Is Bitcoin Really Untethered?

• Date: 01 August 2020
• Author: AMIN SHAMS,JOHN M. GRIFFIN
• DOI: http://doi.org/10.1111/jofi.12903
• Published date: 01 August 2020

THE JOURNAL OF FINANCE •VOL. LXXV, NO. 4 •AUGUST 2020

Is Bitcoin Really Untethered?

JOHN M. GRIFFIN and AMIN SHAMS∗

ABSTRACT

This paper investigates whether Tether, a digital currency pegged to the U.S. dollar,

influenced Bitcoin and other cryptocurrency prices during the 2017 boom. Using al-

gorithms to analyze blockchain data, we find that purchases with Tether are timed

following market downturns and result in sizable increases in Bitcoin prices. The flow

is attributable to one entity, clusters below round prices, induces asymmetric auto-

correlations in Bitcoin, and suggests insufficient Tether reserves before month-ends.

Rather than demand from cash investors, these patterns are most consistent with the

supply-based hypothesis of unbacked digital money inflating cryptocurrency prices.

INNOVATION,EXCESSIVE SPECULATION,AND DUBIOUS behavior are often closely

linked. Periods of extreme price increases followed by implosion, commonly

known as “bubbles,” are often associated with legitimate inventions, technolo-

gies, or opportunities. However, they can be carried to excess. In particu-

lar, financial bubbles often coincide with the belief that a rapid gain can be

∗John M. Griffin is at the McCombs School of Business, University of Texas at Austin. Amin

Shams is at the Fisher College of Business, Ohio State University.Helpful comments were received

from Stefan Nagel (the editor); an associate editor; two anonymous referees; Cesare Fracassi; Sam

Kruger; Shaun MaGruder; Gregor Matvos; Nikolai Roussanov; Clemens Sialm; and seminar and

conference participants at the Chinese University of Hong Kong, Cryptocurrencies and Blockchain

Conference at the University of Chicago, FBI CPA Conference, Financial Intelligence and Inves-

tigations Conference, Fintech Conference at the Hong Kong University, Hong Kong University of

Science and Technology, Hong Kong Securities and Futures Commission, Korea Advanced Insti-

tute of Science and Technology, Korean Financial Supervisory Service, Japan Financial Services

Agency, Santa Clara University, TexasBitcoin Conference, Tsinghua University, U.S. Commodity

Futures Trading Commission, University of Texas-Austin,University of Zurich, and Wharton Liq-

uidity Conference at the University of Pennsylvania. Integra FEC purchased data and provided

research assistant support for the project. Griffin is an owner of Integra FEC, which engages in

financial consulting on a variety of issues related to financial fraud, including cryptocurrencies.

See disclosure statement. We especially thank Tin Dinh for excellent conceptual assistance and

Prateek Mahajan for research assistance.

Correspondence: Amin Shams, Department of Finance, Ohio State University, 2100 Neil Ave,

Columbus, OH 43210; e-mail: shams.22@osu.edu.

This is an open access article under the terms of the Creative Commons Attribution-NonCom-

mercial License, which permits use, distribution and reproduction in any medium, provided the

original work is properly cited and is not used for commercial purposes.

DOI: 10.1111/jofi.12903

C2020 The Authors. The Journal of Finance published by Wiley Periodicals LLC on behalf of

American Finance Association

1913

1914 The Journal of Finance R

obtained from simply selling an asset to another speculator.1Perhaps because

of the focus on speculative activity rather than verifiable fundamentals, bub-

bles have historically been associated with various forms of misinformation and

fraud. For example, in the Mississippi Bubble of 1719 to 1720, promoters en-

gaged in false marketing about the potential of income-generating assets, price

support by the stock itself, and distribution of paper money that was not fully

backed by gold as claimed (Dale (2004), Kindleberger and Aliber (2011)). As

we briefly discuss in Section I, an abundance of evidence suggests that famous

bubbles such as the 1840s Railroad bubble, the roaring 1920s stock market

boom, the dot-com bubble, and the 2008 financial crisis all involved misin-

formation, false accounting, price manipulation, collusion, and fraud, often in

sophisticated forms.

Cryptocurrencies grew from nearly nothing to over $300 billion in market

capitalization in only a few years and fit the characterization of bubbles quite

well–extreme speculation surrounding an innovative technology. To many, Bit-

coin and other cryptocurrencies offer the promise of an anonymous, decen-

tralized financial system free from banks and government intervention. The

conception of Bitcoin corresponds to the 2008 to 2009 financial crisis, a time

of growing disdain for government intervention and distrust of major banks.

