CFTC subpoenas add to fears of an unsustainable crypto bubble

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Cycling and other professional sports have doping, and now concerns are mounting that the cryptocurrency industry may have used a kind of performance-enhancing drug of its own, in the form of a digital token called tether.

The Commodity Futures Trading Commission sent subpoenas last month to Tether, the company that issues the token, and to Bitfinex, one of the world's largest digital-asset exchanges and a company with close ties to Tether. If the subpoenas should lead to an enforcement action, it may scare off banks, big technology firms and other institutions that have been warming up to cryptocurrency.

News of the subpoenas, which were delivered on Dec. 6 but reported only this week, prompted a sell-off of bitcoin and related assets and stoked fears that the market's meteoric rise and sky-high valuations may have been fueled by fake money.

Tether tokens are supposed to function as digital dollar receipts, with the value pegged to the U.S. dollar and the company holding fiat currency in reserve for every token it issues. That way, exchanges like Bitfinex have a token of stable value that can be used to facilitate cryptocurrency trades.

Where a problem would arise is if the dollar reserves were a fiction and Tether has simply been printing digital money to drive up asset prices. More than 2.2 billion tokens have been issued so far. The collapse of a house of cards that big could tank cryptocurrency prices and usher in a prolonged bear market.

Concern over the systemic risk Tether might pose has been growing in some quarters. Tether recently broke things off with accounting firm Friedman, which was to perform an audit of the company.

"Given the excruciatingly detailed procedures Friedman was undertaking for the relatively simple balance sheet of Tether, it became clear that an audit would be unattainable in a reasonable timeframe," Tether said in a statement on Monday.

Skeptics have looked askance at Tether's continued issuing of new tokens in the absence of a verifiable audit. Others are encouraged by it, taking Tether's continued operations while under CFTC scrutiny as a sign the company must be solvent.

It may also indicate that authorities don't want to rush to judgment — though experts say regulators will never again be as hands-off as they were in 2015 and 2016.

"The U.S. government is taking the time to fully understand the industry and implications of their actions, which is the right move," said Andy Bromberg, CEO of CoinList, a platform that hosts and manages token offerings. "We've seen an increasing pace of memos, enforcement actions and public statements over the past six months from agencies like the [Securities and Exchange Commission] and the CFTC, and expect to see them continue to increase their presence over the coming months."

Online, in the communities where cryptocurrency traders gather to share news and gossip, reaction to news of the subpoenas was mixed.

Many members of a Reddit board for traders of ether, the native token of the Ethereum network, seemed incredulous at the notion that the $2.2 billion worth of tether issued so far might actually be fully backed by dollar reserves. They compared it to fractional-reserve banking — a system many bitcoin users would like to escape.

Others argued that Bitfinex fees relative to trading volume were likely sufficient in and of themselves to cover the outstanding token balances.

"Long term, the tech will prevail," one user wrote. "Short term, may be a bloodbath."

According to a memo authored by Friedman, the accounting firm, Tether had $443 million in the bank as of Sept. 15, by which date the company had issued 442,481,760 tokens. However, in keeping with the general air of secrecy surrounding Tether — the identity of its CEO, a man named Jan Ludovicus van der Velde, only became publicly known last month — the names of the bank's holding company funds were blacked out in the document.

Still other digital-currency enthusiasts dismissed the regulatory action as old news, after an initial Bloomberg story was updated to reflect the fact that the subpoenas had been delivered weeks ago. Whatever fear, uncertainty and doubt the news might justifiably inspire, they said, insiders had already priced it into the market, which had fallen from a Jan. 7 high of more than $830 billion to $506 billion by Wednesday afternoon, according to CoinMarketCap.

"Be careful selling here, because my tinfoil hat says the insiders have already manipulated the market with their own insider selling far ahead of today's announcement," wrote one member. "I'm personally not thinking this is going to tank the market further, but I guarantee the sharks will take those coins off your hands just fine."

Many long-time cryptocurrency investors declared that if digital-asset prices did plummet, they would keep buying all the way down.

Investment banks and other traditional institutions could be forgiven for feeling whiplash as they follow the headlines and try to figure out what stance to take toward bitcoin and other digital assets. Goldman Sachs and JPMorgan Chase recently began settling bitcoin futures for clients.

Regardless of the day's news, Bromberg argues that the industry's fundamentals remain "incredibly strong."

"Looking far beyond the prices, we're seeing an increasing number of high-quality projects in the space, with experienced teams, impressive early technological breakthroughs, and rigorous legal structuring," said Bromberg. "We expect to see this continue into 2018 as the industry matures and professionalizes."

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