The Central Bank of Crypto

This isn’t some big secret. In a widely circulated 2017 paper, researchers attributed over half of the then-recent rise in Bitcoin’s price to purchases made by a single entity on Bitfinex, a cryptocurrency exchange headquartered in Hong Kong and registered in the Virgin Islands. These purchases were timed to buoy the price of Bitcoin during market downturns in a way that so strongly indicated market manipulation, the authors found it inconceivable that such trading patterns could occur by happenstance.

Critically, these purchases were not made with dollars, but with Tether, another type of cryptocurrency known as a “stablecoin” because its price is pegged to the dollar so that one tether is always worth one dollar. Many offshore cryptocurrency exchanges lack access to traditional banking, presumably because banks deem doing business with them too risky. Bitfinex, which shares a parent company and executive team with Tether Ltd (the issuer of its namesake cryptocurrency), struggled to find US banking partners after Wells Fargo abruptly stopped processing wire transfers between the exchange’s Taiwanese banks and their American customers in 2017 without giving reason.

This was a problem. Without traditional banking relationships for issuing wire transfers, exchanges cannot easily facilitate trades between buyers and sellers on their platforms — someone has to pass cash between buyers and sellers. Stablecoins solve this problem by standing in for actual real dollars. They allow cryptocurrency markets to maintain ample liquidity — the ease with which assets can be converted into cash — without actually having to have cash on hand.

Tether has become integral to the functioning of global crypto markets. The majority of Bitcoin trades are now conducted in Tether, 70 percent by volume. By comparison, only 8 percent of trade volume is conducted in real dollars, with the remainder being other crypto-to-crypto pairs. Many industry skeptics, and even proponents, see this as a systemic risk and ticking time bomb. The whole system relies on traders actually being able to exchange tethers for real cash or — far more commonly in practice — other traditional cryptocurrencies that can be sold for cash on banked exchanges like Coinbase or Gemini, both headquartered in the United States.

Should faith in Tether falter, we could see its peg to the dollar collapse in a flash. This would be a doomsday scenario for crypto markets, with investors holding or trading crypto assets on unbanked exchanges unable to “cash” out, since there was never any cash there to begin with, only stablecoins. This would almost certainly cause a liquidity crisis on banked exchanges as well, as investors rush to cash out their crypto anywhere possible amid cratering prices, and banked exchanges processing far less volume would almost certainly not be able to pick up the slack.

There is no reason to have any faith in Tether. Tether’s peg to the dollar was initially predicated on the claim that the digital currency was fully backed by actual cash reserves — a dollar held in reserve for every tether issued — though this was later shown to be a lie. The company has since continuously revised down claims about how much cash they keep in reserve. Their latest public attestation on the matter, from March of last year, claimed to be holding only 3 percent of their reserves in cash. The rest was held in “cash equivalents,” mostly commercial paper — essentially IOUs from corporations that may or may not exist, given that reputable actors trading in commercial paper don’t appear to be doing any business with Tether.

While even these modest claims about their reserves may be a lie, as Tether has never undergone an external audit, none of this really matters, since Tether’s own terms of service make it clear that they do not guarantee the redemption of their digital tokens for cash. Should the market suddenly lose faith in Tether and exchanges become unable or unwilling to exchange them one for one with dollars or the respective amount of cryptocurrency, Tether accepts no obligation to use whatever reserves they may or may not have to buy back tethers.

And in practice, Tether rarely buys back or “burns” their tokens (sending the tokens to a receive-only wallet so as to remove them from circulation and decrease the supply, in an attempt to raise the price), as one would expect if the purpose was simply to provide market liquidity as claimed. If that were the case, we would expect the overall supply of Tether to closely track daily crypto trading volumes. Exchanges would only keep enough Tether on hand to cover trading volume and presumably sell off or redeem excess Tethers for cash when fewer people are actively trading crypto.

Instead, the Tether supply has been growing exponentially for years, exploding during crypto market bull runs and continuing straight through years-long downturns. There are now over 78 billion tethers in circulation and rising, about 95 percent of which was issued since the latest cryptocurrency bull market started in early 2020.

There is no conceivable universe in which cryptocurrency exchanges should need an exponentially expanding supply of stablecoins to facilitate daily trading. The explosion in stablecoins and the suspicious timing of market buys outlined in the 2017 paper suggest — as a 2019 class-action lawsuit alleges — that iFinex, the parent company of Tether and Bitfinex, is printing tethers from thin air and using them to buy up Bitcoin and other cryptocurrencies in order to create artificial scarcity and drive prices higher.

