Things Got Weird for Stablecoin Tether

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Also Uber, Slack and mortgage settlements.

Tether!!

Yesterday evening, the Office of the Attorney General of New York State announced an absolutely bananas lawsuit against Bitfinex and Tether. Bitfinex is a cryptocurrency exchange, and Tether, “which is owned by the same small group of insiders that own and operate Bitfinex,” is the issuer of a cryptocurrency also called Tether (or USDT). That cryptocurrency is a “stablecoin,” meaning that one Tether is supposed to be worth exactly one U.S. dollar, a ratio that is maintained, Tether claims, by keeping one dollar in a bank account for each Tether that it issues. People have for a long time had doubts about those claims, because Tether never got around to releasing audited financial statements proving that it had the dollars.

The New York attorney general’s filing refutes the extreme version of those doubts — Tether mostly had the dollars — but it is nonetheless a wild ride that alleges that Tether’s backing might not be as good as it claims. Here are the attorney general’s memorandum of lawsupporting statement, which I read last night with growing amazement. 1  But when I got to these two paragraphs I felt dizzy and had to lie down. This is heady stuff:

During November 2018, Tether transferred $625 million held in its account at Deltec to Bitfinex’s account at Deltec. Bitfinex, in turn, caused a total of $625 million to be transferred from Bitfinex’s account at Crypto Capital to Tether’s account at Crypto Capital, through a LEDGER entry at Crypto Capital crediting Tether’s account in the amount of $625 million and debiting Bitfinex’s account by a corresponding amount. The purpose of this exchange was to allow Bitfinex to address liquidity issues unrelated to tethers.

In or about late December 2018, the Companies and their counsel developed concerns about the availability of some of the funds at Crypto Capital, totaling over $850 million. While Crypto Capital’s principals have represented that the unavailable funds have been seized or otherwise restrained by governmental authorities in Poland, Portugal, and the United States, the Companies grew concerned that Crypto Capital’s principals may be engaged in a fraud.

I am quoting from the attorney general’s office’s supporting statement, but are quoting, here, a letter from Bitfinex’s and Tether’s lawyers. This is Bitfinex’s and Tether’s own version of events, and it is madness.

Do you see the madness? It might be better to read the second paragraph first. The second paragraph is where Bitfinex and Tether start to worry that Crypto Capital might be doing fraud. Crypto Capital Corp. is “a (believed to be) Panamanian entity” that Bitfinex used as a payment processor to transfer money to and from its customers. The business of a cryptocurrency exchange is to let customers turn their dollars (or other regular currency) into Bitcoins (or other cryptocurrency), but it is not exactly easy, for a lightly-regulated cryptocurrency exchange, to take dollars from customers, or to send dollars back to them. A lot of banks are hesitant to work with crypto exchanges. And so Bitfinex ended up using, not a big regular bank, but Crypto Capital as its payment processor. “By 2018,” says the attorney general, “Bitfinex had placed over one billion dollars of co-mingled customer and corporate funds with Crypto Capital.” Also, allegedly, “no contract or similar written agreement was ever entered into between Crypto Capital and Bitfinex or Tether,” okay! Okay! Okay! 

At some point Crypto Capital stopped giving the money back. According to the Attorney General’s complaint that point came in mid-2018, when Bitfinex started sending frantic requests to Crypto Capital asking it to maybe process some payments. (“The communication logs made clear that Bitfinex knew at the time that Crypto Capital’s inability or unwillingness to return any of the funds made it impossible for Bitfinex to honor its client’s withdrawal requests,” says the memorandum of law. 2 ) According to Bitfinex’s and Tether’s lawyers, it was only “in or about late December 2018” that they “developed concerns” about the money at Crypto Capital.

