Is the Bitcoin Comeback for Real?

Illustration by II

Illustration by II

“It’s pretty much uncontroversial that some crypto trading is manipulated.”

The collapse of Silicon Valley Bank on Friday, March 10, threatened to leave many startups in a perilous financial position. But few had more at stake than Circle Internet Financial Ltd., the venture-capital-backed crypto company whose role in the digital ecosystem was as an issuer of the most trusted stablecoin, USD Coin, or USDC.

Stablecoins are akin to poker chips that can be used to buy and sell crypto. Because they were originally 100 percent backed by dollar equivalents like Treasury bills, they could trade at parity with the dollar. The problem for Circle: $3.3 billion of its cash reserves were stuck in an account at SVB, which had just been seized by the Federal Deposit Insurance Corp. The lack of cash led USDC to lose its peg to the dollar, and by the next morning — a Saturday — it traded as low as 87 cents.

Circle’s banking problems didn’t start or end with SVB. The stablecoin issuer also had previously banked at California-based Silvergate Bank and New York-based Signature Bank — two banks whose internal blockchain trading networks had facilitated the crypto boom. Both banks are now gone, as are their trading networks. A significant portion of the assets of Signature, also seized by the FDIC, was bought by New York Community Bank, but its remaining $4 billion in crypto assets were not part of the deal. Silvergate is winding down operations, and it and Signature are under investigation by the U.S. Department of Justice and other authorities, suspected of facilitating money laundering amid a lack of proper oversight.

The demise of these three banks cut off the crypto world’s predominant access to the U.S. banking system, leaving investors shaken. Almost immediately, Bitcoin slipped below the $20,000 floor it had established after falling over the past year following a cascade of debacles: the demise of stablecoin issuer Terraform Labs, the liquidation of crypto hedge fund Three Arrows Capital, the high-profile bankruptcies of Voyager Digital and Celsius Network, and finally the ignominious end to Sam Bankman-Fried’s allegedly fraudulent FTX crypto empire.

But despite all these headwinds, something strange happened. Bitcoin began to rally. It’s now up 35 percent since the SVB collapse, and the crypto faithful say it’s just more proof that the lack of trust in government institutions that led to Bitcoin’s birth following the 2008 financial crisis is alive and well.

“Bitcoin is a report card on monetary policy and financial stability. In other words, it was built for these times,” Mike Novogratz, CEO of crypto firm Galaxy Digital and one of crypto’s most influential boosters, tweeted on March 23. “On a risk-adjusted basis, [Bitcoin] is the best-performing asset of the year, outpacing growth stocks, banks, and major stock benchmarks.” (Bitcoin is still down more than 50 percent from its peak in November 2021.)

Novogratz later called the banking crisis “an adrenaline shot” for crypto.

That crisis clearly has been a boost to the Bitcoin bulls. “The story right now is banks are in trouble,” explains Molly White, a fellow at the Harvard Library Innovation Lab who is researching cryptocurrencies and the blockchain. Other U.S. banks have been looking vulnerable, as have European banks following the Swiss-government-backed rescue of Credit Suisse by UBS. For the Bitcoin “maximalists” — those who White says believe the banking system is near collapse and hyperinflation is coming — “the way to protect yourself is by buying Bitcoin; taking your savings account, withdrawing that cash, using it to buy Bitcoin, and that will protect you.” It is the same narrative that propelled Bitcoin in the first place — despite there being no evidence to support it, she says.

In fact, much of the evidence points to something more nefarious. “It’s pretty much uncontroversial that some crypto trading is manipulated,” says White, who was named one of crypto’s most influential people by CoinDesk in 2022. “The question really is just how much.”

The recent surge in Bitcoin’s price came as no surprise to John Griffin, a finance professor at the McCombs School of Business at the University of Texas at Austin. “You should not look at the price of Bitcoin as a real market-based price that means much,” he told Institutional Investor in a recent interview.

Griffin and Amin Shams, a former student of Griffin’s and now an assistant professor of finance at the Ohio State University Fisher College of Business, studied the Bitcoin market for a paper first published in June 2018 titled “Is Bitcoin Really Untethered?” They concluded that its price was manipulated by the issuance of Tether, or USDT, which is the dominant stablecoin — and one that appears to have benefited from the recent crypto banking crisis. (Since the collapse of SVB, USDT’s market cap has jumped $10 billion to $81 billion, while Circle’s USDC has slid to $31 billion from $42 billion.)

