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 algorithms 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 autocorrelations 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. JEL Codes: G14, G23, G29.

I. Overview of Bubbles, Bitcoin, Tether, and Hypotheses

 Speculative Bubbles and the Prevalence of Dubious Market Activity

Periods of excessive price speculation often share the themes of optimism around a new technology, focus on selling to others rather than economic cashflows, and questionable activities. The famous South Sea Bubble of 1719-1720 is often described as a sophisticated Ponzi scheme where old investors were paid high dividends not from operations, but from new stock issuances with the hope of higher prices at future issuances [Hutcheson (1720) and Temin and Voth (2013)]. Scheinkman (2013) notes that there were also many other similar com Electronic copy available at: panies around this time that seem to have been fraudulent. The Railroad Bubble of the 1840s led to a host of companies who merely sought to procure funds from investors and had no intention of actually building railroads [Robb (2002)]. In the Roaring Twenties, investment pools would manipulate a stock price through ‘wash-sales,’ collusion with stock-exchange specialists, and coordinated publicity from commentators in order to pump a stock at an inflated price to the public [Malkiel (1981)]. The technology or ‘dot-com’ bubble of 1997 to 2000 also contained strong elements of stock promotion through inflated forecasts from affiliated analysts [Lin and McNichols (1998)], pushing or ‘laddering’ prices through implicit agreements to purchase more IPO shares in the aftermarket [Griffin, Harris, and Topaloglu (2007a)], and accounting fraud (e.g., Enron and Worldcom). Hedge funds and other institutional investors were the main net buyers of overpriced technology stocks during this period [Brunnermeier and Nagel (2004) and Griffin, Harris, Shu, and Topaloglu (2011)]. One line of thinking is that more fraud exists in economic booms because individuals monitor their investments relatively less closely [Povel, Singh, and Winton (2007)]. Akerlof, Romer, Hall, and Mankiw (1993) argue that historical actors involved in ‘looting’ an organization (such as banks in the U.S. savings and loan crisis) moved capital into a space in a manner that systematically increases asset prices. In our analysis of Bitcoin and Tether, we are able to examine if either of these views fits the data.

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