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”.