As the professors explained in the paper, Tether is used for more Bitcoin transaction dollars than the U.S. dollar, precisely because most Bitcoin transactions cannot be done through a U.S. bank account. They said that necessitates the use of a stablecoin to allow for “dollar-like transactions without a banking connection.”

At times, Tether too has struggled to find a U.S. banking connection, but it has still managed to thrive, which critics view suspiciously. Looking at some of the largest purchases of Bitcoin with Tether from March 2017 to March 2018, the professors said the data indicated that Tether was “being printed unbacked and pushed out onto the market, which can have an inflationary effect.”

“While we expect that there are some sources of legitimate demand for Tether, they do not appear to dominate the Tether flow patterns observed in the data,” they added. The professors concluded that this potential manipulation of Bitcoin accounted for as much as half of Bitcoin’s price gains during this period. Bitcoin has always been volatile, and when Bitcoin’s price would fall, Tether’s sister company, the Bitfinex exchange, would use Tether to buy Bitcoin, keeping the price artificially high, according to the professors. (They did not name the individual buyer behind the Bitfinex trades.)

Tether Holdings, which is headquartered in the British Virgin Islands, has since been mired in controversy. (Its reclusive CEO, Dutch native Jean-Louis van der Velde, has a history of business failure and lawsuits in China, according to the Financial Times.) Along with Bitfinex, Tether has been under investigation by the DOJ since 2018 for manipulating the price of Bitcoin. It also reportedly has been used by terrorists laundering their cash, and recently Transparency International found that it was helping Russians evade sanctions that have prohibited them from using Western banks.

Bitcoin entered a prolonged bear market in 2018, with its value falling by almost half during what’s been called the first crypto winter. Some investors say Tether was to blame. “The disappearance of $265 billion in Bitcoin wealth was the result of Bitfinex and Tether propping and popping the largest bubble in history,” alleged attorneys Kyle Roche, Joseph Delich, and Velvel Freedman in a purported class action against the two companies (and related corporate entities) that was filed in 2019 in the Southern District of New York. “Tether and Bitfinex purchase Bitcoin with fake USDT to draw in momentum investors, then cash out by selling it to them for real U.S. dollars,” the lawsuit alleges. Tether and Bitfinex have denied the allegations, but their efforts to dismiss the suit were unsuccessful, and discovery is proceeding.

In February 2021, Tether settled with the New York attorney general over allegations that it lied about its reserves during a period similar to the one Griffin and Shams analyzed. The New York attorney general found that, at times, the cash simply wasn’t there. Tether and Bitfinex paid an $18.5 million fine and agreed to cease trading with New York residents and entities. Then, in October 2021, Tether and Bitfinex reached a settlement with the Commodity Futures Trading Commission over the lack of adequate reserves, among other issues, between at least June 1, 2016, and February 25, 2019, paying an additional $42.5 million. Tether neither admitted nor denied the allegations.

Both regulators and the professors had concluded that Tether was printing money out of thin air, but neither of the companies nor the popular stablecoin was put out of business. By then, Bitcoin was entering its next bull market, and Tether issuance was booming again.

Tether has since sought to prove its reserves are just fine. For example, in February, accounting firm BDO Italia gave “assurances” about Tether’s reserves as of the end of last year. That report — a snapshot of a point in time — showed that 82 percent of Tether’s reserves were in cash or cash equivalents. The rest included corporate bonds, funds, precious metals, and digital currencies. Tether currently has banking relationships with two Bahamian banks, while Cantor Fitzgerald is a custodian for its Treasury bills.

But Tether’s critics have not been mollified. They say that Tether has never obtained the type of audited financial statements that banks must report and has changed auditors several times, noting that BDO Italia got poor marks from the U.K. accounting regulator last year. Moreover, Tether’s terms of service state that the company is not obligated to redeem USDT for fiat currency, and several investors have reported being unable to get their money back.

Griffin says he has not analyzed recent Tether and Bitcoin trading patterns and blockchain transactions, but notes that “the features that would allow manipulation are still there in the market.” Those features, he says, include “a market that is opaque, largely trades in unregulated offshore exchanges, and is dominated by large, sophisticated players with little oversight.”

One of the most common ways Bitcoin can be manipulated is with a technique called wash trading, which Griffin says is “rampant on these markets.”

Wash trading, a form of market manipulation that’s illegal in the U.S., occurs when an investor simultaneously buys and sells the same financial asset to create artificial activity in the marketplace and push the price up. A 2022 National Bureau of Economic Research study led by Lin William Cong of Cornell University found that an average of more than 70 percent of the trading on unregulated, offshore exchanges was due to wash trades.

