To find out if you are in a bubble, you need to find the source of the hot air. Obviously for GameStop,

but not so much for Bitcoin.

In July 2018, we wrote about the cryptocurrency company Tether, which is issuing tokens called Tether, which trade under the symbol USDT and should be worth $ 1. This makes the currency a “stable coin”. According to a University of Texas newspaper, the creators of Tether may have tampered with Bitcoin by, for better or worse, issuing tokens that are not backed by real dollars and then buying Bitcoin to raise the price. (The company claims the research is flawed.)

At that time, the total value of Tether was around 2.7 billion US dollars, and the website says, “Every Tether is always backed 1: 1 by the traditional currency held in our reserves.” So there would have real money in somewhere A total of 2.7 billion dollars – this is how a stable coin should work. In November 2018, New York Attorney General Letitia James cited the Martin Act to open an investigation into iFinex, which owns Tether and the Bitfinex cryptocurrency exchange, “in connection with ongoing activities that may have defrauded New York investors” . The company has denied the attorney general’s allegations, misled customers, saying it would oppose any action. An appeals court rejected his challenge to the investigation last year.

Bitcoin peaked at $ 19,000 in late 2017 and plunged to $ 3,200 the next year. Well – they are Baaack! On Friday, Elon Musk was the last to pump Bitcoin, which briefly hit nearly $ 38,000. There are now USDT tokens valued at $ 26.4 billion, of which $ 18 billion has been created since March 2020. Why the increase? Nobody has a good explanation.

Not everything that glitters is gold. In 2019, Tether subtly updated its claim that reserves “may contain other assets and receivables from loans Tether has made to third parties.” Tether has even admitted that it only has 74% of the cash or cash equivalents to secure its stablecoin. Hmmm. Basically not secured.

In October 2019, a separate lawsuit was filed against Bitfinex alleging the exchange’s alleged market manipulation “likely exceeds $ 1.4 trillion,” which Bitfinex denies. Yes, that’s trillions at a Deltec Bank & Trust based in T. Bahamas with which Tether has an account. It has recently been claimed that “every tether is covered by a reserve and its reserve is more than in circulation”. OK, but it turns out “reserves” may include a $ 850 million loan to Bitfinex. Is that the hot air? Oh, and reserves can include bitcoin too. Audit, anyone?

Don’t worry: “Momo” momentum investors dove in anyway. Bitcoin went from $ 7,000 in January 2020 to nearly $ 42,000 on January 8th. But the Bitcoin bulls and bears argue. A few weeks ago a poster dug up on Medium called Crypto Anonymous (which is worth it, you know your customer) found that up to two-thirds of Bitcoin purchases on any given day were tethered, even though crypto Cops Insist Chinese Crypto Investors Use Tether to Buy Bitcoin. Try to check it out! The graph of the output of Bitcoin and Tether looks correlated, but a study published by the Center for Economic and Political Research found no correlation. And I should note that wallet provider Coinbase, the largest holder of Bitcoin, says it “doesn’t support USDT”. Do you know something?

In the meantime, more than two years later, the New York attorney general can get the documents it needs. I hope this includes a test of Tether looking for $ 24.5 billion in cash, or even $ 19 billion if it is 74% backed. I doubt all that money exists. The attorney general alleged in a press release that some fish money, perhaps $ 850 million that is now part of Tether’s reserves, was withdrawn from Tether to cover the losses at Bitfinex. Yikes

I contacted the Attorney General’s office and asked about the status of the investigation and the information received. I was referred to the original filing for the scope of the investigation. It includes accounting for all Tether transactions. On January 19, iFinex’s attorney said in a letter that it had “largely completed the preparation of the documents” and would “contact the court in about 30 days” to update the status. So we’ll know something soon.

Meanwhile, around the same time as this letter, Tether temporarily stopped creating more currency. This could explain the rapid drop in Bitcoin’s price from $ 42,000 to below $ 30,000 in mid-January. If fraud is detected, please see below.

Normally I wouldn’t care. Bitcoin is nothing, it’s steam, a concept of an idea. Transactions with Bitcoin are few and far between. It’s not a store of value – anything that falls 30% in a week cannot play that role. But we get Bloomberg Wealth stories that say, “New Bitcoin investors tell us what inspired them to buy at record prices.” Many people who cannot afford it can be seriously injured. Robinhood put a brake on some crypto purchases on Friday.

So all crypto eyes are in mid-February. The power of summons is strong. I have no insight into what New York’s attorney general will find. She could close the investigation and continue on her cheerful path because there is no crime, or uncover a scam that could make Bernie Madoff look like he was stealing from a lemonade stand. We know what happens to bubbles when the hot air runs out.

Write to kessler@wsj.com.

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