On December 6th, 2017, the company operating Bitfinex and its affiliate Tether received a subpoena from the CFTC. The CFTC is a regulator, and they have the ability to require a financial company that operates with U.S. customers to answer questions. Why would the CFTC be concerned about Bitfinex, which is an exchange incorporated in the British Virgin Islands with a principal address in Hong Kong?
Reading through Bitfinex’s terms of service, I learned that Bitfinex is incorporated in the British Virgin Islands under the name IFinex Inc, and “Bitfinex” refers to two distinct subsidiaries: BFXWW Inc., the Bitfinex exchange for non US citizens, and BFXNA Inc., the Bitfinex exchange for U.S. citizens.
On June 2, 2016, BFXNA, which operates the Bitfinex exchange with U.S. customers, agreed to a legal order from the CFTC without denying or accepting responsibility for engaging in illegal off-exchange commodity transaction and failing to register as a futures commission merchant. It is unclear why the CFTC did not force BFXNA to exclude U.S. investors then. They clearly got a pass, at least that time, but the controversy surrounding the exchange continued to shadow its legacy. Last summer, Bitfinex announced its discontinuation of serving US retail customers due to regulatory issues. Now, they are facing similar regulatory pressures with its business concerning individual US traders.
The CFTC has spoken, issuing a new subpoena in December, and this could be much more damaging to Bitfinex. There are no leaks as to what this new investigation is about, but the rumor mills are operating at a very high level. It is also not known if the SEC is involved, which would be logical because they are operating as an unregulated exchange trading tokens deemed securities by the SEC.
The rumored main accusation is that Bitfinex is manipulating the price of Bitcoin because they also own Tether, which sells Tether tokens to investors that are tagged to the US dollar. Tether is called a stable coin because it will not increase or decrease in value. However, though the company claims that a single Tether token equals one dollar, they have provided no proof of the dollar reserves necessary to keep that value constant. Traders then use Tethers to purchase and sell Bitcoins on the Bitfinex exchange.
It’s important to note that Bitfinex and Tether have the same CEO, CFO, chief strategy officer, and general counsel. So people buying Tether tokens through Bitfinex are paying the same people twice? If that sounds shady, that’s because it is.
The rumor mill accuses Tether to be a fraud because the company does not have the dollar reserves they claim to have in order to keep the value of the Tether constant, or tethered to the dollar. Instead, accusers claim that Tether is creating new Tether tokens out of thin air and selling them to encourage investors to exchange them for Bitcoin, artificially inflating the price of the other token.
This whole issue is further clouded by the fact that Bitfinex’s exchange has been hacked before, costing the company $60M in Bitcoin, which further begs the question, does Bitfinex have the reserves to back their claims? Friedman LLP, the New Jersey auditor who was hired to publish a report on just that question, recently resigned on January 27th, Bitfinex confirmed. This all points to serious issues within the company.
The financial industry is based on trust. In order to earn trust, companies must offer transparency, and more importantly, the company must also be regulated to provide customers the assurance of government oversight. Bitfinex is an exchange trading commodities in the form of Bitcoin but also dozens of other tokens, which according to the SEC are probably securities because of the method of sale. In addition, Tether could also be a security because it is a derivative financial product representing the value of a dollar.
Investors using Bitfinex should worry because the CFTC and the SEC could seek an injunction from the Justice department and seriously harm the company. So what should Bitfinex do?
The best course of action for the company is to create a U.S. based subsidiary and seek registration with the SEC as an exchange, and if they are rejected, seek to become a broker dealer. This would permit the company to trade securities legally and offer its customer some form of protection through The Securities Investor Protection Corporation which will insure investor accounts up to $500K.
Of course, for the company to become regulated they would also need to do the same in each country where they have customers from. This would require them to become a multinational financial firm. It is unlikely they seek this route and instead go against the regulators, including the CFTC and the SEC. Not a pretty picture.
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