Why a Bitcoin Crash May Be Imminent

The SEC is not doing their job very well. Back in 2017, we wrote a popular piece titled Why Cannabis Science (CBIS) Should Scare You to Death which was met with a great number of threats and accusations from people who didn’t like the facts we presented and the red flags we raised. Shortly afterwards, we filed a complaint with the SEC for which we received no further follow up.

An SEC complaint filed against CBIS - Credit: Nanalyze
An SEC complaint filed against CBIS – Credit: Nanalyze

It’s a shame that complaint fell on deaf ears. Who knows how many retail investors were fleeced until regulators suspended trading when the company failed to file its financials. We’ve seen dozens of scams on the over-the-counter (OTC) follow a similar path which is why we advise investors to never invest in OTC stocks (with foreign shares being one exception). Today, we’re going to talk about something that should have crypto market participants quaking in their faux leather boots.

The Bullish Bitcoin Thesis

You know how to tell if someone is a vegetarian? They’ll tell you. The same holds true for the cult of crypto that blabs on incessantly about how cryptocurrencies are here to “democratize wealth.” And whenever someone makes that claim (we’re looking at you Robinhood), they’re usually pissing on your feet and telling you it’s raining. As risk-averse investors, we believe that most crypto “assets” have no intrinsic value and are being propped up by greater fools. Good examples include ICOs and NFTs. The extent to which cryptocurrencies are being hyped means that it’s best to stay on the sidelines until we arrive at the “trough of disillusionment.”

The trough of disillusionment. Credit: Wikipedia
Credit: Wikipedia

Right now, we appear to be rapidly approaching the “peak of inflated expectations” for cryptocurrencies, and today’s story provides some convincing proof of that.

Perhaps the most legitimate cryptocurrency out there is bitcoin, and we’ve discussed how ARK Invest made a compelling case for bitcoin acting as digital gold. Around two percent of our assets are in bitcoin at the moment, so we have a reason to be concerned about something that nobody seems to be talking about much – Tether.

I think the Bitcoin ecosystem does have its own […] ticking time bomb demons too, like Tether is one example.

Vitalik Buterin, one of the co-founders of Ethereum

The Story of Tether

What follows is a story that’s almost too incredible to believe. It all starts with what the crypto community calls a “stablecoin,” a cryptocurrency that is pegged to an external reference. Tether is a U.S. dollar stablecoin that is pegged to the U.S. dollar. The amount of tether stablecoins outstanding has soared from $2 billion in February of 2019 to $74 billion today. During this period of growth, the company behind the stablecoin – Tether – assured investors they were holding one dollar for every coin issued. They weren’t.

Bitfinex and Tether recklessly and unlawfully covered-up massive financial losses to keep their scheme going and protect their bottom lines,” said Attorney General James. “Tether’s claims that its virtual currency was fully backed by U.S. dollars at all times was a lie. 

Credit: New Yawk State Attorney General (AG)

Turns out that tether didn’t actually have U.S. dollars backing their stablecoins, something that resulted in the company having to pay a measly $41 million fine. The press release from the New York AG is nothing short of scary and details other findings about how Tether lost $850 million to a shadowy Panamanian firm called Crypto Capital Corp, all because many banks don’t want to do business with Tether.

At this point in time, it’s hard to imagine anyone would need further evidence that Tether’s stablecoins should be avoided like the plague, but crypto traders don’t seem to care. The sort of people who buy digital pictures of rocks propped up by wash trades aren’t easily bothered.

Tether and Commercial Paper

We’ve written before about the appeal of commercial paper as a financial product, but it’s far from a risk-free asset. Look no further than the implosion of Greensill Capital for evidence of that. Yet for whatever reason, nobody seems to be concerned that 44% of the assets backing Tether stablecoins are made up of commercial paper.

Tether Income report. Credit: Tether
Credit: Tether

Anyone Seen Tether’s Billions? was the title of an investigative report by Bloomberg which claimed Tether’s holdings included “billions of dollars of short-term loans to large Chinese companies – something money-market funds avoid.” We don’t link to paywalled pieces, but it had some good bits.

An excerpt of Bloomberg's article which which claimed Tether’s holdings included “billions of dollars of short-term loans to large Chinese companies – something money-market funds avoid.” Credit: Google
Credit: Google

Tether previously stated none of their commercial paper was exposed to China’s Evergrande, and one would certainly hope it’s not. That’s about all the detail we’re provided from the company, along with an assurance that their commercial paper holdings are highly rated according to “multiple rating agencies.”

