Beware the Bitcoin Bail-In

Imagine that, just before you read this article, you received an email from a financial institution where you have a substantial trading account…

The email said other accounts had been hacked, but not yours. Nevertheless, the financial institution was deducting 36% of your holdings and replacing them with shares in its parent company — shares that you can’t trade. You just have to hold them and hope for the best.

How would you feel? How do you feel just imagining it?

Probably a lot worse than the clients of Cypriot banks, who had to forfeit between 6.75% and 9.9% of their account holdings as part of the infamous “bail-in” of 2013. Besides the fact that the percentage is much larger, your bail-in was totally unexpected. Nobody saw it coming.

And there’s nobody to whom you can complain. The financial institution is unregulated. There’s no backstop and no clear rules. You’re entirely on your own.

That’s the situation increasing numbers of us are in these days … a situation we were promised wouldn’t happen.

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Bitter Bitcoin Irony

The “genesis block” of bitcoin — the very first block of that cryptocurrency’s blockchain — contains the following statement in hexadecimal code: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.” That was the London newspaper’s headline on that date.

The reference is unmistakable: Fiat currencies and mainstream banks are unsafe. If something goes wrong, your money may be on the hook. Bitcoin is the answer. As one analyst put it:

Bitcoin presented a choice that has never existed before. Its mysterious creator Satoshi Nakamoto described it as “a distributed system with no single point of failure” where “users hold the crypto-keys to their own money and transact directly with one another, with the help of the P2P network to check for double-spending.” The white paper published under pseudonym was a promise. Bitcoin, which became operational in 2009, was its fulfillment. The promise was to build security through cryptographic proof, replacing third-party trust and creating networks resilient to counter-party risk.

That promise is surely a bitter irony for customers of Hong Kong-based bitcoin exchange Bitfinex, who have lost more than one-third of their money as a result of a hack.

Stealing From Clients: Not Just for Banks Anymore

On August 2, Bitfinex said that hackers had stolen 119,756 bitcoins from some clients’ accounts. It was the second-biggest such hack in dollar terms, after the 2014 hack of bitcoin exchange Mt. Gox.

Bitfinex later said it would spread the losses across all its customers, whether or not they had been hacked — or even held bitcoin. Customers would forfeit 36% of their holdings. As compensation, they’d receive “BFX tokens” that could be redeemed by the exchange someday, or converted to shares in its parent company.

It’s exactly the same sort of “haircut” that Cypriot bank customers received in 2013, with one essential difference: It’s unilateral and not governed by any law. Bitfinex just made it up.

Bitfinex’s terms of service say “bitcoins in your multi-signature wallets belong to and are owned by you.” That’s a clear statement of a banking relationship with its clients, in terms of which “the depository … is obligated to return, on demand, the same monetary objects deposited.” The 36% haircut of its clients, in other words, is “theft” as defined by Bitfinex.

Moreover, compensatory “tokens” redeemable by the exchange or convertible to shares are something between a bond and a security. In the U.S. at least, that requires licenses that Bitfinex doesn’t have.

Free Markets Can Be Costly…

So what are Bitfinex clients to do?

Unregulated cryptocurrency exchanges like Bitfinex exist in the free-market nirvana we’re told is the solution to all of our problems. Bitfinex is free to innovate … as it has clearly done in response to this hack.

In this regulation-free context, Bitfinex clients have the choice of accepting the company’s 36% fait accompli or suing. But if just one client goes to court, the company will almost certainly be placed in receivership, and all accounts will be frozen pending the outcome. Given that clients of cryptocurrency exchange Mt. Gox — which suffered the biggest bitcoin theft of all time in 2014 — are still waiting to be made whole pending ongoing court proceedings, that isn’t much of a choice.

…But They Remain the Only Answer

Many of us love bitcoin and other cryptocurrencies. They promise the freedom we all desire.

But large-scale trading of cryptocurrencies has recreated the exact problem bitcoin was meant to solve: a “single point of failure.” Instead of “users hold(ing) the crypto-keys to their own money and transact(ing) directly with one another,” the global cryptocurrency market is dominated by massive exchanges that operate exactly like banks, except that they are unregulated and make their own rules.

