Acton Institute Powerblog

How a virtual central bank may have created the Bitcoin bubble

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Imagine if you could own a company that had the ability to print money—literally to create the equivalent of U.S. dollars out of thin air.

Here’s how it could work: The company prints it own form of currency and sends it to another firm where the newly created pseudo-money is used to purchase assets. Because of supply and demand (and a bit of investor speculation), the buying drives up the asset’s price. After the price has risen, the company then sells the asset for actual U.S. dollars.

That appears to be what a company called Tether Limited was doing. And it may explain the meteoric and inexplicable rise in the price of Bitcoin last year.

A new paper by John Griffin, a finance professor at the University of Texas, and his grad student, Amin Shams, provides convincing proof that two companies, Tether Limited and Bitfinex, may have manipulated the price of Bitcoin. As the researchers note, “Overall, we find that Tether has a significant impact on the cryptocurrency market. Tether seems to be used both to stabilize and manipulate Bitcoin prices.”

Tether Limited is the company that issues the cryptocurrency Tether Token. The company claims Tether Tokens, “gives you the joint benefits of open blockchain technology and traditional currency by converting your cash into a stable digital currency equivalent.” Tether Tokens have a conversion rate of one Tether Token to one U.S. dollar and are supposedly “100% backed by actual fiat currency assets in our reserve account.”

No one knows if that last claim is strictly true, though. Despite being a cryptocurrency, the terms and service agreement states, “Tether Tokens are backed by money, but they are not money themselves.” And as late as December 2017, the agreement stated, “There is no contractual right or other right or legal claim against us to redeem or exchange your tethers for money. We do not guarantee any right of redemption or exchange of tethers by us for money.” Tether Unlimited has also never publicly released an audit of their books, and in 2017 they were unable to fill all redemptions—which increased concern that the fiat-backed deposits were fictional.

So how could Tether Limited manipulate Bitcoin? According to the study, it possibly worked something like this:

Step 1: Tether Limited creates Tether Tokens and moves them to the cryptocurrency exchange, Bitfinex. (The paper doesn’t note the interesting connection between the two companies: both share the same CEO, Jan Ludovicus van der Velde.)

Step 2: After certain downturns in the price of Bitcoin, the creators of the Tether Tokens use them to buy Bitcoin. This creates a price floor, which encourages other investors to buy Bitcoin.

Step 3: The increased buying of Bitcoin pushes the price higher, allowing the owner of the Tether Tokens to take their profits. But instead of exchanging Bitcoin back into Tether, the profits are taken in other crypto or fiat currencies.

Step 4: The profits could then be  put back into the bank of Tether Limited, giving the appearance that the Tether Tokens were backed by dollar reserves all along.

The paper makes a compelling case that this occurred. And it’s possible for a single company to have such a huge effect on Bitcoin, since 40 percent of the cryptocurrency is held by about 1,000 people. But the strongest evidence appears to be what happened when Tether came under closer scrutiny.

On December 6, 2017, the U.S. Commodity Futures Trading Commission sent subpoenas to both Bitfinex and Tether Limited.

Eleven days later, Bitcoin reached it’s all-time high of $19,783.06.

On January 1, 2018, the company announced, “Tether Tokens will no longer be issued to U.S. Persons.”

On January 7, Bitcoin was still trading at around $17,000 a coin. After that date the price began to steadily decline. Today, it is around $6,500.

The connection may be merely coincidental, of course. But if Tether was manipulating the price of Bitcoin, it would not be surprising if the price declined once regulators started looking closely at the company.

Tether may have found a way to create its own version of the U.S. Treasury as well as a virtual central bank. This may have allowed the company to print money, increase the money supply, and then artificially inflate asset prices—a perverse form of quantitative easing.

Bitcoin was created, in part, to get around fiat currency and central banks. It would be an ironic twist of the Bitcoin story if the cryptocurrency was taken down by a faux, virtual central banking system.

Several years ago I produced a three part series explaining what the average Christians should know about Bitcoin (123; full PDF here). The basic facts about Bitcoin haven’t changed much, but this latest incident has shown how the debate needs to expand to include broader ethical concerns.

Christians who are Bitcoin enthusiasts have a special duty to help uncover and expose manipulation in cryptocurrency markets. In the short-term, such news might embolden the skeptics (like me) who are convinced Bitcoin can never be a viable currency. In the long term, though, self-policing the crypto markets and exposing fraud is the only way to build the public’s trust in blockchain technologies.

Joe Carter Joe Carter is a Senior Editor at the Acton Institute. Joe also serves as an editor at the The Gospel Coalition, a communications specialist for the Ethics and Religious Liberty Commission of the Southern Baptist Convention, and as an adjunct professor of journalism at Patrick Henry College. He is the editor of the NIV Lifehacks Bible and co-author of How to Argue like Jesus: Learning Persuasion from History's Greatest Communicator (Crossway).

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