The first paragraph is where Bitfinex takes $625 million from Tether’s bank account — because, the attorney general alleges, it needed the money to meet redemptions and couldn’t get it from Crypto Capital. Now, again, many people doubted that Tether actually had dollars in its bank account. Part of the problem is that, again, a lot of banks are hesitant to work with lightly-regulated crypto issuers, or to admit that they’re doing so. But in fact Tether have the money, at a real bank, and at this point that bank was Deltec Bank & Trust Ltd. in the Bahamas. And then in November 2018 it gave $625 million of that money to Bitfinex “to address liquidity issues.”

Now, that’s an awkward thing to do. The point of the backed stablecoin is that the dollars are supposed to be in the stablecoin’s bank account. It’s not good to transfer them to an affiliated cryptocurrency exchange: That means that the dollars are no longer there to back the stablecoin. 3 It’s okay though! It’s no problem! Bitfinex gave Tether the money right back: It moved $625 million from Tether’s Deltec bank account into Bitfinex’s, but it simultaneously transferred $625 million back from Bitfinex’s Crypto Capital account into Tether’s. Bitfinex didn’t $625 million; it exchanged one $625 million for another $625 million.

Except that they only did this transaction because Bitfinex couldn’t get its money out of Crypto Capital! A month later, according to Bitfinex’s and Tether’s lawyers, they started to worry that the money at Crypto Capital had maybe already been stolen, and that the $625 million that Bitfinex transferred to Tether in their Crypto Capital accounts might be worthless. A month later! As I put it on Twitter, “Bitfinex took $625 million in real money at a real bank from Tether, and in exchange gave Tether back $625 million in fake money at a fake bank.” Or as the attorney general’s office

That “credit” was illusory, though, since Bitfinex knew at the time that Crypto Capital was refusing or unable to process withdrawals or return funds. In effect, in November 2018 Respondents fraudulently shifted most or all of Bitfinex’s risk of loss of several hundred million dollars onto Tether’s balance sheet, but continued to represent to the market that tethers were fully “backed” by U.S. dollars sitting safely in a bank account. They were not. 

Now, to be fair, Bitfinex and Tether deny that the money at Crypto Capital was stolen. Bitfinex put out a statement this morning saying that “the New York Attorney General’s court filings were written in bad faith and are riddled with false assertions, including as to a purported $850 million ‘loss’ at Crypto Capital”:

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. 

Also, to be fair, after they “grew concerned” about Crypto Capital in December, Bitfinex and Tether re-papered this transaction, reversing the $625 million Crypto Capital transfer and instead characterizing the money that Bitfinex took from Tether as a loan (that Bitfinex will have to pay back with real money rather than with a ledger entry at Crypto Capital). On the other hand they also expanded the size of the loan to let Bitfinex take even more money from Tether. Again quoting the attorney general’s office quoting Bitfinex’s and Tether’s lawyers:

Bitfinex immediately undertook negotiations with Tether on an agreement under which Tether extended a secured, revolving line of credit of up to $900 million on commercially reasonable terms (including a term of three years and an interest rate of 6.5% in outstanding loans under the facility), documented in a loan facility negotiated between the two companies at arm’s length with the benefit of separate counsel and approved as required by each company’s corporate governance processes. Under this transaction, the line of credit is secured by a share charge over 60,000,000 iFinex Inc. shares owned by DigFinex, which DigFinex agreed not to otherwise encumber. That transaction closed on or about March 19, 2019. The total accessed under the loan facility as of today’s date is equal to $700 million. 

DigFinex and iFinex are some of the entities that run Bitfinex, meaning that the loan is secured only by shares in the owners of Bitfinex, not by hard assets worth $700 or $900 million. The attorney general’s office is entirely unimpressed by this loan:

As described by counsel, Bitfinex would take a “line of credit” of $600 to $700 million on the reserve funds backing tethers. Counsel did not suggest what, if any, benefit would accrue to Tether, or holders of tethers, from this transaction. Nor did counsel suggest that this transaction would be disclosed to the public, including investors trading on the Bitfinex platform or holders of tether.