Tether's assurance their commercial paper holdings are highly rated according to "multiple rating agencies."  Credit: Tether
Credit: Tether

Another curiousity surrounds the duration of the notes they hold. While your average commercial paper note has a duration of 30 days, the type of notes Tether holds are much longer than that.

While your average commercial paper note has a duration of 30 days, the type of notes Tether holds are much longer than that. Credit: Tether
Credit: Tether

In the United States, commercial paper cannot exceed a duration of 270 days without being classified as a security. Tether’s overweighting of long-duration commercial paper implies they’re taking on more risk to get a higher interest rate.

The Federal Reserve will only accept commercial paper as collateral if it has a term of 90 days or less. This increases the demand for commercial paper with terms of 90 days or less, and, therefore, lowers the interest rate that the issuer would otherwise have to pay for the same term.

Credit: CUCFA.org

Maybe the biggest point of contention right now is Tether’s unwillingness to provide any color on how much commercial paper they’re taking on from the Chinese.

The People Behind Tether

So who are the three main men behind Tether? Folks, if we’ve learned one thing over the years it’s that you don’t criticize people who are making easy money and have billions of dollars readily available to craft their narrative. But if you’d like to do the due diligence yourself, maybe start with a fascinating interview conducted this past July with the CTO of Tether who brought along legal counsel – as one does. CNBC TechCheck’s Deirdre Bosa interviewed Tether’s CTO and General Counsel about the company’s role in crypto and the future of stablecoins and it was an absolute train wreck of an interview.

Deidre pushed hard on trying to understand Tether’s commercial paper holding and largely got nowhere. When pressed on what that commercial paper consists of, Tether said “we don’t disclose our commercial partners.” With some critics expressing concern over Tether’s exposure to risky commercial paper in China, it was an opportunity for the company to put that concern to rest. The below chart shows how bitcoin and tether’s rise – both of which are highly correlated – also seem to coincide with a jump in Chinese commercial paper.

Chinese Commercial Paper size vs BTC and Tether Market Cap. Credit: Coindesk
Credit: CoinDesk

When pressed on their exposure to China, Tether only said they have “international exposure,” and wouldn’t provide any further details when pressed. When asked about who rates their commercial paper, they first started to say S&P and then quickly corrected that to “multiple rating agencies.”

Tether talks about being leaders in transparency, then says that the CEO and CFO aren’t available for media interviews because they’re too busy. The whole interview is extremely awkward with evasive answers and carefully crafted words.

  • Deirdre: Did you say that no one has ever had any issue redeeming tether for U.S. dollars?
  • General Counsel: That’s exac… well, we have never refused a redemption by a Tether customer. That’s what I said.

They’re “working towards getting” a financial audit. The interviewer asks why none of the people at CNBC have heard of Tether even though they’re one of the top-10 commercial paper holders in the world, and the explanation is that multiple intermediaries are involved. When pressed, one bank is mentioned – Deltec Bank & Trust in the Bahamas. What isn’t touched on in the interview is the relationship between Tether and Bitfinex, one of the ten largest crypto exchanges in the world.

Bitfinex and Tether Deceived Clients and Market by Overstating Reserves,
Hiding Approximately $850 Million in Losses Around the Globe

Credit: New Yawk State AG

The CTO/CFO/CEO of Tether also happen to be the CTO/CFO/CEO of Bitfinex, and questions have been raised about how the printing of Tether might be correlated to the rising bitcoin price. Furthermore, allegations have been made that Tether has been manipulating the price of bitcoin over time. There’s an entire rabbit hole that one might go down next, but we’ve seen enough. The Feds have decided to step in, and if Tether is a house of cards, it’s going to come crashing down soon. Maybe.

Why a Bitcoin Crash May Be Imminent

The entire cryptocurrency infrastructure depends on tether to function. Just over half of all bitcoin trades against stablecoin tether (USDT), according to data from CryptoCompare. They’re the most popular stablecoins based on market cap and 24-hour volume. That’s why regulators have become increasingly concerned over the systemic risks that stablecoins present to not just the cryptocurrency community, but the entire U.S. financial system. This past July, Janet Yellen summoned key regulators because “Tether had gotten so large that it threatened to put the U.S. financial system at risk,” per the aforementioned Bloomberg piece. On November 23rd, the U.S. Senate Committee on Banking, Housing, and Urban sent a letter to Tether – along with other stablecoin providers – with a list of questions to be responded to by December 3rd.