A while back I wrote an article about the looming danger of blockchain-based currencies. They promise to do away with banks, but would be vulnerable to arbitrary government interference … and confiscation.

What are we to do, then?

As one cryptocurrency analyst has put it: “Problems of centralization cannot be solved through the same modes of thinking that created them. Instead, solutions require innovation from below.”

As I write, and as you read, developers are working furiously to create a mechanism for ordinary people to trade cryptocurrencies without centralized exchanges that function exactly like banks, with all their vulnerabilities. Theirs is an open-source project that can be studied, modified and freely shared, not a private money-making business. Until they succeed, my advice is to keep your bitcoin and other cryptocurrency investments modest.

Unless, of course, you fancy a 36% haircut out of the blue.

Kind regards,
Beware the Bitcoin Bail-In
Ted Bauman
Editor, The Bauman Letter

  • Mabel Gerhardt

    what about one coin?

  • iliad007

    There are 500+ cryptocurrencies available now. If people expect crypto to be used as a medium of monetary exchange it’s impossible. You’re talking about a trading platform 100 times more complex than the FOREX market.

  • William

    I have very little money in banks or in the stock market. I have it stashed in CASH. I know that is where the biggest part of our nations debt lies due to Obama using it to prop up the stock market. They need to start selling off little by little if not and it goes FLOP again the FED is going to be hurting big time. They will turn huge profits if they can sell everything that they invested and even pay off the national debt and have plenty to spare as the stock market was way down back then and returns would be very good. Don’t dump it all at once if they do it will crash for sure.

  • christopher beach

    hard wallet

  • marcospolo3

    “Probably a lot worse than the clients of Cypriot banks, who had to forfeit between 6.75% and 9.9% of their account holdings as part of the infamous “bail-in” of 2013”.
    Thats not bad if you had made 30-40% interest for the last a few years.

  • seriouslynow

    Bit coin success in the early to middle stages is like a thermometer of the morality and ethics of the world’s currency. Remember when Obama had made a deal to get Iran $1.5 or was it $2.5 BILLION and the Berlin Connection-then back to Iran–it was messy, however using my rule that “cheaters have the most rabid fans- as long as they are winning”, the story “wore out” , oh . our world is full of cheaters
    would have been a much cleaner with one agent dropping off a coin or two. I also look at the coins mania as a huge buy signal..for silver. Why are ‘s Carlos Slim of the world are boring!! His traders could slowly accumulate silver taking delivery in odd spots manned by ex seals and the right weapons. Before all of this, get some men onto the board of directors- or the group setting Margin., so that the sellers cannot do the trick pulled on the Hunt Brothers .No this time,A LL THE SHORTS, IF they call for all cash- Slim writes the check- yet as it backfires and silver goes vertical-
    with no cave in, as no delieveries can be made because they are truly hidden and protected. So, Slim, why NOT have some fun, who here would rather be long bitcoins or silver of deposits, after one has bought out all the shares in the miners,, VIX, calls in the slv coins etc. goes higher

