A recent academic paper claiming that Tether manipulation caused the 2017 bitcoin bull market has raised a lot of eyebrows.
The paper was originally released in 2018, but it has recently been updated with new analysis. According to the personal website of Prof. John Griffin, a University of Texas At Austin Professor and one of the two authors of the paper, a new version is forthcoming in The Journal of Finance, a prestigious peer-reviewed journal.
Tether denies the claims made in the paper, mocking the study as “built on a house of cards” and saying that “the authors demonstrate a fundamental lack of understanding of the cryptocurrency marketplace.” However, Tether did not address why the arguments in the paper lack merit beyond broadly naming “methodological defects” and the “absence of a complete data set.”
Elsewhere, New York-based legal firm Roche Freedman filed a class-action lawsuit against Tether and sister company Bitfinex this October, accusing them of market manipulation and money laundering. That lawsuit includes a claim that massive amounts of unbacked Tether are issued to manipulate the price of the crypto market at large.
Tether has likewise denied the validity of those claims.
Tether issues the most popular stablecoin in the crypto market, but it may also be the most controversial.
The company claims that every Tether issued is backed 100% by its reserves, though its definition of “reserves” seems to have changed from “traditional currency” to “traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties” at some point this year.
Also, the company's claimed level of transparency has changed from “professional audits” to no outside audit at all. According to Bitfinex shareholder Dong Zhao in September this year, Tether is at least 83.75% backed by USD, not counting the loan to Bitfinex.
Despite these changes in official promises, the market still has quite a lot of confidence in Tether, as evidenced by its trading at near parity against the dollar. It also remains the top stablecoin by market capitalization.
Even a legal case filed by the New York Attorney General’s Office, alleging that Bitfinex has misappropriated customer funds from Tether, only depressed the price of Tether temporarily.
Assessing Manipulation Claims: Reviewing the Paper
What’s the truth at the center of this latest controversy? We’ll attempt to find it, beginning with a brief review of the academic paper that sparked the controversy — the study that Tether says is “built on a house of cards.”
The conclusion of the paper is worded quite unequivocally, which is unusual for an academic paper. In its original form, it reads: “Rather than demand from cash investors, these patterns are most consistent with the supply-based hypothesis of unbacked digital money inflating cryptocurrency prices.”
We don’t know whether the published version of the paper will retain this strong language. But after a close reading of the evidence presented, we are not convinced that the strong conclusion is warranted.
First, the paper’s only evidence supporting that Tether is unbacked is a circuitous hypothesis related to how cash management works for Tether auditing. The authors hypothesize that since Tether is due to be audited each month, it needs to sell some of its Bitcoin holdings at the end of each month if large amounts of Tether have been issued that month, which then causes the price of Bitcoin to drop near the end of each month. The authors present evidence that out of the 24 months in their sample, the end of month effect is indeed found to be statistically significant.
But the paper doesn’t seem to account for other possible reasons why this end of month effect might arise. And the authors admit themselves that once the two most significant months, December 2017 and January 2018, are dropped, end-of-month effect fails to be statistically significant.
In other words, this part of their conclusion is based upon two outliers in a small sample size of 24. That isn’t particularly convincing.
Second, the authors observe that the Tether flowing from one cluster of whale accounts (known as 1LSg) on Bitfinex favor trading just below cut-off Bitcoin prices of around $500 increments. Using a statistical model, the authors found a large effect of these whales' trading on Bitcoin price within a three-hour window, and the effects are stronger after new Tether authorization.
The authors interpret this finding to be evidence of price manipulation. But it is widely known that whales can move short term crypto prices due to exchange slippage, so this part of the paper does not seem to contribute to its main thesis.
Overall, the paper does a very poor job of convincing us that Tether is manipulating the market.
Assessing Manipulation Claims: Our Own Research
To provide more context around the question, LongHash decided to pursue our own research on this topic.
To measure the impact of Tether on the Bitcoin market, we calculated a metric called Tether Purchasing Power, which is defined as the market cap of Tether divided by the market cap of Bitcoin. It measures how many Bitcoins can be purchased with all the Tether supply in the market at its current spot price. The higher the ratio, the more potential manipulation could have been perpetrated with Tether.
In the graph above, we can see that during the bull market of 2017, Tether Purchasing Power increased up until the summer, and then gradually declined until the end of the year. Then it shot up considerably during the bear market, reaching its peak at the end of 2018.
This suggests that even if Tether were indeed manipulating the market, its ability to do so actually is strongest when the Bitcoin price falls. This contradicts the claim that Tether issuance drove the 2017 bull market. The supply of Tether actually failed to keep up during the height of the bull market.
Given that stablecoins besides Tether, many of which follow different issuance mechanisms and have different transparency guarantees, are entering the market, it is even more difficult now to argue that Bitcoin prices are driven by Tether.
Below we've plotted the market share of Tether in the stablecoin market. We see that over the course of 2018, new stablecoins gradually emerged and started to grab market share from Tether, although this trend seems to have reversed a little since the beginning of 2019.
We find the current evidence that Tether is manipulating Bitcoin prices to be lacking.
Furthermore, our original research suggests Tether’s potential influence on Bitcoin prices to be maximal during bear, not bull, markets. As more and more stable coins enter the marketplace, some of the controversies surrounding Tether may also gradually dissipate.