University of Texas at Austin Study All But Confirms Tether Is Manipulating Bitcoin

Well, this is unexpectedly expected. A University of Texas at Austin study has alleged that the questionable USD backed cryptocurrency Tether is responsible for affecting the price of Bitcoin.

If you're a cryptocurrency investor, then you would know 2018 has been a rough year to be in crypto. Combined with a prolonged bear market after a meteoric rise in prices in 2017, 2018 has seen hit after hit on crypto from hacks to Mt Gox cashing out large amounts of Bitcoin and everything in between.

Paper authors from the University of Texas at Austin in the department of finance John M. Griffin and Amin Shams have taken an in-depth look at the secretive and suspicious cryptocurrency issued by Bitfinex' called Tether.

The abstract for the paper succinctly describes what the paper is about:

This paper investigates whether Tether, a digital currency pegged to U.S. dollars, influences Bitcoin and other cryptocurrency prices during the recent boom. Using algorithms to analyze the blockchain data, we find that purchases with Tether are timed following market downturns and result in sizable increases in Bitcoin prices.

Less than 1% of hours with such heavy Tether transactions are associated with 50% of the meteoric rise in Bitcoin and 64% of other top cryptocurrencies. The flow clusters below round prices, induces asymmetric autocorrelations in Bitcoin, and suggests incomplete Tether backing before month-ends.

These patterns cannot be explained by investor demand proxies but are most consistent with the supply-based hypothesis where Tether is used to provide price support and manipulate cryptocurrency prices.

The paper goes into a bit of detail about the study, how they analysed the blockchain data and determined their outcome. I want to discuss a few pullouts here to make things a little more digestible.

The intent of this post is not to analyse every detail uttered in the paper (it's massive), but share some of the thought around Tether manipulating the price of Bitcoin and how they possibly do it.

On page #3 of the paper, the author shares a bit of information on the motivations and actions that arise from selling or buying Tether and how it can affect the price of Bitcoin.

First, if the Tether founders, like most early cryptocurrency adopters and exchanges, are long on Bitcoin, they have a large incentive to create an artificial demand for Bitcoin and other cryptocurrencies by 'printing' Tether. Similar to the inflationary effect of printing additional money, this can push cryptocurrency prices up.

Second, the coordinated supply of Tether creates an opportunity to manipulate cryptocurrencies. When prices are falling, the Tether creators can convert their Tether into Bitcoin in a way that pushes Bitcoin up and then sell some Bitcoin back into dollars to replenish Tether reserves as Bitcoin price rises.

Finally, if cryptocurrency prices crash, Tether creators essentially have a put option to default on redeeming Tether, or to potentially experience a ’hack’ where Tether or related dollars disappear.

This is one of the simplest and digestible explanations on how Tether possibly affects the price of Bitcoin by creating artificial demand for Bitcoin by print more Tethers. Like a yo-yo, when Bitcoin falls they can sell Tether for Bitcoin which drives the price up and when it goes up, sell it for Tether again. It's a form of money laundering when you think about it.

Before we get into the meat and potatoes of the study, on page #3 of the report the dataset and where the data came from is shared:

we grouped over 680 thousand wallet addresses as Bitfinex, 950 thousand addresses as Poloniex, and 1.4 million wallet addresses as Bittrex

Given the elusiveness of Bitfinex and Tether, it's impossible to obtain true precise data, but there is enough from wallet addresses at exchanges to be able to assess the effect Tether has on prices.

In the first shared figure in the paper, we see how Tether flows between major exchanges and participants from the Tether genesis block to March 31, 2018. The size of the nodes is proportional to the sum of coin inflow and outflow to each node and the thickness of the lines is proportional to the sum of coin inflow.

_{Image used from provided research paper}

The flow goes like this:

• Tether is created
• Tether is then moved to Bitfinex
• Tether is slowly moved out to other crypto exchanges (mainly Poloniex and Bittrex)
• No Tether ever returns to the Tether issuer to be redeemed, and the only exchange where Tether can be exchanged for USD is Kraken, which as you can see accounts for a small portion of transaction volumes

Further down in the report, the paper essentially correlates periods of negative Bitcoin return to Tether flow and subsequently price effects driven by issuing Tether.

following periods of negative Bitcoin return, Tether flows to other exchanges are used to purchase Bitcoin. Second, these flows seem to have a strong effect on future Bitcoin prices. They are present only after periods of negative returns and periods following the printing of Tether, that is, when there is likely an oversupply of Tether in the system

A placebo test finds no evidence of Bitcoin price movements following large flows of Bitcoin from Poloniex and Bittrex to major exchanges other than Bitfinex. This phenomenon strongly suggests that the price effect is driven by Tether issuances.

Things really start to get interesting when the research focuses on the data and price movements with a more fine-grained microscope.

To illustrate the potential magnitude and predictive effect of Tether issuances on Bitcoin prices, we focus on the hours with the largest lagged combined Bitcoin and Tether flows on the two
blockchains.

These 87 hours have large negative returns before the flows but are followed by large return reversals. These 87 events account for less than 1% of our time series (over the period from
the beginning of March 2017 to the end of March 2018), yet are associated with 50% of Bitcoin’s compounded return, and 64% of the returns on six other large cryptocurrencies (Dash, Ethereum
Classic, Ethereum, Litecoin, Monero, and Zcash).

A bootstrap analysis with 10,000 simulations demonstrates that this behavior never occurs randomly

Rounding off the above observations the paragraph concludes:

Consistent with Tether being used to buy Bitcoin when prices drop, we find a statistically and economically strong reversal in Bitcoin prices, but only following negative returns. The Bitcoin reversal did not exist before Tether was prevalent in the market and disappears during the period when Tether stops being printed.

Echoing concerns that many have had about Tether, including its unwillingness to have its own books audited by a third-party, the paper goes on to say:

If Tether is pushed out to other crypto exchanges rather than demanded by investors with dollars in hand, Tether may not be fully backed by dollars when issued.

Analysing its limited dataset the report then unofficially confirms that Tether is not being printed proportionate to investors handing over real US Dollars.

Our results are consistent with Tether being pushed out onto the market and not primarily driven by investors' demand, but we nevertheless further examine two direct implications of the
'pulled' hypotheses

Concluding its research into Tether price manipulation the paper then goes on to say:

Overall, we find that Tether has a significant impact on the cryptocurrency market. Tether seems to be used both to stabilize and manipulate Bitcoin prices

Our findings suggest that market surveillance within a proper regulatory framework may be needed for cryptocurrency markets to be legitimate stores of value and a reliable medium for fair financial transactions. Additional research is necessary to further understand these markets

Conclusion

Like any unreviewed research papers, there may be inaccuracies and undiscovered flaws in the methodologies and algorithms used in the creation of this paper. The information contained in this post and subsequent paper should be held to a high level of scrutiny.

But it doesn't take an academic to see Tether has been operating as a shady business since the beginning and its continual secrecy and non-willingness to open its books to a third-party under an extensive audit just further add to the red flag pile.

The paper calls for the need for regulation and while many cryptocurrency proponents are against the idea of government intervention, financial products like Tether claiming to be backed by actual US Dollars should be held to a high regulatory standard. Tether is not a cryptocurrency in my opinion and like ICO's already are, should be regulated.

Do you think Tether needs to be regulated and are you concerned of the alleged manipulative effect it has on Bitcoin prices and other subsequent cryptocurrencies?