When asked by attorneys for OAG whether the contemplated transaction would constitute a conflict of interest (given that Bitfinex and Tether are owned and operated by the same people), counsel characterized the impending transaction as “arm’s length” without providing justification for how that could be the case. 

It is all arguable, I suppose, but it is not . Saying “our stablecoin is backed one-for-one by U.S. dollars in a bank” is not quite the same as saying “our stablecoin is backed by an equal notional amount of three-year dollar-denominated loans to our affiliated crypto exchange, much of whose cash is currently frozen.” If everyone redeemed their Tethers today, it is not clear how Tether would come up with the money: Its loan to Bitfinex is not due yet, and I’m not sure that it would fetch its full face value on the open market.

Tether was trading at about $0.9926 as of 10:30 a.m. today, by the way, within 1 percent of dollar parity, suggesting that, for Tether holders, backing by a big loan to Bitfinex really is about as good as backing by immediately available dollars. I know nothing! (Bitcoin, on the other hand, had a bigger fall, as there is a widespread view that issuance of Tether is an important driver of demand for Bitcoin.)

What are the lessons here? So many! Here are a few suggestions. First, the Securities and Exchange Commission is absolutely right to want to treat most crypto projects as securities and push them to provide public-company-like levels of disclosure and governance. You can’t just casually lose access to $850 million of customer money, keep it secret, and then quietly lend yourself a big heap of restricted cash from an affiliate if you have quarterly audited financial statements and independent directors. 

Second, never mind public companies, stablecoin issuers are kind of like , and should perhaps have similarly strict customer-protection regulations. We talk sometimes about how cryptocurrency investors are constantly rediscovering all of financial history; this might be the part where — well, Emin Gun Sirer tweeted, “I believe you’re about to invent Glass-Steagall

At the same time, though, there is a dark side to regulation here. Reading the attorney general’s filings you get the sense that Bitfinex’s and Tether’s hearts were more or less in the right place, that they were honestly trying to run a good crypto exchange and a good, dollar-for-dollar-backed stablecoin. But they needed someone to handle payments for them, and they couldn’t get a normal bank to do it, because regulators have made most normal banks afraid to get involved with crypto companies. And so they got a … less-normal bank … to do their payments, and then their money … went to a strange place. (Possibly “lost,” possibly “seized and safeguarded,” but strange anyway.) And then they went to strange places to continue operating while their money sat in limbo. In some (very tendentious) sense it is the fault of regulators — regulators in the U.S. who make it difficult for crypto exchanges to do business with regular investors, regulators around the world who make it difficult for banks to do business with crypto exchanges, regulators in Poland and Portugal who may or may not have seized some of Crypto Capital’s money — that Bitfinex and Tether find themselves in this pickle. It is a perennial problem in financial regulation: The higher your standards are for regulated activity, the more activity you push to the unregulated shadows. And then bad things happen in the shadows.

the deal

Uber Technologies Inc. is seeking to raise as much as $9 billion in an initial public offering that could give the ride-hailing giant a market valuation of as much as $84 billion.

The No. 1 ride-hailing company plans to offer 180 million shares at $44 to $50 each, according to a regulatory filing Friday. The filing puts Uber on track to make its trading debut in May on the New York Stock Exchange in what is expected to be the year’s biggest U.S. IPO.

At the top of the range the listing would value Uber at almost $84 billion, based on the number of shares outstanding after the offering, as detailed in the filing. On a fully diluted basis, including the addition of stock options, restricted shares or other stakes not included in the outstanding total, the valuation could top $91.5 billion.

