New York Attorney General Letitia James has accused cryptocurrency exchange Bitfinex of using undisclosed transactions that represented a conflict of interest in order to cover up $850 million in losses. Bitfinex is an online trading platform enabling cryptocurrency transfers, and is among the very few such exchanges that also allow people to deposit and withdraw fiat currencies such as dollars, pounds and yen. 

The issue involves a cryptocurrency called "Tether," which is said to be pegged directly to the U.S. dollar; one dollar equals one Tether token. The attorney general said that the purpose of this coin is to facilitate other cryptocurrency transactions: Traders can use Tether to trade between different currencies or across different trading platforms with minimal short-term price risk. In order to assure investors that Tether is indeed backed by the U.S. dollar, the entity that issues it has claimed that for every outstanding token issued the company will hold one U.S. dollar in reserve and, eventually, other assets as well. 

The attorney general's filing, an application for a court order, notes that the "small group of executives and employees" that controls Tether is the same one that owns the Bitfinex exchange. While investors were previously able to get tokens from the Tether website, from November to December 2018 they were available only via the Bitfinex trading platform. 

The attorney general said that Bitfinex and Tether had long had a fraught relationship with banks. Since both companies needed to hold large sums of U.S. dollars, they needed to maintain banking relationships so they could reliably hold and process client deposits and withdrawals. However, many banks would either decline to service them, or would at first agree but then shortly after go back on the deal and kick them out of their financial institution. This led them to eventually do business with a "(believed to be)" Panamanian entity, Crypto Capital Corp. (CCC) as a payment processor, placing over a billion dollars of co-mingled customer and corporate assets with the firm. This was apparently done with no contract or similar written agreement. Tether and Biftinex supplemented this relationship with a number of other agreements with third-party payment processors to handle client withdrawal requests, as well as executives and even friends of Bitfinex employees who were willing to use their own accounts to transfer money. 

The deal with CCC turned out to be a mistake, as around the middle of last year, Bitfinex was having great difficulty processing client requests to withdraw money because the financial institution either could not or would not release the funds. Executives at Bitfinex "beseeched" CCC to transfer the money back to them to little avail. CCC responded that they post as many transfers as possible to their partner banks but "every time we push them, they push back with account closure without reason." About a month later, after further pressing, CCC told Bitfinex that the funds had been seized by government authorities from Portugal, Poland and the United States. The attorney general said Bitfinex didn't believe CC, with a chat transcript with an executive saying that CCC should "stop playing and tell me what's really going on." CCC continued, apparently, to insist that it didn't have the money anymore and that governments had seized it. 

Meanwhile, Bitfinex kept telling investors that everything was fine and that any rumor otherwise was a targeted campaign to smear their company. Behind the scenes, though, executives were hurriedly coming up with a plan that would allow Bitfinex to take a $600 million to $700 million line of credit from the case reserves of Tether, which, remember, was owned by the same people who owned the exchange. There was no plan or schedule to repay this credit. This transaction would not be disclosed to the public. Executives did not consider this a conflict of interest, telling the attorney general's lawyers that it was an arm's length transaction, though providing no justification as to what made it so.

When the attorney general sent a letter asking for detailed information about this transaction, Bitfinex first said that it could not get it all by the March 7 deadline, and while it did respond to the questions about a week later, it came primarily in the form of tweets and blog posts by Bitfinex and Tether, none of which mentioned the transaction. So the attorney general asked them again about the transaction, the response to which was composed largely of screenshots and picture files of previously produced materials, none of which were relevant to the request. Then, on March 29, the company finally answered the questions, two days after the "line of credit" transaction had already closed. The description of the transaction, said the attorney general, differed significantly from what the company had said just weeks earlier. This raised even more questions, which the attorney general said have been poorly answered. In response, the office is now demanding a great deal of documentation concerning the company, its users, its accounts, its communications, and its transactions. 

The attorney general noted, however, that it is not interested in shutting down or otherwise interrupting the orderly operations of Bitfinex and Tether. Rather, it seeks a preliminary injunction and a court order requiring the companies to produce documents and information itemized in the application.

"Indeed, protecting legitimate traders using the Bitfinex platform, and legitimate holders of Tether, primarily those residing in New York, is why a preliminary injunction is necessary now to preserve the status quo pending the completion of the OAG's investigation," said the Office of the Attorney General (OAG) in its recent filing. "However, the OAG does seek to enjoin Respondents from taking any further actions to access, loan, extend credit, encumber, pledge or make any other similar transfer or claim between Bitfinex and Tether in order to preserve the status quo and protect the interests of New York Tether holders and Bitfinex clients."

It added that, because Bitfinex and Tether might immediately initiate a further loan if given advance notice of the order, the companies have not been given notice of the OAG's application.