The NBER report confirms what others have said. For example, in March 2019, Bitwise Asset Management told the U.S. Securities and Exchange Commission it had found evidence of wash trading at several cryptocurrency exchanges, concluding that 95 percent of the reported Bitcoin trading volume was fake.

“The high trading volume feigned by wash trading exchanges raises their visibility on popular websites that monitor cryptocurrencies markets … and improves their attractiveness to investors who look for maximum liquidity,” a recent analysis by the Blockchain Research Lab in Hamburg, Germany, noted. “The result may be unexpected obstacles to trade and erroneous investment decisions based on false information. Wash trading also hurts legitimate exchanges, which risk losing customers to unfair competition — unless they engage in wash trading themselves.”

Stablecoins are often used for wash trading because they make it easier to conceal the activity, says Lee Reiners, policy director at the Duke Financial Economics Center.

Since stablecoins can be used pseudonymously, he says, it’s impossible for exchanges to fully follow the know-your-customer and anti-money-laundering rules required to determine that the owner is not using crypto to launder illicit funds. That also makes it more difficult for regulators to crack down on fraud like wash trading. “Given the opacity and the nature of crypto,” he says, “it’s hard to say, ‘This is not a legitimate order.’”

Reiners argues that if the world of crypto were fully regulated, “the whole business model would not be permissible.”

“Crypto exchanges perform multiple functions that by law are separated in traditional securities markets,” he explains. “They’re the broker, they’re the one taking your order, they’re the exchange where your order is getting matched. In some cases, they’re the market maker, meaning that they are the ones actually executing your order, and then they’re the custodian.”

Such activities aren’t allowed in regulated securities markets, but “because [most crypto exchanges] are not registered as a broker-dealer or a national securities exchange, it’s easier for them to get away with wash trading, and there’s no prohibition on them front-running their customers if they want to do that. That’s perfectly legal given how they’re currently set up.”

U.S. authorities are attempting to close some of the regulatory loopholes that have allowed the boom-bust crypto phenomenon of recent years. This year, the SEC, the DOJ, and the CFTC have taken a flurry of enforcement actions against a variety of crypto players. The SEC has sued Kraken, Genesis Global Capital, and Gemini Trust Co. for offering unregistered securities, and it is on the verge of legal action against Coinbase, the only U.S.-based publicly traded crypto exchange. (Coinbase — which is threatening to leave the U.S. — and Gemini are contesting the allegations, while Kraken has settled.)

The SEC has also refused to approve a spot Bitcoin ETF, citing problems with wash trading, insider information, manipulative activity involving purported stablecoins including Tether, fraud and manipulation at Bitcoin trading platforms, and “persons with a dominant position in Bitcoin manipulating Bitcoin pricing,” among other issues.

Last week, in a hearing before the House Financial Services Committee, SEC Chair Gary Gensler defended the agency’s tough approach to crypto. “I’ve never seen a field that’s so noncompliant with laws,” he said. “It’s not a matter of a lack of clarity. I think [crypto] is a field that, in the main, has built up around noncompliance, and that’s their business model. They have chosen, even though it’s not the law, to be noncompliant.”

Earlier in the week, the SEC had charged Seattle-based Bittrex for operating an unregistered exchange, broker, and clearing agency. Bittrex had recently said it would close its U.S. operations by the end of April due to “regulatory uncertainty.”

Even those outside the U.S. have not escaped the long arm of the law. Terraform Labs founder and fugitive Do Kwon was arrested in Montenegro in late March, followed by a DOJ criminal complaint against him for fraud associated with the failed TerraUSD stablecoin. The SEC also accused another well-known crypto player, Justin Sun, of market manipulation in the form of wash trading on his Tron blockchain network. In the complaint, the SEC listed more than 600,000 wash trades Sun allegedly directed his employees to make using the Tronix stablecoin. Both deny the charges.

The most significant action came in late March, when the CFTC sued Binance — an offshore exchange that now accounts for 60 percent of the entire crypto trading market following the collapse of rival exchange FTX — along with its founder, Changpeng Zhao, and other executives. The CFTC alleges that Binance has been doing business with U.S. citizens in violation of U.S. law. It also accused Binance — which, like Tether, has never been audited — of working with criminals and possibly manipulating the market.

