The launch of the first bitcoin-focused exchange-traded fund last week proves crypto bulls need to meet John Law. The Scottish gambler, economist and financier is likely why why so few top French banks have Banque in their name. Instead, there is Crédit Agricole, Société Générale and Crédit Mutuel. Law’s Banque Générale, later renamed Banque Royale, issued bank notes out of thin air, then royally blew up in 1720 and destroyed the French economy. The reputation of French banks has never fully recovered.
Law’s connections gave him exclusive rights to trade between France and its Louisiana Territory. The Mississippi Co. was funded by selling new shares of Banque Générale that could be paid for with bank notes issued by—wait for it—Banque Générale. Shares took off, rising from 500 livres to 10,000 livres from January to December 1719. Soldiers had to be sent in to keep order in the frenzied financial district.
Law’s flaw was issuing bank notes willy-nilly, without real backing for their value, to keep the stock price rising. The French government eventually made the huge mistake of making these bank notes legal tender, doubling the French money supply. Inflation raged, hitting a 23% monthly rate in January 1720. By September 1721, shares dropped back to 500, and the French economy imploded.
Fast-forward 300 years. Crypto had a big October, with bitcoin rising from almost $44,000 to a $66,000 peak in anticipation of the ProShares Bitcoin Strategy ETF, which actually doesn’t buy bitcoin—it buys bitcoin futures. Meanwhile the stablecoin issuer Tether Ltd. paid a $41 million penalty after the Commodity Futures Trading Commission found the company had falsely claimed it had adequate dollars in reserve to back its tokens.
The New York attorney general’s office ran a similar investigation over Tether’s claim of 1-to-1 backing with U.S. dollars. It ended, unsatisfactorily if you ask me, with an $18.5 million settlement paid in February and an agreement to produce reports on reserves for tether. Why not dig further? Tether neither admitted nor denied the attorney general’s findings.
I wanted to know more, so I submitted a Freedom of Information Law request with the New York attorney general’s office requesting reserve statements, ledgers and bank records from Tether. It was denied, citing disclosure that would “constitute an unwarranted invasion of personal privacy” and “interfere with law-enforcement investigations or judicial proceedings.” Thanks for nothing.
Tether released vague pie charts of its $42 billion in “reserves” in May. Only 5% was in cash or Treasurys, and around half of the backing of Tether was unnamed commercial paper. Is it AAA-rated paper from JPMorgan Chase or an IOU backed by Dogecoin? They don’t say. When Coindesk filed a FOIL request for documents detailing Tether’s reserves, Tether attempted to block it, arguing: “The competitive advantages Tether gains from its investment strategy would be wiped away if competitors had full visibility into Tether’s investments.”
The attorney general’s office did release details of a fascinating cat-and-mouse game in its settlement agreement after stating that “Bitfinex and Tether deceived clients and market by overstating reserves.” Until Sept. 15, 2017, an account at the Bank of Montreal held most of Tether’s cash, some $61.5 million backing the 442 million tethers then in circulation. Not 1 to 1. Sister company Bitfinex held $382 million in a “comingled [sic] account” that Tether called a “receivable.” Tether was claiming money on another company’s balance sheet as its own reserves.
Here’s where it gets funny. Tether engaged Friedman LLP for “consulting services” “to analyze our bank balances” on Sept. 15, 2017. That morning, Tether opened an account at the Puerto Rico-based Noble Bank, and later that day Bitfinex transferred more than $382 million into Tether’s account. Friedman verified Tether’s assets that evening.
According to the settlement agreement, in October 2018 Bitfinex and Tether dropped Noble Bank and opened an account at Deltec Bank & Trust Ltd. in the Bahamas. On Nov. 1, 2018, Tether produced a letter on Deltec letterhead saying that as of Oct. 31 the portfolio cash value of its account was over $1.8 billion. On Nov. 2, the attorney general’s office notes, Tether started transferring a total of $475 million to Bitfinex accounts at Deltec, clearly a game of pass the assets.
Can we trust Tether, which has grown from 21 billion to 69 billion tethers in circulation this year? Doesn’t it sound a bit like John Law’s Banque Royale issuing bank notes? And what is Tether buying? It isn’t clear. The most recent disclosure from an independent accountant in the Cayman Islands—not an audit—for Tether reserves shows a lot of commercial paper and certificates of deposit and secured loans. Only about a third of its reserves are cash and Treasurys.
How about a real audit? Recently, the Biden administration announced it is considering regulating stablecoin issuers as banks. Mandating transparency for crypto would go a long way. But it could get ugly for crypto investors. In June the stablecoin IRON, supposedly “soft pegged” to the dollar, dropped from $1 to under 70 cents after TITAN, its collateral token, fell from about $64 to nearly zero in a few hours of frenzied selling that caused $2 billion in losses.
Like Law, are stablecoins being issued willy-nilly and increasing volatility in bitcoin and other crypto? How much leverage is there in crypto world? Bahamas-based crypto exchange FTX allowed 100 times leverage for margin trading, though in July the company trimmed it to a still insane 20 times. According to Bloomberg, part of Tether reserves includes a $1 billion loan to Celsius, a crypto-lending startup. If cryptocurrencies are to become the backbone of a modern financial system, let’s open them up for scrutiny before a Banque Royale-esque bubble bursts into the real world.
Write to kessler@wsj.com.
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