Tether has effectively become the central bank of crypto. Like central banks, they ensure liquidity in the market and even engage in quantitative easing — the practice of central banks buying up financial assets in order to stimulate the economy and stabilize financial markets. The difference is that central banks, at least in theory, operate in the public good and try to maintain healthy levels of inflation that encourage capital investment. By comparison, private companies issuing stablecoins are indiscriminately inflating cryptocurrency prices so that they can be dumped on unsuspecting investors.

This renders cryptocurrency not merely a bad investment or speculative bubble but something more akin to a decentralized Ponzi scheme. New investors are being lured in under the pretense that speculation is driving prices when market manipulation is doing the heavy lifting.

This can’t go on forever. Unbacked stablecoins can and are being used to inflate the “spot price” — the latest trading price — of cryptocurrencies to levels totally disconnected from reality. But the electricity costs of running and securing blockchains is very real. If cryptocurrency markets cannot keep luring in enough new money to cover the growing costs of mining, the scheme will become unworkable and financially insolvent.

No one knows exactly how this would shake out, but we know that investors will never be able to realize the gains they have made on paper. The cryptocurrency market’s oft-touted $2 trillion market cap, calculated by multiplying existing coins by the latest spot price, is a meaningless figure. Nowhere near that much has actually been invested into cryptocurrencies, and nowhere near that much will ever come out of them.

In fact, investors won’t — on average — be able to cash out for even as much as they put in. Much of that money went to cryptocurrency mining. Recent analysis shows that around $25 billion and growing has already gone to Bitcoin miners, who, by best estimates, are now spending $1 billion just on electricity every month, possibly more.

That money is gone forever, having been converted to carbon and released into the atmosphere — making cryptocurrencies even worse than traditional Ponzi schemes. Most of the money lost in Bernie Madoff’s infamous Ponzi was eventually clawed back and returned to investors. Much of the money put into cryptocurrency, even if courts could trace back tangled webs of semi-anonymous cryptocurrency transactions, can never be recuperated.

Regulatory Failure

Ponzi schemes of this scale typically target other financial firms, banks, elite institutions, and other wealthy investors. Cryptocurrency, by comparison, is the people’s Ponzi. Cryptocurrency exchanges with user-friendly interfaces, as well as financial services companies like Square and PayPal, allow retail investors with few assets and little financial literacy to buy cryptocurrency on their smartphones.

The minimum purchase on Coinbase is only $2. On Robinhood, it’s a buck. A recent Pew survey found that one in three adults under thirty have bought or used cryptocurrency. It is everyday working people who will suffer most when their savings inevitably evaporate overnight.

Regulators and policymakers have been slow to protect the public. Ponzi schemes can remain solvent for years while flying under the radar of law enforcement and regulators. Madoff ran his hedge fund as a Ponzi for at least seventeen years. While the Securities and Exchange Commission (SEC) failed to heed multiple warnings from an industry whistleblower for seven years, regulators acted quickly once Madoff was turned in by his own children. He was, after all, defrauding the wealthy, bankers, celebrities, and elites.

The cryptocurrency Ponzi scheme has its own whistleblowers, but they’re hardly necessary. Tether is built atop and hosted on other public blockchains, predominantly Ethereum and Tron at the moment. Every time Tether prints another round of stablecoins, now by the hundreds of millions or billions at a time (always in suspiciously round numbers), sometimes several times a week, literally anyone can see. There are Twitter bots analyzing cryptocurrency blockchains and posting large or suspicious transfers of new stablecoins that make this as easy as clicking follow. Tether is cooking the books right out in the open. Skeptics have been pointing this out for years, but regulators and policymakers did virtually nothing until cryptocurrency went mainstream and wildly overvalued cryptocurrency companies began posing a risk to traditional financial markets.

Their response is a case of too little too late. The SEC and US Commodity Futures Trading Commission subpoenaed Tether and Bitfinex in 2017. In 2018, the Justice Department launched a broad probe into cryptocurrency price manipulation and quickly homed in on Tether. Tether was ultimately fined $41 million for lying about their reserves, among other wrongdoings, and also settled a suit with the New York attorney general for $18.5 million for the same reason. But these actions are a slap on the wrist given the level of fraud and have not slowed down Tether’s money printer in the least.

Meanwhile, regulators haven’t even tried to stop cryptocurrency from infecting broader financial markets. The SEC let Coinbase go public in April, and several other US-based cryptocurrency exchanges, including Kraken and Gemini, are planning to do the same. The first cryptocurrency futures ETFs have debuted in recent months, giving traditional investors indirect exposure to cryptocurrency by investing in a range of cryptocurrency companies. Fidelity Investments also launched a spot cryptocurrency ETF in Canada that would actually hold cryptocurrencies, which would allow investors to make direct investments in cryptocurrency on the same platform where they manage retirement savings; Fidelity is seeking the green light from US regulators to allow Americans the same direct access.

