably genuinely believe that this market manipulation-y period is just a phase we’ll get through on our way to mainstream, legitimate acceptance of Bitcoin as the new gold standard.

Plus, even if you did know about all of this (as some people did, like @bitfinexed on Twitter, who I’m indebted to for helping us understand everything), it can be really lonely yelling “fraud” when everybody’s too busy getting rich. In a community built around a common dream of building a decentralized, prosperous future, worrying about all of this wealth being systemically exposed to a single, central point of failure won’t get you invited to many parties.

Speaking of single points of failure:

Allegation #2: Tether became a systemically important, money laundering conduit for the crypto ecosystem

But wait! You ask, perceptively. How does Tether get away with passing off their unbacked synthetic dollars as real, actual dollars? How did it become so embedded into the way the crypto exchanges operate? Good question!

Patrick McKenzie wrote a very good explainer of this aspect of the story a few days ago, which you can read here. I encourage you to take the time and read it through. I’ve summarized what I believe are the important points here.

In order for Bitcoins and other cryptocurrencies to have much value in the real world (and, especially, in order for people to speculate on them with real table stakes) you need some way to bring traditional currencies in and out of the system. You need real on-ramps to the world’s financial system; specifically, the US financial system.

If you run a crypto exchange, your customers are gonna want to buy, sell, and hold balances in traditional currency. To do that, you need a partnership with a bank. Annoyingly, banks have some degree of awareness that if they do business with criminals, they will get in trouble. So in order to work with you, banks require that you follow some rules, like KYC/AML compliance, which is fine in the real world but hard for anonymous online digital crypto exchanges.

Some of the more reputable exchanges do the hard work and make it happen; that’s why Coinbase asks to see your driver’s license. But many don’t. It goes against the culture: the whole point of cryptocurrency is decentralized, permissionless infrastructure for making transactions; enforcing KYC kinda kills the vibe there. Plus it’s also really hard.

Tether has stepped in as a kind of glue for all of these exchanges to quote, exchange, and hold US Dollar balances for their customers. As banks get more strict about partnering with crypto exchanges, Tether has replaced them, and in doing so, became systemically important to the crypto ecosystem.

An illustration of the flow of Tether to and from many of the largest crypto exchanges through 2018. From the Griffin paper, Page 37.

I wrote about this exactly one year ago, in a long analogy about Pokemon cards. You can go back and read that piece if you want to. The important takeaway is that the customers using these unbanked crypto exchanges don’t know/care that the “Dollars” they’re trading back and forth aren’t really dollars, they’re Tethers.

You can understand the appeal here: Tether gave exchanges a way to have their cake and eat it too. If you’re only doing crypto-to-crypto trades, it’s easy to stay in the dark, but harder to deliver on the core promise of cryptocurrency for many of their users, which is “get me rich”. Tether gives you both, sort of - as long as it doesn’t break, and ideally, if you don’t cash out. Exchanges today freely quote US dollar rates and exchanges, but they don’t really use dollars. Without Tether, those exchanges freeze up.

As a general rule, you should be careful around investments that are easier to enter than exit. As exchanges lose their banking relationships, it gets harder to pull money out; as Tether replaces them, it remains easy to keep doing stuff with that money inside the ecosystem. Tether acts like a monkey trap for the whole system: once your hand is in the jar, Tether gives you this seductive freedom of movement to do whatever you’d like while inside. But it’s hard to leave.

To quickly recap here, we understand how Tether became systemically important to cryptocurrency exchanges by patching their banking problem. We also understand how Bitfinex and their partners took advantage of Tether’s ubiquity, and used the Tether printing press as a way to manipulate the price of Bitcoin and get rich.

Meanwhile - here’s where the story takes a turn in a new direction - Tether has actually found real product-market fit recently. It found a real, non-speculative use case among real customers with a job they needed done. Who might be interested in a conduit between people who have banking licenses and can interface with the real world, and people who don’t have banking licenses and therefore operate in the dark? Money launderers.

You know how people in crypto stubbornly insist that there is real crypto adoption out there in the world, for real financial purposes, just not where you’re looking? Well, they could be right! Millions of dollars (in Tethers) are supposedly crossing the China-Russia border every day, through a network of OTC brokers who use Tether to evade capital controls and fund who-knows-what activity. This is a bona fide use case for cryptocurrency, and for Tether specifically: swapping it back and forth, all day long, between people who maintain balances with each other across international borders, and who might not want report it.

And then there’s the bad stuff.

Meet the next key player in our story: Crypto Capital Corp.

Look, I know Tether and Bitfinex don’t look so great in this story so far. Sure, maybe they propped up the whole cryptocurrency market in the 2017 bubble, and tried to get rich off it. But, I mean, you can kind of understand their point of view: they care about crypto, they want the ecosystem to win, and yeah sure, they want to make a pile of money along the way. Who among us, etc.

They’re not the real bad guys. Crypto Capital Corp are the real bad guys.

Crypto Capital Corp is a shadow bank for criminals. Its president, Ivan Manuel Molina Lee, was arrested a few days ago and is accused of being a part of an international drug cartel and money laundering operation by Interpol and the DEA. Its principal mastermind, Reggie Fowler, was arrested earlier this year in the United States. We don’t know the extent of their business yet, but in order to get those kind of law enforcement agencies to work together, it’s usually because you did some pretty bad things.

If you’re a criminal and you need access to the banking system, CCC does an important job for you. They set up shell companies and numbered accounts at sketchy, low-security banking establishments that don’t ask too many questions, advise you on how to send wire transfers in and out of that institution (helpfully suggesting narratives like “Treasury transfer back to my own account”), and then hold a balance for you in Shadow Bank Land, for you to go use for whatever hidden purposes you want.

I’m sure you’re not surprised to hear that Crypto Capital Corp inevitably became Tether’s bank. That’s when the story takes a turn for the truly ridiculous.

Come back next week for part 2!

What’s left of Condé Nast: Two years after Si Newhouse died (and Graydon Carter left), Anna Wintour and a new CEO map out the future they can afford | Reeves Wiedeman, New York Magazine

A really interesting read about Condé Nast, once (and maybe still, or one day again?) the king of culture, but facing an uphill climb at every angle in the digital age. Also, it included this bit which made me lose it:

Here is an outstanding letter to shareholders about what it looks like when “Tech-enabled” lower-margin real world businesses become publicly traded companies, from GrubHub:

GrubHub letter to shareholders | Matt Maloney & Adam DeWitt

And another widely read piece on the same topic by David Sacks:

The gross margin problem: lessons for “Tech-enabled” startups | David Sacks

Narrative violation:

Social media has not destroyed a generation | Lydia Denworth, Scientific American

And finally, just for fun, here’s a great Twitter thread of one of my absolute favourite annual traditions: Tokyo’s Mundane Halloween Costume Party. Featuring costumes like, “Guy who brought an umbrella, but then it stopped raining”, “Lady who is drinking something hot”, “Lady who can’t find a place to sit at the food court" and “Guy at the glasses store who gets mistaken for staff.”

Have a great week,

Alex