Let’s call it $91.5 billion at the high end, which is meaningfully less than the $100 billion number that was informally thrown around when Uber first filed its IPO prospectus, which in turn was meaningfully less than the $120 billion number that was thrown around when banks were pitching Uber to go public last October. When number was being thrown around,

You know, those valuation proposals are free. You can just type a number in them. It’s not like Goldman or Morgan Stanley made a binding bid to pay $120 billion for Uber. Obviously the number needs to be supported by some plausible logic, but in general the higher the number you type into the presentation, the more likely Uber is (1) to be excited about going public and (2) to want to hire you to do the IPO. (“They must really understand our story if they think it’s worth $120 billion!”) Much of the skill of being a capital markets banker is in typing in a very high number in those initial presentations in order to win the mandate, and then imperceptibly walking it back so that by the time the IPO actually prices the client is satisfied, even if the price is much lower.

With a deal as high-profile as Uber’s, it’s pretty hard to imperceptibly walk back the price, but they are walking it back anyway. Obviously there are reasons! Lyft Inc. has gone public and has not traded particularly well; there has been a rush of unicorn IPOs; Uber keeps losing money and facing competitive pressures. Uber’s bankers can definitely tell Uber with a straight face “we told you $120 billion back in October but the facts have changed since then.” For , this is working out fine.

Anyway the Uber roadshow starts tomorrow and from now on, with any luck, the bankers’ job will be to walk the price back . The ideal path of an IPO is to launch the roadshow with some price range, raise the price range in the middle of the roadshow due to strong demand, price the IPO at the top of the revised price range, have the stock open for trading at a moderately higher price than the IPO price, and then have it trade solidly up from there. Pure perfection would be if Uber moves the range to $52 to $54, prices at $54, opens at $60 and closes at $66 on its first day of trading. (Incidentally that would mean pricing the IPO at just a hair under $100 billion, and ending its first day of trading at about $120 billion.)

Or, I mean, I say that because I am a former capital markets banker and that is the aesthetic sensibility that one develops in that job. It doesn’t really matter that much. Like if Uber prices at $57, opens at $55, closes at $51 on its first day, and then over the course of its first six months as a public company rallies inexorably to $80, then capital markets bankers will sort of wince at the artlessness of the pricing, but as a matter of corporate finance it will be absolutely fine. The IPO price matters, somewhat, because the higher it is the more money Uber will raise in the IPO; the long-term valuation matters, somewhat, because the higher it is the richer Uber’s investors will be; the actual path of prices in the next few weeks is just something for us to talk about. Still it really is a thing that people love to talk about

The rocky start created pressure for Uber to be conservative in its pricing, and avoid “breaking” — or falling below — its I.P.O. price, said Kathleen Smith, a principal at Renaissance Capital, which provides institutional research and I.P.O. exchange-traded funds.

“Lyft acts as a very important valuation benchmark for Uber,” she said. “Uber cannot break its I.P.O. price. The best way to avoid breaking your I.P.O. price is to be conservative when you start out with your valuation.”

Look, again, I share this aesthetic sensibility, but as a practical matter it is just not true. “Uber cannot break its IPO price”? Sure it can. Lyft did — it fell below its IPO price on its second day of trading, and closed yesterday 22 percent below the IPO price — and it is not bankrupt. Its executives are not in . Nothing all that bad happened to it except that it is a $16 billion company instead of a $20 billion one. Its early investors are still sitting on big gains. People who bought in the IPO (including some drivers who were given a special opportunity to do so, oops) and held their stock have lost money, but, you know, people lose money in the stock market sometimes. Lyft’s aggressive pricing on its IPO, and the subsequent decline in its stock price, were bad for Uber, because investors are probably more cautious about buying into big ride-sharing IPOs, but if Uber repeats those mistakes that will primarily be bad for the big unicorn to go public. Uber will already have the money.

Also this is a little weird, from Uber’s revised prospectus filed this morning:

In April 2019, we entered into a stock purchase agreement with PayPal, Inc. (“PayPal”), pursuant to which PayPal will purchase $500 million of our common stock from us in a private placement at a price per share equal to the initial public offering price. ... Concurrently, and subject to the closing of the private placement, we and PayPal extended our global partnership through the execution of an addendum to our existing commercial agreement. We and PayPal intend to explore future commercial payment collaborations, including the development of our digital wallet.

