What does a bank run look like in a world without banks? For an industry that on the surface has all the hallmarks of finance, the world of cryptocurrencies is increasingly growing devoid of banks. If you read my diary of a cryptocurrency investor, this is part two; a behind the scenes analysis on how hobbyist support of Storj and Ethereum was inadvertently parlayed into more than 11x gains in real world value.
Like everyone else, at the time I chalked it up to the increasingly mainstream adoption of Bitcoin and other cryptocurrencies. Ethereum was becoming a platform for startup funding via Initial Coin Offerings (ICOs) and was drawing increasing media attention, and with it money. Yet six months on, and cryptocurrency prices continue to rise, despite the ICO craze waning, and an increasing number of people calling “bubble”.
The follow up to my original story began with a recent article published on a hack of a cryptocurrency service called Tether. I would describe Tether as operating similar to a cyber central bank. They take deposits of USD and issue their own US dollar backed tokens, Tethers (USDT). You can take these Tethers to various cryptocurrency exchanges and convert them with much more ease than moving actual US dollars. Within the cryptocurrency circles, Tethers are becoming a convenient safe haven in times of volatility as their value is engineered to be “pegged” against the US dollar. In the hack, $31 million USD is lifted from the Tether treasury, and the company brushes this off casually. In fact, in the following weeks the service continued to issue millions more Tethers.
Suspicious of this activity, I spent a weekend reacquainting myself with the latest news in the world of cryptocurrencies. One online persona, bitfinexed, has compiled a laundry list on Tether, its sister company Bitfinex, and the characters that pull their strings. I’ve been a supporter of cryptocurrencies since 2015, and the transpiring events are gravely concerning. Transposing the events around Tether against my own experiences, I believe that Tether is single-handedly driving the rise in Bitcoin’s price and renewed interest in other alternative cryptocurrencies. Tether appears to be injecting millions of US dollar Tethers (potentially unbacked) into exchanges around the world.
Around March of this year, Bitfinex began reporting problems with their real world banking arrangements. By June, Tether was issuing USDT at a quickening pace. It was around this time that I began selling down my positions in Storj and Ethereum because I couldn’t make sense of the price rises. Both these alternative cryptocurrencies are small players compared to Bitcoin. Their markets have low liquidity and are based around very small trades, which make them easy to manipulate by a well financed trader. Wash trading is often possible at exchanges, which allows traders to buy and sell to themselves at increasingly higher prices to “ramp” up the price in a bid to draw in unwitting investors. In my own experience around that time, it seemed like the market for Storj showed symptoms of this and my actions to progressively sell down my large holdings temporarily put an end to this by intercepting wash trades with my own legitimate sell orders. By the time I had completed my sell down, the Storj market had declined to a lower but less volatile valuation.
Cut to November and Bitcoin is now worth five times as much as before, and the number of Tethers in circulation has ballooned to match. As the real world of finance increasingly distances itself from cryptcurrencies, Tether has stepped in to fill the gaps. It has become the bank of last resort for many bitcoin entrepreneurs, by providing a stable US dollar denominated store of value in an ecosystem full of constant volatility. It would appear that in the cyberscape of blockchains, there is so much faith in technology that trust in the people that run the systems no longer matters.
As long as these digital currencies remain in the realm of enthusiasts and hobbyists, there is no systemic risk to the global economy. In a closed system, Tether can print as much USDT as it likes without affecting real US dollar supply, foreign exchange or inflation rates. In fact, a virtual printing press like Tether might play a critical role in creating a sense of purpose in a deflationary system like Bitcoin, where a lack of inflation and slow adoption creates little incentive or opportunity to spend a Bitcoin. With much bigger asset bubble problems in the real world, governments and regulators have little time to tinker with Bitcoin or Tether.
The looming start of futures trading on Bitcoin only serves to further quarantine the world of cryptocurrencies. Contrary to what many amateur investors believe, futures markets do not draw institutional money into an asset class. Instead they serve to separate commodity pricing from speculative investing, by creating a playground of bets for and against the price of an asset without actually buying or selling the asset. Much like how placing a $1 wager on a horse race doesn’t make your horse run any faster, a dollar going into the futures market will not go anywhere near a Bitcoin. Creating a futures market for Bitcoin could actually draw away any existing institutional investors by creating an mechanism where they can wager on the future price of Bitcoin without ever purchasing, holding or selling a Bitcoin. Investing via futures contracts eliminates the costs and risks of holding Bitcoin directly. Nobody can hack and steal your futures contracts.
Ironically, instead of bringing money into the cryptocurrency ecosystem, a futures market might actually create the best opportunity to generate wealth off of the blockchain and into real world profit. As long as everyone continues to believe that every current and future USDT in circulation will be backed by a real US dollar, Tether can control the price of Bitcoin! The current Tether induced escalation in Bitcoin’s price could be preparation for a very large short contract on Bitcoin that would pay off handsomely in real US dollars if Bitcoin’s price were to suddenly collapse. Given the amount of USDT already spent in the last year buying Bitcoin to support its increasing price, it’s likely that Tether’s sister company, Bitfinex holds a significant quantity of Bitcoins. Whoever controls both Tether and Bitfinex can force Bitcoin’s price in either direction depending on the most profitable futures contracts placed on the market!
It’s sad to think that Bitcoin could become a swindler’s pendulum, milking profit from the futures market while counting down to the day authorities would be forced to intervene. If cryptocurrencies fail to gain legitimacy as a medium of exchange or a store of value, at least there will always be kittens.
UPDATE: It would seem that real world bankers are not sitting idly on the sidelines. They have lodged a protest against the start of the Bitcoin futures market and could severely limit client access to such markets.
UPDATE: Investigations into market manipulation are beginning with several exchanges being subpoenaed by the US Commodity Futures Trading Commission. There are also signs that a criminal investigation into Tether is in progress with the details of subpoenas previously handed to Tether being kept secret.