By taking on Binance, the CFTC is also seeking to push back on the notion that offshore entities are immune to regulatory action by the U.S. “There is no location, or claimed lack of location, that will prevent the CFTC from protecting American investors,” CFTC Chair Rostin Behnam said in announcing the suit against Binance, a global behemoth notorious for having no named location for its headquarters, making it difficult to subpoena records and individuals.

Binance’s apparent efforts to avoid scrutiny make the information in the 74-page complaint even more tantalizing. The complaint includes chats and texts from insiders detailing how Binance helped U.S. clients evade the law. These clients include three unnamed quantitative trading firms headquartered in New York and Chicago that also have offshore arms, where the trades were placed. (Texts with one New York firm CEO on encrypted messaging app Signal are included in the complaint.)

The trading firm in Chicago was a top-five client responsible for 12 percent of Binance’s total trading volume, according to the CFTC complaint. Binance says it had daily trading volume of $76 billion as of August 2022, which would put the Chicago firm’s portion at greater than $9 billion.

The CFTC even offers evidence from insider chats that Binance knew it was doing business with Hamas, which the U.S. classifies as a terrorist organization.

But perhaps the CFTC’s most stunning allegation is that Zhao controlled more than 300 proprietary accounts on the exchange. Binance does not disclose to its customers that it is trading in its own markets, the CFTC alleges, nor did Binance make such disclosures when the CFTC issued investigative subpoenas seeking information concerning its proprietary trading activity. Those 300 house accounts are not subject to “any anti-fraud or anti-manipulation surveillance or controls,” the CFTC charged.

“You have to ask yourself why Zhao would need over 300 trading accounts to trade on Binance,” says a prominent blogger whose 100,000 Twitter followers include journalists like The New York Times’ Andrew Ross Sorkin and Bloomberg’s Matt Levine. A programmer, IT professional, and former Bitcoin investor, he has served as a consultant to lawyers regarding cryptocurrency matters in recent years and tweets under the pseudonym Bitfinex’ed, based on his longstanding criticisms of both Tether and Bitfinex, which landed him on CoinDesk’s Most Influential list in 2021.

Trading among so many different accounts could facilitate wash trading or other manipulative activities, he suggests. “They can make the prices do whatever they want.”

In response to the CFTC, Zhao said in a blog post that “the complaint appears to contain an incomplete recitation of facts, and we do not agree with the characterization of many of the issues alleged in the complaint.” He added that Binance “does not trade for profit or ‘manipulate’ the market under any circumstances.”

The CFTC seeks to bar Binance, Zhao, and other top executives from ever doing business in the markets it regulates. The alleged money laundering and suspected manipulation could eventually bring criminal charges, and the DOJ has reportedly been investigating Binance for years. But to date, it has not acted. If it does, it may face difficulties bringing Zhao to justice in a U.S. court. The Binance founder and CEO has said that he is now living in Dubai, which does not have an extradition treaty with the U.S.

These new regulatory actions might be considered more reason for investors to lose faith in Bitcoin — and news about the CFTC’s complaint against Binance did drag Bitcoin down 3 percent the day it was filed. But Zhao had a quick retort: “While some were panic selling, remember, there is always a buyer on the other side of the trade.”

Those who’ve invested in Bitcoin and have followed its activity for years say that bad news often is accompanied by a surge in Bitcoin prices. That can sometimes occur right before the bad news becomes public, according to several critics II has interviewed. “It’s not an accident that prices skyrocket just prior to enforcement actions. The exchanges know that they’re about to be sued, they know they ignored subpoenas,” tweeted Bitfinex’ed the day of the CFTC complaint against Binance.

As Griffin noted in his report on Tether and Bitfinex, which was also published in The Journal of Finance in 2020, “Bitcoin prices are subject to gaming by a small number of actors.”

Bitfinex’ed, who says he was a “hardcore, diehard believer in Bitcoin” in its early years, has watched the bad-news price hikes play out repeatedly, starting with the first big scandal surrounding the Japanese Mt. Gox exchange — at the time said to be responsible for 70 percent of all Bitcoin trading. But Mt. Gox lost its banking access in 2013 and began inflating the price of Bitcoin in what became known as the Willy Bot scheme. In his trial for data manipulation and embezzlement, former Mt. Gox CEO Mark Karpeles admitted he was behind the bot scheme.

As Bitfinex’ed watched the machinations surrounding the failure of Mt. Gox play out over several years, the former true believer decided to sell out of Bitcoin in 2017.

