"This is the start of the mainstream adoption!" crowed Bitcoin enthusiasts across chatrooms and pubs around the world, all apparently saturated in crypto-frenzy.

"This is the beginning of world domination!"

But long time Bitcoin market watchers were wary; market fundamentals hadn't actually changed, supply wasn't dramatically different, so was it really just hysterical demand driving this price rise?

Were mainstream, everyday people actually pouring as many US dollars, euros, Aussie dollars and yen into crypto as the blistering price rise would suggest?

Now fingers have begun pointing at Bitfinex, which has been burning through US dollars at an astonishing pace, despite having no access to a US bank.

Bitfinex has already been hacked twice. Last year, 120,000 Bitcoin (worth around $US72 million at the time, over $US1 billion today) were stolen. The hackers were never identified.

The exchange, in a bid to compensate the irate wallet holders who had lost their stash, issued a new token that would ultimately be called "Tether", insisting they were backed up by US dollars. [Updated Monday, 4 December 2017: see below]

Instead of paying off the hack with the businesses' profits, Bitfinex issued equity.


So, if your Bitcoin had been stolen, you now had the equivalent face value amount in "Tether" tokens, which you could swap for Bitcoin or US dollars on the exchange, which traded at 30 cents on the dollar after the hack.

People were wary, but Bitcoin prices were rising and Bitfinex was treating these new tokens as a proxies for US dollars, so you could swap it for all kinds of crypto-assets and everyone was making money.

But because Bitfinex is the portal where fiat currencies swap to cryptocurrency, they have to deal with banks.

And in March, Wells Fargo, who was handling the US dollar side of things, suddenly suspended transferring wires to Bitfinex's correspondent accounts.

"Not only had the exchange suffered a significant hack and provided "tokens" as recompense, the company was now in a position of being unable to move US dollars in and out, a potential business killer," says Brian Worley, author at CoinReport. "So how does one move dollars around without moving dollars around?"

Many suspect the Bitfinex bosses have allegedly created something like a hawala and are effectively "wash trading".

A hawala is a traditional system of transferring money used in Arab countries and South Asia, whereby the money is paid to an agent who then instructs an associate in the relevant country or area to pay the final recipient.

For example, if Alice wanted to withdraw funds from a Bitcoin exchange, but the exchange has no banking and can't physically send the money, it needs someone else to step in.


Bob wants to deposit money in a Bitcoin exchange, because he'd like to own a Bitcoin, but instead the exchange directs Bob's money to Alice, and credits Bob's account.

But in order to keep covering withdrawals, the exchange needs prices to keep rising.

"No one can say definitively, but the fraud rumours have been circulating for some time," says Emin Gun Sirer, professor of computer science at Cornell University.

Despite losing Wells Fargo's transaction support in March, the exchange is still seeing meteoric rises in what look to be US dollar trades. But rather than seeing actual US dollars pour in, many suspect the exchange of just creating Tether tokens and wash trading them.

Wash trading is a form of market manipulation in which an investor simultaneously sells and buys the same financial instruments to create misleading, artificial activity in the marketplace.

Bitfinex lost its banking capacity on March 23, 2017 when the market cap of its Tether token was around $US44 million.

Since then, the Tether market cap has exploded. With no bona-fide banking, more than $US770 million has poured into the proxy-token which is swapping madly for Bitcoin, which itself has exploded in value.

"There is no transparency on Tether reserves," says Professor Gun Sirer. "But it defies logic that businesses would send millions of dollars to an exchange that has no publicly known correspondent banks."


Last week, Tether Holdings, one of the many companies revealed to have links to offshore law firm Appleby in the Paradise Papers, announced that $US30 million worth of its tokens had been hacked.

"As Tether is the issuer of the [US Dollar] managed asset, we will not redeem any of the stolen tokens, and we are in the process of attempting token recovery to prevent them from entering the broader ecosystem," reads the company's website.

As of Friday afternoon, Tether - this strange US-dollar pegged asset - is still trading on various exchanges around the world, but even the New York Times has questioned whether Bitfinex has the money it says it does.

The rumours and concerns about Bitfinex' operations have not dented Bitcoin's value, which is still hovering at astonishing highs.

"But the golden rule is that if you don't hold the private keys to your bitcoin then it's not your bitcoin," says Chris Mountford, a software engineer at Digital Asset Blockchain, based in Sydney.

"This means that any exchange can operate only to the standards to which they are held by their customers, auditors and regulators. Bitcoin makes no impact on this fact any more than gold does. Is the bitcoin real? Is the gold really in the vault? It's analogous.

"Only when you have the private keys for bitcoin do you truly possess it like gold in your hand."

Those using Tether may be in for quite a shock.


--

[Monday, 4 December]

An earlier version of this story read: "The exchange, in a bid to compensate the irate wallet holders who had lost their stash, issued a new token that would ultimately be called "Tether", insisting they were backed up by US dollars."

Correction:

At the time of the hack in August 2016, Bitfinex seized 36 per cent of all Bitcoin balances it controlled, which represented $US72 million at the time. To compensate those wallet-holders the exchanged issued one token for every dollar they confiscated, which represented one dollar of debt. This token was called the BFX token and was free-floating (not pegged to the US dollar).

According to exchange participants, Bitfinex paid back a small portion of the BFX tokens on a pro-rata basis after the hack, but most of them were redeemed for equity which Bitfinex itself valued. In January 2017, the Bitfinex exchange began issuing Tether tokens, the rate of which matched BFX redemption. The exchange claimed that Tether was backed up directly by US dollars. From January to March, volumes of Tether released onto the exchange increased from 10 million to 45 million.

When the exchange lost its banking relationship with Wells Fargo in March 2017, the rate of Tether printing increased dramatically. In April, the exchange announced all BFX tokens were "paid off" and any outstanding BFX tokens were retired.

Users had converted their BFX tokens to Bitfinex equity or received Tethers in their place.