Given what we know so far, a quarterly assurance attestation from an independent accounting firm in the Cayman Islands is not sufficient due diligence regarding the $74 billion in assets behind Tether. There’s also a curious relationship between Tether and the price of bitcoin, something that’s been elaborated upon by academics and pundits alike.

Some might argue that no matter how bad the outcome might be, Tether could simply be replaced by any other pegged digital currency, and we can move on with never-ending price appreciation. But what does this say about the fragility of the entire cryptocurrency world? The trilemma seems to hold true. Cryptocurrencies need to have three qualities – decentralization, security, and scalability – but right now they can only have two. 

Furthermore, there’s a concern around the blatant disregard by thought leaders in the crypto space who recognize the risk but fail to denounce it from the rooftops. Being a crypto enthusiast means you’re not allowed to say bad things about any of the leading cryptocurrencies, something they’ve immortalized with the acronym FUDfear, uncertainty, and doubt. Cryptocurrency trading has experienced a great deal of volatility, but that might pale in comparison to what’s coming.

If the crypto community isn’t sufficiently preparing themselves for Tether’s insolvency, we could see a doomsday-like event in the markets. This includes exchanges halting withdrawals, trading paused, excessive panic and fear, prices plunging as investors rush to get out, new government regulations, and banks even freezing all Bitcoin deposits.

Credit: Mr. Whale

One wonders how buy-the-dip cheerleaders like Nayib Bukele will react when faced with a run on the bank in the crypto market, not to mention the effect this might have on all these bitcoin mining firms popping up. Since we’re largely playing with the house’s money which represents a small percentage of our overall capital, we won’t be losing any sleep over a systemic failure in the cryptocurrency market. If a crypto crash happens, let’s just hope it doesn’t affect the broader financial markets and financial institutions.

Conclusion

Something seems rotten in Denmark. When regulators fear that stablecoins are presenting a systemic risk to the U.S. financial system, one needs to be careful buying the dip. We continue to hold around two percent of our assets in bitcoin in hopes that regulators will quickly move to identify the risks inherent to tether and mitigate them. Maybe the United States Senate will prove to be more effective than the SEC has been in protecting retail investors from investment vehicles that don’t act in their best interests.

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4 thoughts on “Why a Bitcoin Crash May Be Imminent
  1. One of the things to suggest for your crypto position would be to split it into bitcoin and ethereum position. Ethereum may be more resilient in case of bitcoin crash. Eg: ARK was going to reallocate its crypto assets into 60% for bitcoin and 40% for ethereum.

    1. This is an interesting idea, bot not sure of the diversification effect. From Reuters:

      Ether is both highly correlated with bitcoin and more volatile than bitcoin. To borrow the lingo of equity markets, this makes ether a high beta version of bitcoin. When bitcoin prices rise, ether prices tend to rise more. When bitcoin prices fall, ether prices tend to fall even further.

      We’ve added this to our research queue as a possible future topic. Thank you for the suggestion Stan!

  2. If you expected the SEC to do anything in response to your appeal to them, then you know nothing about the SEC. You’d have a much better chance of getting a response had you contacted the Southeastern Conference offices. The SEC that allegedly regulated the markets is utterly arrogant and useless. Been there. Done that. Will not waste my time with them anymore.

    1. Thank you for the comment Richard. Our own anecdotal evidence on our perceived incompetency of the SEC is all we have to go on and we can’t admit hearsay 😉 Point noted on Southeastern Conference offices.

      We’ve been covering OTC junk companies for over a decade now. Whether the management teams behind these companies were behaving maliciously or were genuinely incompetent didn’t matter. In nearly all cases investors were fleeced. In many cases, these were blatant stock promotions that were ran with impunity.

      For a country that cares so much about protecting the vulnerable and disadvantaged, America does very little to protect the savings of her elderly. It is our parents and grandparents that are being fleeced so we have an obligation to say something. As for Tether, the people who know the problems that exist and choose to ignore them are doing so at their own peril.

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