Soon he started seeing a similar pattern at Bitfinex and Tether. The price of Bitcoin doubled right after the CFTC subpoenaed Bitfinex in December 2017, and it did so again in May 2019, when the New York attorney general sued Bitfinex. “I mean, maybe it’s all just one big happy coincidence that so many large moves are right around major Bitfinex/Tether events,” he says. The former Bitcoin trader currently has no investments in crypto or crypto-related entities.

The skeptics acknowledge that there are people who believe in Bitcoin and are no doubt among its current buyers. Sometimes it is hard to separate the faithful from the opportunists. In her Substack newsletter, White recently commented on a wildly improbable bet by Bitcoin bull Balaji Srinivasan that the U.S. would enter hyperinflation within 90 days, which he also believes means Bitcoin will hit a price of $1 million. The bet, which will cost him $1 million if he is wrong, garnered a lot of attention on Twitter, most of it negative.

White argues that Srinivasan, who was previously a partner at Andreessen Horowitz and then the CTO at Coinbase, “does not actually believe that the U.S. is about to enter some completely irrational and ahistorical hyperinflation scenario, but simply has a ton of money in Bitcoin, and is desperate for the price to go up. His bet is more easily explained as a publicity stunt intended to manipulate the market.”

Then there is Novogratz, whose firm lost $1 billion last year. “Despite what you would think are insurmountable odds, crypto prices are higher,” he said on Galaxy Digital’s quarterly call with investors in March. “You can take shots at us, you can knock us down, but we’re going to be here.”

Novogratz recently told CNBC that it’s not “new money” that has been driving the price higher these days and that the institutional adoption he has touted has yet to occur. As longtime crypto skeptic Peter Schiff put it on Twitter, Novogratz “basically admitted the entire Bitcoin rally was driven by existing #HODLers buying more.”

Certainly, many of the young, unsophisticated traders who swarmed into Bitcoin during 2021, helping push it to $64,000 per coin, lost money during last year’s crash and have left the market. The lack of enthusiasm can be seen in attendance at crypto classes at the University of Texas in Austin. Griffin says that in the fall of 2021, a period of peak Bitcoin fever, “the crypto and blockchain course at UT was standing room only,” with many attendees not even taking the course for credit. That euphoria has dissipated, he says.

“Among my students, I ask who trades crypto, and now hands go up sheepishly; many say they used to trade it,” says Griffin. He estimates that the number of crypto enthusiasts in his class last fall was 5 percent, compared to “at least 30 percent” before crypto’s crash. Meanwhile, trading in Bitcoin is thin, accentuating price moves due to the lack of liquidity.

But Bitcoin isn’t expected to go away anytime soon. Despite the Biden administration’s growing concerns about fraud in cryptoland and its efforts to crack down on abuses and money laundering, it is not illegal for U.S. banks to deal with crypto. Already, a bank has jumped into the vacuum left by the demise of SVB, Signature, and Silvergate. It’s Cross River Bank, a small, privately owned, FDIC-insured bank located in Fort Lee, New Jersey, that has been financed by major crypto venture investors including Andreessen Horowitz. After the collapse of SVB, Circle quickly moved its business to Cross River, allowing it to re-establish its peg to the dollar.

And Binance U.S. — which previously had accounts at both Silvergate and Signature — has also been directing client funds to Cross River via a U.S. fintech company called Prime Trust, according to documents II has seen. On April 21, however, Binance U.S. customers were told that banking arrangement was no longer possible.

“There is a religion built around” Bitcoin, explains James Block, an investor who has become well known for his Dirty Bubble Media newsletter, which called out problems at FTX ahead of its failure, along with those at Signature before it was seized by the FDIC. “There is a group of people who are true believers in Bitcoin in a way that few other supposed assets have ever captured.” (Like several other crypto critics II has interviewed, Block hasn’t shorted the volatile coins or tokens, just the publicly traded companies tied to cryptocurrencies.)

Block says the crypto ecosystem doesn’t make sense for someone who is trying to do things legitimately. “Why would I want to take on the risk of buying a stablecoin when I could just have dollars?” he says. “That’s a significant risk there. The whole point of crypto is you’re not supposed to have to trust anybody. It’s supposed to be a system. And yet the whole thing is built around a construct — stablecoins — that requires you to absolutely trust that the issuer has the money that they claim to have. I mean, that’s a great oxymoron at the heart of the whole stupid thing.”

“There’s no doubt that there is real trading in Bitcoin,” Block says. “There are definitely real people and real companies gambling on this stuff. But the idea that, for the most part, those legitimate traders are what’s really determining the market? I have a hard time believing that.”