While a few listed companies, most notably Tesla and MicroStrategy, have taken multibillion-dollar gambles on cryptocurrency with company money, most of these companies are simply offering custodial or transactional services rather than investing into cryptocurrencies themselves. They are operating parasitically, profiting off investments into the crypto Ponzi while rushing toward IPOs before the whole thing collapses.

These companies hold precious little cryptocurrency themselves and thus little risk. Even MicroStrategy, though initially spending $250 million in company money on Bitcoin in August 2020 while the CEO shilled crypto on Twitter, proceeded to raise billions more in repeated rounds of fundraising.

Policymakers have done little to curb any of this. Even those paying attention to problems with unregulated stablecoins seem hell-bent on trying to preserve the wider cryptocurrency industry. A recent report from the Biden administration assesses the risk of stablecoins without investigating their primary role in market manipulation. SEC chair Gary Gensler wants to regulate stablecoins as either securities or money market mutual funds accounts. The STABLE Act, a bill languishing in Congress since last year, would require stablecoins be fully backed and regulate issuers and anyone offering related services.

These efforts are as insufficient as they are misguided. Governments won’t be able to keep unregulated stablecoins from being traded on exchanges operating outside their jurisdiction. Tether is not the only stablecoin game in town. Tether has printed more than $8 billion in stablecoins since November. Meanwhile, South Korean crypto firm Terraform Labs, which few people have even heard of, minted another $8 billion of their own stablecoin (TerraUSD). There are others behaving similarly. Shut these operations down and there’s nothing to stop them or a copycat from setting up shop elsewhere.

The problem extends beyond unregulated exchanges and issuers. Coinbase also has its own stablecoin pegged to the dollar, USDC, managed by partner company Circle, which is also looking to go public with an SPAC deal that would exempt it from the scrutiny of a traditional IPO. There are now 45 billion USDC stablecoins in circulation, most of them issued since 2020, just like with Tether. Coinbase and Circle also lied about their stablecoin being fully backed by cash when in fact reserves are mostly composed of yet more mysterious commercial paper, which is less liquid and far riskier. As Amy Castor, who has long reported on cryptocurrencies, put it, “Despite efforts to distance itself from Tether, Circle is starting to look more and more like a similar scheme, only with a different critter on the wildcat banknotes.”

Ban Them All

Going after fly-by-night stablecoin issuers will devolve into a hopeless game of whack-a-mole. The only real solution is to ban the trade of private cryptocurrencies entirely. We cannot stop foreign actors from issuing unbacked stablecoins and manipulating crypto prices on unregulated exchanges. But we can make it illegal to sell cryptocurrencies on banked exchanges, such as Coinbase, operating entirely legally while they cash people out of the Ponzi scheme.

This would, of course, kill off cryptocurrency almost entirely, relegating it back to an oddity of the tech enthusiast. No one should shed a tear. Cryptocurrencies have virtually no legal use case. They’re great for facilitating ransomware, laundering money, distributing narcotics and child porn, running Ponzi schemes, and… not much else. They fail as currencies due to high transaction costs. They fail as “digital gold” or a “store of value” because they consume ludicrous amounts of energy to run what is essentially a glorified spreadsheet.

China already banned cryptocurrencies entirely, and India and Pakistan are poised to do the same. Other countries have also made moves to prohibit or constrain cryptocurrencies, but Western liberal democracies are notably permissive. This is in no small part due to aggressive industry lobbying, which includes hiring former financial regulators and compliance officers into the industry to influence policymakers.

Among their ranks is Brian Brooks, who was the chief legal officer at Coinbase before serving as acting Comptroller of the Currency in the Trump administration. Now CEO of blockchain mining company Bitfury, which is also purportedly looking to go public, Brooks joined other crypto CEOs to testify before the House in December. Predictably, they oppose meaningful stablecoin regulation, as they understand that it would kill the industry and render their companies worthless.

These people and everyone else in the cryptocurrency industry are complicit in the Ponzi scheme and actively misleading the public. They understand that fraud is the engine driving their industry and fueling their profits — and that is perhaps the most damning indictment of private cryptocurrencies and the industry surrounding them.

The 2008 financial crisis made clear why the financial sector must be brought under public control. Cryptocurrency and “decentralized finance” aren’t special — they’re just more of the same privatization and deregulation masquerading as high-tech “solutions” we’ve seen in other industries. Unregulated, privatized financial markets pose the same risks to the public whether or not they are “on the blockchain.”

In the case of cryptocurrency, regulation is an existential risk precisely because regulatory loopholes and fraud are the only reason the industry appears profitable despite being wholly unproductive and a waste of energy resources. The same applies to private cryptocurrencies as a whole. The longer governments take to ban them, the worse normal people will be hurt.