  • seriouslynow

    WARNING: There is an article out there about the easy money short puts.
    23 year on floor Options trader..
    Being short Puts allows smarty pants with no ability to see the “what ifs” , well I have seen men destroyed being short puts- how dare anyone think for a second that he is guaranteed to get them back?? Long calls- a good run- Feel good.
    A portfolio of short puts, with the event of N Korea getting close to San Fran at 3 am in the morning and the market won’t open, in about 5 minutes you are “a cheatin way of going out of biz, because the numbers are so horrific ,that the American Tax payer will pay for your “easy money” which will be paid off the same way of the German’s wheelbarrow, not only , for the first time in your life you feel true panic, and realize , your “skill” had, since you opened any trade selling puts, put you, family, and making enough money to have that LBI shore House- you are wiped out- The wife’s hysteria,and the reality that ALL short Volatility players are NO DIFFERENT than very successful casino’s “Until the Flood came and took them all away” The only honest way to trade derivatives is to be long premium, knowing every day how well you have to inter day trade the stock, or the real skill, reading all the tea leaves for the next direction. Further more , as in 87 , when I had been getting calls to “lighten up my puts” as my account drained, which was a true honest loss on my part, Yet when someone spends a lot of money “owning the Puts” and it is finally payday, after being mocked/..almost out of Biz (The 87 Chart was looking at breaking the support line from 1929 but it did it’s duty of making as few a traders hang in even if they had predicted, but their last puts had expired…”Timing is everything” . Back to my point, the honest trader, payday of such multitudes it is bewildering,,,,knows full well that if it does not stop- not the market per se but the emotion of panic
    makers people “take the pipe” One of a few rules dad had- meaning going into the garage, close the door., and crank that Buick up) Who can tell me why Bill …… was in the Commerce Bank 1900 market street Phila, had a large suitcase,
    as he was yelling at the clerk to fill it with the largest bills they had. You see Bill was a winner, and I was a winner, but we each knew that another half day of the
    precipitous fall, that even winners, because the delusions of their “ignorant grandeur” put the winners in financial purgatory with no guarantee that the money won would ever be seen, or yes the cash is received but what is it’s worth?? Of course I realize that without “Volatility sellers of calls and Puts”
    I would not have been able to go long, it. However the risks of international black male I have said too much- there are no ways to margin a put, period. Oh I would love to debate short put lovers all day long. If you can’t make money being long , as an independent trader, in the medium term, walk away, and your comfort will be “I never traded on the “people’s” currency

  • ThomasXxs

    How is it that “our nation’s debt” is in cash? That’s pure nonsense. Cash is an asset, not a debt. If you think your cash is a debt, just stuff it all in a box and send it to me. I’ll be delighted to take all of your cash “debt” off your hands, for free!

    Just like the people who think paper money is “worthless” and must be redeemable in gold to have “real value”. More nonsense. If your paper money is truly worthless, then why does your local grocery store accept it as payment for real food and other products? You want to exchange your dollar bills for gold? No problem doing that either – it’s commonly known as “buying gold”.

  • gabi

    OMG!!! Fairly certain that no one else attempted to wade through your word-maze to the last one, I would like to offer a suggestion, nonetheless: Try using the “sentence” to convey ideas. These (sentences) usually begin with a CAPITAL-lettered word, have a SUBJECT, a VERB and frequently an OBJECT as well, all of which are followed with a PERIOD.

    Until you’ve mastered the construction of the basic 3-word “sentence, containing the SUBJECT, VERB, OBJECT (He bought bread.),” do not use fancy punctuation marks like the comma, colon, semicolon, ellipsis dots (…), or even quotation marks, all of which will invariably serve to further confuse the misfortunate reader, given that you now use verbs as nouns and nouns as verbs WHILE still using our “old” grammatical system of using verbs as verbs and nouns as nouns (You can see how confusing this “dual system” can be, right?)

    And, please, we beg you, leave biggies like “furthermore” (your “further more”) and “nevertheless” (I cannot imagine how you would construct this.) to the experts whom your “special” type of usage confuses to the point of loading their 45s so they can aim for their temples rather than to try to make further headway in your vomitus of random words appearing to be some sort of statement or (do I dare say it) explanation.

    On behalf of desperate READERS the world over, may I say “THANK YOU!”

  • gabi

    Well, not exactly.

    In 1975 you’re paid $700 in paper money (the cost of around 1 ounce of gold at the time). If you had been paid in gold instead of “worthless” paper, then TODAY you would still have your 1 ounce of gold! (worth roughly $2,100 of paper money today)

    Whereas, with that PAPER $700, today you would have only 1/3 ounce of gold. Big difference.