The promise of a decentralized ledger with independently verifiable transac-

tions has enormous appeal,2especially in an age when centralized clearing is

subject to concerns about both external hacking and internal manipulation.3

Ironically, new large entities have gained centralized control over the vast ma-

jority of operations in the cryptocurrency world, such as centralized exchanges

that handle the majority of transactions and stable coin issuers that can con-

trol the supply of money like a central bank. These centralized entities operate

largely outside the purview of financial regulators and offer varying levels

of limited transparency. Additionally, operating based on digital stable coins

rather than fiat currency further relaxes the need for these entities to estab-

lish a legitimate fiat banking relationship.4Trading on unregulated exchanges,

specifically on cross-digital-currency exchanges, could leave cryptocurrencies

vulnerable to gaming and manipulation.

In this study, we examine the role of the largest stable coin, Tether, on Bit-

coin and other cryptocurrency prices. Tether, which accounts for more Bitcoin

transaction volume than the U.S. dollar (USD), is purportedly backed by USD

1For example, in the bubble model of Scheinkman and Xiong (2003), investors purchase assets

not because of their belief in the underlying cash flows, but because they can sell the asset to

another individual with a higher valuation.

2The appeal, underlying value, and mechanics of cryptocurrencies and decentralized ledgers

have been described in recent descriptive and theoretical work (Yermack(2017), Sockin and Xiong

(2018), Cong, He, and Li (2019), Cong, Li, and Wang (2019)).

3Recent examples of apparently manipulated markets include LIBOR (Mollenkamp and White-

house (2008)), FX manipulation (Vaughan and Finch (2013)), gold (Denina and Harvey (2004)),

and the VIX index (Griffin and Shams (2018)). Kumar and Seppi (1992) and Spatt (2014)discuss

conditions that may facilitate manipulation.

4By May 20, 2018, over 1,600 cryptocurrencies and digital tokens were trading on various digital

exchanges.

Is Bitcoin Really Untethered? 1915

reserves and allows for dollar-like transactions without a banking connection,

which many cryptoexchanges have difficulty obtaining or keeping. Although

some in the blogosphere and press have expressed skepticism regarding the

USD reserves backing Tether,5the cryptocurrency exchanges largely reject

such concerns and widely use Tether in transactions.

To shed light on the driving forces behind the 2017 boom of cryptocurrency

markets, we examine two main alternative hypotheses for Tether: whether

Tether is “pulled” (demand-driven), or “pushed” (supply-driven). Under the

pulled hypothesis, Tether is driven by legitimate demand from investors who

use Tether as a medium of exchange to enter their fiat capital into the cryp-

tospace because it is digital currency with the stability of the dollar “peg.” In

this case, the price impact of Tether reflects natural market demand.

Alternatively, under the “pushed” hypothesis, Bitfinex prints Tether regard-

less of the demand from cash investors, and additional supply of Tether can

create inflation in the price of Bitcoin that is not due to a genuine capital flow.In

this setting, Tether creators have several potential motives. First, if the Tether

creators, like most early cryptocurrency adopters and exchanges, have large

holdings of Bitcoin, they generally profit from the inflation of the cryptocur-

rency prices. Second, coordinated supply of Tether creates an opportunity to

manipulate cryptocurrencies—when prices are falling, the Tether creators can

convert their large Tether supply into Bitcoin in a way that pushes Bitcoin up

and then sell some Bitcoin back into dollars in a venue with less price impact to

replenish Tether reserves. Finally, if cryptocurrency prices crash, the founders

essentially have a put option to default on redeeming Tether, or to potentially

experience a “hack” or insufficient reserves where by Tether-related dollars

disappear. The “pushed” and “pulled” hypotheses have different testable im-

plications for capital flows and cryptocurrency returns that we can take to the

powerful blockchain data.

We begin our exercise by collecting and analyzing Tether and Bitcoin

blockchain data using a series of algorithms that reduce the complexity of

the blockchain. In particular, because of the semitransparent nature of the

transaction history recorded on the blockchain, we are able to use variations of

algorithms developed in computer science to cluster groups of related Bitcoin

wallets. Large clusters are then labeled by identifying certain member wal-

lets inside each group and tracking the flow of coins between major players in

the market.

Figure 1plots the aggregate flow of Tether among major market participants

on the Tether blockchain from its conception in October 6, 2014 until March 31,

2018. The size of the nodes is proportional to the sum of coin inflow and outflow

to each node, the thickness of the lines is proportional to the size of flows, and

all flow movements are clockwise. Tether is authorized, moved to Bitfinex, and

then slowly distributed to other Tether-based exchanges, mainly Poloniex and

Bittrex. The graph shows that almost no Tether returns to the Tether issuer to

5For example, see posts by Bitfinex’ed account at https://medium.com/@bitfinexed and Popper

(2017).