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Bitcoin criminal probe said to home in on spoofing, manipulation

Nov 20 2018 16:43
Matt Robinson and Tom Schoenberg, Bloomberg

As Bitcoin plunges, the US Justice Department is investigating whether last year’s epic rally was fueled in part by manipulation, with traders driving it up with Tether - a popular but controversial digital token.

While federal prosecutors opened a broad criminal probe into cryptocurrencies months ago, they’ve recently homed in on suspicions that a tangled web involving Bitcoin, Tether and crypto exchange Bitfinex might have been used to illegally move prices, said three people familiar with the matter.

Bitfinex has the same management team as Tether, a Hong Kong-based company that created the namesake cryptocurrency. When new coins come to market, they’re mostly released on Bitfinex.

Some traders - as well as academics - have alleged that these Tethers are used to buy Bitcoin at crucial moments when the value of the more ubiquitous digital token dips. JL van der Velde, the chief executive officer of Tether and Bitfinex, has previously rejected such claims.

Bitfinex’s general counsel, as well as outside lawyers for the exchange and Tether, didn’t respond to phone calls and emails seeking comment.

The Justice Department’s probe adds to an existing inquiry into possible misconduct. Both Tether and Bitfinex received subpoenas last year from the US Commodity Futures Trading Commission, Bloomberg reported in January. The Justice Department and CFTC are coordinating their examinations, the people said.

It couldn’t be determined whether government officials are solely investigating activity that occurred on Bitfinex or if exchange executives are suspected of illegal behavior. Neither the Justice Department nor the CFTC has accused anyone of wrongdoing, and authorities may ultimately conclude that nothing illicit occurred.

Spokeswomen for the Justice Department and CFTC declined to comment.

Cryptocurrencies captured investors’ attention in 2017 with Bitcoin surging to a record high of about $20,000 last December. But it’s been a different story this year as many on Wall Street have concluded the market was a fad. Another factor in Bitcoin falling below $4,225 Tuesday: Scrutiny by government officials, who’ve repeatedly warned that the mostly unregulated industry is likely rife with fraud.

A focus of the Justice Department’s investigation is whether the dramatic rise of digital tokens in recent years was purely driven by actual demand, or was partially fanned on by market tricks. Along with the CFTC, prosecutors have been looking into a number of trading strategies, including spoofing - the illegal practice of flooding the market with fake orders to trick other traders into buying or selling, Bloomberg reported in May.

While not as well known as Bitcoin, Tether is widely used by traders to bet on price moves for other cryptocurrencies. That’s because the token is more stable than other digital coins but remains outside the traditional banking system, making it relatively easy to transfer between different crypto exchanges.

Tether’s stability, and it’s name, comes from the fact that its value is supposed to be tethered to the US dollar. Tether even says that for each digital coin issued, it has $1 in the bank. Some investors have questioned that claim. One reason the CFTC subpoenaed the company was to seek proof that tokens are backed by a reserve of US dollars, Bloomberg reported in June.

Among the issues the Justice Department is examining is how Tether creates new coins and why they enter the market predominantly through Bitfinex, the people said.

The probe follows allegations made in a June paper by University of Texas Professor John Griffin and co-author Amin Shams. Griffin and Shams wrote that trading in Tether shows a pattern of underpinning, and manipulating, Bitcoin.

They claimed that Tether was used to buy Bitcoin at pivotal periods, and that about half of Bitcoin’s 1,400% gain last year was attributable to such transactions. Griffin briefed the CFTC on his findings earlier this year, according to two people with direct knowledge of the matter.

Griffin declined to comment on whether he’s been contacted by government officials.

After Griffin and Shams published their paper, Van der Velde, the Tether and Bitfinex CEO, disputed its findings. He said in a statement that, “Tether issuances cannot be used to prop up the price of Bitcoin or any other coin/token on Bitfinex.”

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