    1 ounce gold = 1 ounce gold – – always ☻ ☺

    Paper money can become totally worthless = $0.00
    incapable of being “REDEEMED” for its “gold value”

    I’m not talking about interest rates or even the fact that gold’s value has increased to about 3 times the price it was in 1975 (all-time high)… just about the fact that IF we were paid WITH the COMMODITY which the paper REPRESENTS, then we would still/always HAVE that COMMODITY, which is a much BETTER DEAL (unless gold somehow became worthless and paper became treasured… hahaha, which MIGHT happen if we keep deforesting)!

  • TheoryOfDust

    Thank you! I did not think it was possible to run out of breath while reading, until I waded through the aforementioned post. Long live punctuation and grammar; may they rest in peace… {I meen “piece’) 😉

  • PL RTZ

    OMG. I could not have said that any better. That is classic i am saving this!

  • PL RTZ

    Gabi you sound like a prepper. I don’t know what country you are from but gold is 1275 an ounce. What you totally missing is gold does not pay a dividend or interest. Therefore it is a totally passive investment. There is a place for gold in a persons asset diversification, but beyond 5% is just silly. If you had bought lets say $700 of AT&T stock in 1975 that same investment which paid a fairly consistent 4% and reinvested in the stock it would now be worth $3300. That’s before appreciation, if we factor in the 2100% appreciation of the stock during the last 42 years from $2 inflation/split adjusted to now $38 and change, you would be at $63,000. Try doing that with cash stuffed in your mattress or passive investments like gold! Owning gold in bulk will only destroy your bank account and although cash is a very good thing to have, keeping it in cash is just silly. If by some crazy coincidence the world ends due to some catastrophe which everyone has incorrectly prophesied every year for the last 40,000 years or so, I promise you it won’t matter anyway. Otherwise invest your money like Warren Buffett. It’s the only way to beat the man.

  • PL RTZ

    You are correct sir.

  • PL RTZ

    You are not understanding history apparently. Yes if you bought stocks let’s say in 1999 and sold them in 2001 you would have lost a bunch and you can repeat that as much as you like. But that is not how a person invests in stocks. Stocks are purchased because you believe in the company’s products, it’s management team and it’s financials. You buy great companies at any price and you double up when you can buy at a discount when the market gives you a sale. If your time horizon is 12 months and I suspect yours may be you are correct, you should stay in gold forever. You will definitely lose money (read value) because inflation reduces the value of your gold and cash over time, but you will be able to sleep at night I suppose. But for those who invest in stocks we do it for long term capital gains and while I am no warren buffet or Paul M for that matter, I have earned seriously spendable cash over the long haul which has put my kids through college, my wife and I with solid cash which we bought real estate and other tangibles. And 5% of our investments in gold, but beyond that it is just silly.

  • PL RTZ

    Or you can just go to casino and put it all on black, you have about the same odds.

  • William

    Why don’t you learn to read. I stated I have most of my wealth in CASH I will add this plus real estate. Then stated that the biggest part of our nations debt was due to Oblowzo aka Obama. He made to may blunders to start with as president inexperienced with handling money. Gold is a commodity and it can either go up or go down for the last several year it has been stationary but did rise about 6 to 8 year ago. Paper money is not worthless unless it is burnt. Go play your stock games and when you are broke as a joke don’t come crying to me.

  • William

    WRONG! Gold is worth $1,292.90 an ounce!

  • Carlos Cruz
  • Shane M. Cook

    u want good data or good punctuation ??

  • GENE SLIGH

    thats stock market “LINGO”.Have you ever traded “PUTS”and “SHORTS”?

  • RKRRobinson

    I’m glad you’re a good writer. Somebody needs to go around and pick on people for their lack of skills.
    If you didn’t understand it, then you probably don’t understand trading, though It could have been written better. I like to speed past the holes and my brain fills in the blanks.

    “Yeah. but he can type 500 words a minute!!!”

    Yet it took you 30 mins to write 3 paragraphs LOL! “you so funny”

  • RKRRobinson

    I figured that out years ago after I saw them being traded for profits. Traders influence the values of goods almost as much , and maybe more than consumers of those goods or products. So how can it be a stable system if it’s traded like gold and beans. That makes bitcoins worth beans to me. Trading them as a commodity is the bad part. So its a No for me, thank you!