You can certainly see the logic. PayPal gets to invest in Uber at the IPO price and with a guaranteed allocation: Instead of (having to set up an account with a bank and) putting in an order for shares that might be cut back by the banks in the IPO, PayPal gets a guaranteed $500 million chunk. Uber gets more money, which it seems to want, plus it further cements its commercial ties etc. Also it doesn’t pay the underwriting fees on PayPal’s $500 million. Maybe it’s a little weird that more investors and companies don’t cut side deals like this.

By the way the underwriting fee appears to be 1 percent, 4 or about $90 million for the banks at the top of the marketing range. 

Meanwhile Slack Technologies Inc. also filed its highly anticipated IPO prospectus this morning. Well, Slack is not doing an IPO. But it turns out that, for fairly technical reasons, if you are going public in the U.S. via a direct listing, you nonetheless have to file an IPO prospectus. (So that your private shareholders are legally allowed to sell their shares, basically.) Obviously this is helpful as it gives the public information about, for instance, Slack’s financial results, and its dual-class voting structure, and the prices at which its shares have traded in the private market.

It is also interesting in that it has a little explanation of how Slack’s IPO will work. I mean, again, not IPO. But just as an IPO involves a company’s banks lining up bids for the stock from potential investors, and setting a price that balances that demand with the supply coming from the company and its early investors, a direct listing also involves someone lining up bids from potential investors and finding a price that balances that demand with the supply coming from early investors. From Slack’s “Plan of Distribution

The DMM [designated market maker], acting pursuant to its obligations under the rules of the NYSE, is responsible for facilitating an orderly market for our Class A common stock. Based on information provided to the NYSE, the opening public price of our Class A common stock on the NYSE will be determined by buy and sell orders collected by the NYSE from various broker-dealers and will be set based on the DMM’s determination of where buy orders can be matched with sell orders at a single price. On the NYSE, buy orders priced equal to or higher than the opening public price and sell orders priced lower than or equal to the opening public price will participate in that opening trade. In accordance with NYSE rules because there has not been a recent sustained history of trading in our common stock in a private placement market prior to listing, the DMM will consult with Morgan Stanley and our other financial advisors, in order for the DMM to effect a fair and orderly opening of our Class A common stock on the NYSE, without coordination with us, consistent with the federal securities laws in connection with our direct listing. Pursuant to such NYSE rules, and based upon information known to it at that time, Morgan Stanley and our other financial advisors are expected to provide input to the DMM regarding their understanding of the ownership of our outstanding common stock and pre-listing selling and buying interest in our Class A common stock that they become aware of from potential investors and holders of our Class A common stock, including after consultation with certain institutional investors (which may include certain of the Registered Holders, other than the RSU holders), in each case, without coordination with us. The DMM, in consultation with Morgan Stanley and our other financial advisors, is also expected to consider the information in the section titled “Sale Price History of our Capital Stock.”

There is a sense of a sort of shadow-bookbuilding process: Slack’s banks are not underwriting an IPO, they’re not marketing stock to potential investors on behalf of Slack and its existing investors. But they are having chats with the existing private investors in Slack to see what their interest is in selling, and they’re having chats with potential public investors to see what their interest is in buying, and at what price, and those chats are all being relayed to the designated market maker, who will … just take binding bids and offers for the stock and set a price that clears the market? That last part seems pretty mechanical, which makes it not entirely clear why you need the first part, but I guess it is hard to let go of the IPO process entirely.

Mortgages

When do you think the last bank will pay the last fine for mortgage-related misconduct leading up to the 2008 financial crisis? The statute of limitations ran out some time ago and they keep going, so that can’t limit your answer. It seems entirely plausible to me that there will be an infinite tail of mortgage settlements, that they’ll get fewer and smaller as we move away from the peak but never go away entirely, that in 3246 the Senior Enforcement Robot for Continent 3 will settle a 2006-vintage mortgage action with Deutsche Robinhood for 20 million yuan, and the Money Stuff algorithm will note that it’s the first such settlement since 3213. Certainly there has been a steady continuo of mortgage fines throughout my entire career as a financial writer, and I have come to find them sort of comforting, a reassuring source of stability in this crazy world.

