Crypto’s coming collapse Part II: Silvergate & Tether wash trades go down the drain
There may be very little real money in crypto
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On Wednesday we covered two of the most important institutions in the cryptosphere, and how the Alameda/FTX collapse is exposing their shady, unstable business practices. Today we touch on two more, the space’s most important bank -- Silvergate -- and the main means of exchange throughout the entire industry, Tether.
Banks face regulatory, legal, and reputational risk from any involvement in criminal activity. Cryptocurrency’s main use cases as currency involve ransom, illicit markets, capital control evasion, and sanctions busting -- this has kept most banks out of crypto altogether.
One major exception: California-based Silvergate Bank. At the crypto peak, the bank reached more than $12 billion in assets. Silvergate has billed itself as the “leading bank for business & crypto,” taking advantage of the hesitation its competitors feel towards the space.
This means that the bank is also heavily exposed to all of the cryptosphere’s crises. Silvergate held at least $1 billion in FTX and Alameda deposits, the bank reported, about 10% of its total deposit liabilities. Gemini is among its other largest depositors, as is stablecoin issuer Circle. Circle relies upon Gemini to fund its Circle Yield interest payments, which Circle has now suspended as Gemini teeters on the brink of bankruptcy.
Silvergate’s main role in the crypto economy is as the owner of the SEN network, a payments system that allows crypto institutions to onboard and transfer “fiat” currency. The problem is that SEN seems to be handling an extraordinary level of transactions -- at least $1 trillion in transfers last year on a $14 billion deposit base. By comparison, SEN is doing as much as 10% of the volume of DTCC, which settled trades for the entire U.S. equity market last year.
SEN serves less than 100 major clients: this is like hearing that your neighborhood convenience store was doing 5% of Walmart’s total sales. You know that something is wrong.
One possibility: Silvergate is involved in large-scale money laundering. Investigators in Florida have already identified at least $425 million in transactions to known money launderers from 10 Silvergate customers. Now fears that civil and criminal penalties could cause major damage to Silvergate’s finances and the failure of so many big customers could tank the bank may be leading to a run.
But it’s unlikely that any bank is doing a trillion dollars in money laundering. An even more likely explanation for Silvergate’s extraordinary volume: wash trading, helping its clients transfer money back and forth in fake trades that drive up the quoted price for various cryptocurrencies. Which brings us to the biggest risk of all: Tether.
For those not up to speed on Tether, we covered it in January 2021. Tether is the largest “stablecoin” -- a cryptocurrency pegged to the value of the U.S. dollar. Most crypto buying and selling for real money actually happens by way of Tether since it is hard to get funds into and out of the crypto world with so few banks involved. Tether is owned and issued by iFinex, which also owns Bitfinex, an exchange.
Detailed analysis of the 2017 Bitcoin runup indicates that the rally was driven almost entirely by Tether printing coins and wash trading on its sister exchange, Bitfinex. Tether claims that every “USDT” is backed 1:1 by cash or cash equivalents, but it has never shown what exactly backs its coins. Bond and commercial paper traders say none of them have ever sold the company any assets -- hard to believe if they’ve bought tens of billions of dollars’ worth in the last few years.
Now some critics -- including the short seller Marc Cohodes, long-time Tether watchdog @Bitfinexed, and crypto historian Kurt Wuckert -- are asking whether Alameda Research and FTX were Tether fronts from the beginning.
Cohodes noted even before their collapse that nobody knows where Sam Bankman-Fried got his initial capital, which had to be substantial to pull off the trades he claims made his fortune.
Notably, The New York Times reported on Thursday that FTX bought a U.S. bank, Farmington State Bank, in 2020. The bank’s chairman, Jean Chalopin, is also chair of Deltec, Tether’s main bank.
Most damning of all: Alameda was the #2 recipient of Tethers, receiving fully one-third of all issuance in recent years. At least $37.6 billion of the coin went to Alameda, with more than $30 billion then flowing into FTX.
If Tether is backed 1:1 as they claim, Alameda should have paid cash for those coins. But when former Alameda co-CEO Sam Trabucco was asked on live television whether they used U.S. or offshore banks to transfer the money to Tether, he could not answer the question and resigned not long after. Like GBTC not disclosing its Bitcoin addresses, not having an answer for this simple question is a very bad sign.
It seems likely that when the world got hip to Tether and Bitfinex’s gambit in 2017, Tether helped seed Alameda, which in turn founded FTX and invested in a plethora of other crypto funds and exchanges. These then became convenient places to wash trade Tethers, Bitcoins, and other cryptocurrencies.
And this, of course, means that whatever quoted prices you see for all of these “assets” are just as fraudulent as Gemini, GBTC, Silvergate, Tether, FTX, Alameda Research, Binance, and the rest of the core players in crypto. The bottom line: the money isn’t there, and it never has been.
As rising interest rates pull money out of speculation and back into savings, what little liquidity does exist in cryptocurrencies will dry up too, making the fraud untenable at last. Until then, there’s a little bit of fun in watching the fraudsters thrash -- follow along to see the best of it.
Our only investment advice: Those who do not remember Kitty History are doomed to repeat it.
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