Tether’s Trouble With New York Attorney General — Will Crypto Cope?

Are Bitfinex and Tether in trouble? Maybe, but the thing is, we don't know just how much trouble, because the stablecoin issuer has challenged the New York State Office of the Attorney General's (OAG) case against them. In claims filed in April, Attorney General Letitia James asserted that Bitfinex defrauded its customers, having lost $850 million in client and corporate funds, and then having attempted to cover up this loss by secretly helping itself to around $900 million of Tether's cash reserves. 

Serious charges, but they're denied by Bitfinex and Tether’s parent company, iFinex, which responded in April that the OAG's claims were "riddled with false assertions" and that the lost $850 million is being safeguarded, although it didn't specify whether this amount is being held by Crypto Capital Corp. (which initially received it) or by some other entity. Regardless, iFinex has applied to have the case dismissed, arguing that the OAG has no legal basis to sue it for the simple reason that Bitfinex wasn't operating in New York during the period at issue.

However, while a New York judge has questioned the attorney general's "vague, open-ended" claims and asked for a more precisely constructed revision, recent news surrounding the closing of a New York-based bank account indicates that Tether and Bitfinex may very well have been operating in the state of New York. This would suggest that the OAG's claims are legally valid and that Bitfinex and Tether may end up facing serious repercussions. But even if it does, certain crypto-related legal experts suggest that this wouldn’t necessarily be such a huge blow to crypto, which will endure with or without the liquidity provided by the Tether stablecoin, USDT.

The New York connection

On July 10, it was reported that the crypto-friendly Metropolitan Commercial Bank had closed accounts associated with iFinex. The company and its affiliates had held these accounts for around five months, after which they were closed, with iFinex itself stating that they were discontinued largely because of inactivity. According to iFinex: 

"Metropolitan Commercial Bank had limited, corporate operating accounts with Tether Holdings LTD, iFinex Inc, and Digfinex Inc, all with negligible activity, and requested the accounts to be closed after less than 5 months of the accounts being opened."

As Cointelegraph has reported previously, iFinex denies that Bitfinex and Tether were operating in New York, and it's partly on this basis that the company believes the OAG's case should be thrown out. For its part, the OAG claimed in an affirmation filed in July that iFinex opened the accounts in December 2017 and "transacted in those accounts thereafter." Similarly, it also notes that it held accounts with another New York-based bank, Signature Bank, and "transacted in those accounts until at least April 2018. During that time period, transactions were initiated in those accounts by a senior executive of Respondents located in New York."

But even if iFinex held accounts with New York-based banks, there's still no guarantee the OAG can legally establish that Bitfinex and/or Tether were actually operating in New York and serving New York-based customers. As crypto-specialized lawyer Preston Byrne told Cointelegraph, the simple fact of having an account with a New York-based bank isn't likely to be enough on its own to legally establish operations in the state. He added:

"The short answer is that it depends on what the company is doing and what jurisdictional hook the state uses to regulate the conduct. For any company, the outcome of this analysis will be very fact-dependent. To the extent there is any possible nexus with New York State, businesses really should confer with New York counsel for that advice."

Other lawyers agree that the simple possession of a New York-based account isn't enough on its own to prove anything. Aviya Arika, a lawyer and the chief of blockchain at Aviya Law, explained to Cointelegraph that, during her time as a lawyer, she has opened dozens of bank accounts for clients in numerous nations when responding to the question of whether iFinex having New York-based accounts proves that it operated in the state. Arika said:

"This experience has taught me that having a bank account in country x doesn’t necessarily mean the company is targeting or soliciting clients in that country. Therefore my answer would be negative."

"I don’t see a mandatory connection between the two," she clarified, noting that, conversely, it's also possible to target New York clients and have your bank account anywhere else in the United States. Arika also pointed out that iFinex isn't the only crypto-related company to have set up with Metropolitan and that it's likely many other clients of the bank don't operate in New York State. She said:

"Metropolitan Bank has become very popular in crypto talk and I’m pretty sure not all companies who have accounts there are working with clients in New York. Because of the relative scarcity of crypto friendly banks, companies are not being as picky as to narrow down their options and approach only those within their target markets."

The outcome

The above would suggest that the OAG may struggle in establishing that Bitfinex and/or Tether operated in New York. Nonetheless, it needs to be underlined that the attorney general is indeed making the claim that Bitfinex and Tether served New York-based customers and didn't only have bank accounts located in the state. For example, in its affirmation from early July, Assistant Attorney General Bryan M. Whitehurst wrote that "documents obtained by the OAG in the course of its investigation demonstrate that Respondents did in fact allow customers located in New York to transact on the Bitfinex trading platform after January 30, 2017," which is when Bitfinex announced that it was officially barring New Yorkers from the exchange.

The affirmation then proceeds to cite various pieces of evidence that Bitfinex was serving New York-based customers. For example, Whitehurst refers to enclosed evidence (not publicly available) of correspondence between Bitfinex and a digital currency trading firm located in New York, which used Bitfinex to trade on behalf of numerous "offshore vehicles” and which "conducted significant activity on the Bitfinex trading platform through at least early 2019." Likewise, the OAG also cites evidence that Bitfinex set up an account for Galaxy Digital and "associated entities," as well as evidence testifying to the use of Bitfinex by New York-based traders as late as 2019.