The latest reckoning came on Thursday, when Morgan Stanley agreed to pay $150 million to settle claims by the State of California that it misled investors about the risks of mortgage-backed securities sold to two state pension funds for teachers and public employees.

The case was the last remaining government lawsuit against the bank over issues related to the financial crisis, according to Mark Lake, a spokesman for Morgan Stanley. In the agreement, which included no admission of wrongdoing, Morgan Stanley denied the state’s accusations.

The last, okay.

Things happen

Cantor Fitzgerald Doesn’t Want This Woman Talking About Her Mug in Court. Buffett Preps Berkshire Investors for Soaring Stock Buybacks. Losses deepen at Deutsche’s struggling investment bank. Deutsche Bank Is Fined $500,000 by SEC Over Hedge Fund Disclosures. Venezuela’s Trade Scheme With Turkey Is Enriching a Mysterious Maduro Crony. Hedge fund managers for Universal Basic Income. Wall Street Nears a Big Win in the Latest Revamp of Volcker Rule. Renault to Propose Merging With Nissan. No More Happy Hour: Japan Bank Boss Takes Aim at Drinks Culture. ‘Anna Delvey,’ Fake Heiress Who Swindled N.Y.’s Elite, Is Found Guilty. Cultural Cartography. “Another friend, Jaime, has always liked the idea of being a tree, but wouldn’t want to use soil from a loved one to grow something.” A man was fined for stealing Gerhard Richter’s trash after a judge appraised it at €60,000. 

If you’d like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters . Thanks!

  1. the docket with the exhibits, etc.

  2. The supporting statement adds: “In communication logs produced to OAG covering the period or April 2018 to early 2019, a senior Bitfinex executive (‘Merlin’) repeatedly beseeched an individual at Crypto Capital (‘Oz’) to return Bitfinex’s funds. For example, in August 2018, the senior Bitfinex executive made clear that lack of access to the money held by Crypto Capital made it impossible for Bitfinex to honor its client’s withdrawal requests.” I DON’T KNOW WHY THESE PEOPLE ARE NAMED MERLIN AND OZ, EVERYTHING IS INSANE.

  3. One thing perhaps worth noting here is that a lot of Tether owners probably acquired their Tethers through Bitfinex, so in a sense the money backing Tether came from Bitfinex. A sympathetic view of all of this would be: Look, all of the money held by Tether and Bitfinex at Crypto Capital or Deltec or anywhere else was all there to back customer claims, either customer accounts at Bitfinex or USDT/dollar parity at Tether, and it’s all basically the same set of customers, so shifting money from Tether to Bitfinex to pay the more urgent customer claims is fine, especially if you think you’ll eventually be able to recover or make up for the lost money at Crypto Capital. The attorney general’s view — which I think is clearly correct — is, no, if you go around saying that Tether is fully backed by dollars it needs to be fully backed by dollars, and you can’t — in her words— “treat Tether’s cash reserves as Bitfinex’s corporate slush fund” or use them “to hide Bitfinex’s massive, undisclosed losses and inability to handle customer withdrawals.”

  4. You can tell because Uber is offering 180 million shares, and in its “Use of Proceeds” section it says that “Each $1.00 increase (decrease) in the assumed initial public offering price of $47.00 per share would increase (decrease) the net proceeds to us from this offering by approximately $178.2 million, assuming the number of shares of common stock offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.” If you net $178.2 million from increasing the price of 180 million shares by a dollar, that means you’re paying $1.8 million in fees for every $180 million you raise, or 1 percent.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:

Matt Levine[email protected]

To contact the editor responsible for this story:

James Greiff [email protected]

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