Was Tether USD the Cause of the 2017 Bitcoin Bubble?
Written in response to a client who asked for my thoughts regarding this article by Paul Vigna, published in the WSJ in November of 2019 and headlined “Large Bitcoin Player Manipulated Price Sharply Higher, Study Says”
TL;DR: No. Retail FOMO was.
For some background, a “stablecoin” is a digital token issued by an institution against an asset, such as the USD, in reserve. As a result, the stablecoin trades at or near the value of the underlying asset. The subject of this article is the Tether USD (USDT) stablecoin, one of the oldest. Tether and the Bitfinex (Bitcoin exchange) have many board members and shareholders in common. It has been alleged that they have been using Tether to mint batches of this token out of thin air and using those tokens to buy Bitcoin on their exchange and the open market, thus artificially driving up the price of Bitcoin.
Concerns around Tether USD and its entanglement with the Bitfinex exchange (of which the above WSJ article is the latest incarnation) have come up every couple of months over the past 5 years in theories related to Bitcoin market manipulation. I have been following it closely and have been unsatisfied that there is good reason to believe that Tether is either unsatisfactorily reserved or used to pump the market by Bitfinex. BitMEX research, in particular, has done a great job of investigating the actual USD reserve of Tether in a series of pieces, and continues to follow this quarterly.
Regarding this latest piece in particular, I’m am very unimpressed.
The Merits of Cluster Analysis
In general, I consider it a mistake to draw conclusions based solely on correlations — obtained through cluster analysis or any other means — whether it be related to Bitcoin, Medicine or any other field of scientific inquiry. Finding a correlation does not tell you which way causality runs — or whether or not a causal relationship even exists at all. At best, correlations are useful for generating research ideas. Alas, they are often used, instead, to cause confusion in click-bait news articles under headlines such as “Researchers Find Link Between Strawberries and Cancer”.
Using the same reasoning and given only data on precipitation and umbrella usage, an external observer (perhaps of extraterrestrial origin) could reasonably conclude that it rains because people use umbrellas. However, those of us that use umbrellas know quite well that we take out our umbrellas as a result of the rain.
Explaining the Correlation in Context
Similarly, this analysis has observed large flows of Tether USD between small groups of addresses coinciding with large price spikes — notably, the 2017 spike. In a vacuum, without any context, one might hypothesize that the USDT caused the spike. However, those of us involved in the Bitcoin market know very well that:
(a) Tether USD is used by exchanges and market makers (primarily Bitfinex) to provide liquidity for Bitcoin trading. Until Tether arrived on the scene, the only option for those market makers looking to move USD between Bitcoin exchanges in order to arbitrage price exchange discrepancies was via the traditional banking system. It’s not hard to see the advantage conferred to market makers through the use of Tether and the instant, no-red-tape USD transfers it enables. These transfers are made in batches as retail traders move the rates across exchanges out of sync.
(b) Droves of people enter the market through Tether USD. Tether provides an an entry point to the Bitcoin market for those without access to the banking system or those in the unfortunately very common situation of banking with an institution that will not allow them access to Bitcoin exchanges. These parties purchase Tether which is issued and lives its life in the custody of Tether / Bitfinex, in the same underlying wallet, while being credited to and debited from a multitude of account holders at the same exchange during the course of normal trade.
(c) Perhaps most striking, the 2017 spike also coincided with global Bitcoin pandemonium. In the weeks leading up to the top, my phone rang off the hook from people scrambling to buy Bitcoin. Major exchanges were so overwhelmed with new applicants that they had to turn them away. People complained to me about the major exchanges taking weeks to verify their KYC documents before they could enter the market. The surge in new customer volume also led to trading issues and tech support staff shortages. To leave this out of the analysis… would be a mistake.
So, from where I’m standing, it seems far more likely that USDT facilitated the 2017 spike (by facilitating large digital USD flows between exchanges and inflows from new investors) and that global retail FOMO drove it… and that the conclusion made by the authors of this study is evidence only that they are out of touch with this particular market.
NB: All of this is not to mention my generally contrarian views on “market manipulation” in general which would render even a positive identification of such manipulation far less important, but we’ll leave that for another day because it’s clear enough in this case that it wasn’t.