Given that these aren't the only pieces of evidence the OAG claims to possess, it would seem that iFinex may not be successful in having the case thrown out. That said, there still isn't certainty that the attorney general will succeed in proving a link with New York because, as Aviya Arika indicates, other factors complicate the issue. "Another interesting issue here would be the non-solicitation issue," she said. "What the court’s approach will be if Tether had allowed NY residents to transact but had not solicited or targeted them and had created the relationship with them completely passively."

Also, proving an operational link with New York is one thing, but proving the defrauding of customers — which the Attorney General is ultimately attempting to substantiate — is another. And it's precisely here that the biggest uncertainty resides, with Byrne affirming that, because of the infancy of the legal battle, it would be unwise to stick your neck out with a decisive prediction either way.  Byrne clarified: "It's impossible to know at this phase. I would imagine both sides of this litigation are keeping their cards close to the vest."

Still, even with this uncertainty, it’s unlikely that the New York attorney general would have sued iFinex if it didn’t believe it had a strong case, as suggested by Aaraon Kaplan, a former lawyer who is now the CEO of New York-based trading platform Prometheum. He told Cointelegraph:

“The outcome of the NY AG’s case against Tether will be determined by the facts and circumstances. The attorney general tends to only bring cases they believe they have a good chance of winning. I anticipate that the NY Attorney General believes the state has a very strong case against Tether.”

Implications

But assuming for the sake of argument that Bitfinex and Tether had defrauded customers by covering up an $850 million loss, it would be interesting to consider the kind of impact their defeat in a legal battle would have on iFinex and on the wider cryptocurrency industry. For one, it's likely that iFinex would be hit with a hefty fine, and given that Bank of America had to pay a $42 million penalty in 2018 in connection with electronic trading fraud, it's possible that any fine it could potentially receive would be somewhere in the same region, although it is known that other firms have paid billion-dollar fines to the state of New York in recent years.

"The penalties Tether would face would be heavy fines that it would probably not recover from," Arika said. This is a grave prediction, and while a $42 million-dollar fine probably wouldn't be financially ruinous for iFinex, the damage to its reputation could be more far-reaching — as could be any legal orders it receives concerning its business practices in the U.S. (e.g., the New York attorney general has shut down companies in the past). And if we take the absolute worst-case scenario — the closure of iFinex and the end of Tether — then the implications for crypto could be very ominous. Byrne has also added that a bad outcome for Tether may affect the crypto market negatively:

"As to the wider market, all indications are that Tether plays an increasingly important systemic role in the Bitcoin and cryptocurrency markets. Removing Tether from these markets for any reason would be likely to create a severe liquidity crunch among a number of overseas exchanges that rely on Tether for USD liquidity and could lead to substantial market disruption."

Indeed, USDT has been pivotal in crypto bull markets over the past couple of years, with this year’s rally coming amid a doubling of the Tether supply. In fact, the supply of USDT more than doubled momentarily on July 13, when Tether printed 5 billion USDT tokens, only to burn them almost immediately after. According to the company’s chief technology officer, Paolo Ardoino, this was simply the result of putting a decimal point in the wrong place during the transfer of 50 million Omni-based USDT tokens to the Tron blockchain. However, given that Tether hadn’t been entirely honest regarding its 1:1 backing of USDT, for instance, a number of suspicious tweeters raised the entirely speculative possibility of foul play.

Tether’s past importance to crypto aside, other experts believe that the cryptocurrency market would continue to exist and thrive without Tether. As Weiss Ratings' Juan Villaverde told Cointelegraph in a recent article, the post-April bull market has arguably seen Bitcoin become less dependent on the liquidity provided by USDT, saying, "Let’s not forget that the rally we’ve seen in Bitcoin accelerated around late April, precisely when the market was concerned about the sustainability of USDT as an asset class." Villaverde continued on to clarify that much the same thing had occurred in October, when Bitcoin jumped by over 10% intraday, despite question marks surrounding the transparency of the Tether stablecoin. His point was that the market had already spoken on the issue of USDT, telling us that, even with doubts concerning the stablecoin’s sustainability, the markets were liquid enough to soak up any capital flight.

This may be an optimistic view of things, but Villaverde isn't the only commentator who believes that Tether's hypothetical collapse wouldn't have massive knock-on effects for crypto. In much the same vein, Arika also believes that a hypothetical proof of Tether's fraudulence wouldn't irreparably affect the cryptocurrency industry's reputation, saying:

"If Tether turns out to be a bad actor it would be unfortunate but it shouldn’t stain the whole crypto market. Bad actors exist in every industry. The problem is the negative buzz and the false reaffirmation that the crypto industry is fishy. Generally I think that the creation of case law and pragmatic application of the law to crypto companies is beneficial and constitutes a natural development."

Kaplan agrees, explaining that a potential loss for Tether could be beneficial for crypto insofar as the industry is in dire need of standardization. According to Kaplan:

“The crypto industry needs to realize that in order for crypto to go mainstream there needs to be integrity in the market. That integrity will either be forced upon the industry by regulators and legal actions, or will require standardization and best practices to eliminate activities like commingling customer and exchange funds.”

Taken together, the above observations point to two main points: 1) there isn't enough public evidence right now to conclude either way on whether iFinex defrauded New York-based customers; and 2) even if such evidence emerges and the New York OAG wins its case, the cryptocurrency industry will live on regardless. In other words, you should be worried about Tether's fight with New York only if you happen to be Tether.