On August 2nd, Bitfinex, by some metrics the largest Bitcoin exchange in the world, was hacked and 199,756 bitcoins (~$72m) were stolen. The Bitcoin price plummeted, and the industry gasped in horror, if not surprise, that yet another huge theft had occurred.
With fiery (and justified) condemnation, many fingers can be pointed. Bitfinex clearly screwed up epicly in its wallet management and oversight, and perhaps some blame lies with BitGo as well (Bitfinex’s wallet provider). Who all is precisely to blame, and in what portion, is currently unknown, but hopefully details will be forthcoming such that the industry can learn the exact mistakes made. Let’s let the forensic experts and investigators figure that out.
The most important aspect right now is that thousands of customers have lost a collective $72 million.
I am one of those customers. I had a very significant amount of funds in Bitfinex. ShapeShift is also a customer of Bitfinex, and will endure loss from this hack. I had a pretty shitty week coming to terms with this reality.
So I find myself in the boat with thousands of you now who are owed a fortune by Bitfinex.
I’m also in another boat… I was a victim of MtGox in its early 2014 collapse, losing over 500 Bitcoins in that horrendous mess.
Should I keep fewer funds on deposit with other parties? Yes, obviously. That lesson is an important one and worth repeating endlessly to Bitcoin noobs and veterans alike: Do not leave funds on deposit with other parties unless you fully comprehend and appreciate the counter-party risk you’re assuming. To the victims: this doesn’t mean the loss is “your fault,” but you indeed acted imprudently, and should change your behavior in the future.
Learn the lesson that Bitcoin keeps trying to teach.
What happens from here?
In the old days, pre-blockchain, a loss like this would result almost immediately in bankruptcy and receivership for the insolvent entity. This is the path that some in the community are now pushing for Bitfinex. The /r/bitcoin subreddit is replete with both amateur legal prognosticators (and legitimately frightened and angry victims) proclaiming that Bitfinex should be immediately forced into bankruptcy court.
Game over, Bitfinex, you shalt suffer the wrath of the courts, and justice shall be done upon you.
Indeed, this was the fate of MtGox.
And as a creditor/victim of MtGox, let me tell you how that’s worked out: horribly. In over two years since the hack, I have seen not a single dime of any “justice.” I have no expectation of seeing a dime soon, either. Perhaps, in 1 or 2 or 10 more years, I will get back something like 5% or 10% or 15% of my loss. Who knows. I’ve written it off.
Is this the traditional, formal, legal manner of dealing with such a grand loss at a custodial enterprise? Yes, it is. Has it helped me as a victim? No, it has not. That entire legal apparatus has done, to date, jack shit for me.
But you can bet that a micro-industry of lawyers has been happily feasting off the MtGox carcass, and you can imagine that such lawyers, who like all people act generally in their self-interest, would readily advise that the same fate befall Bitfinex. Years more of carcass-feasting, what could be better? Apparently over $5.5m has been paid to lawyers involved in the MtGox bankruptcy to date.
If Bitfinex is embroiled in lawsuits and forced into bankruptcy, the carcass-feasting will commence yet again. And yet again, victims will see precious little of anything. And it will be years of miserable inter-jurisdictional squabbling.
As someone who is owed a large amount of money by Bitfinex, I might suggest that we try to avoid that situation. And it is avoidable.
Bitfinex has made public the rough outline (yes, more details are needed) of an alternative plan: every depositor takes a 36% loss, and is credited with an equivalent number of BFX Coins representing the dollar value of the loss. $100 loss grants you 100 BFX Coin. Over time, Bitfinex as a profit making enterprise, would attempt to buy back those BFX Coins as close to face value as possible.
There are rumors such coins could, at the holder’s discretion, be converted into Bitfinex equity, though this is so far an unsubstantiated rumor, and sadly regulators may not like such a benefit going to victims. Convertibility to equity may be extended only to accredited investors and may exclude some jurisdictions.
In the best case scenario, victims will get all their lost money back in dollar terms. It may take a few months or ten years, nobody knows, but we’d be made mostly whole. And if the coins actually convert to equity, it’s possible the loss could turn into a profitable gain.
In the worst case scenario, victims end up with worthless tokens, and have fully suffered a 36% loss.
Both the best case and worst case scenario are better, in my opinion, than bankruptcy.
In fact, if forced into bankruptcy, victims will almost certainly get less than 64% of their deposits back (due to years of legal fees), and even that 64% will get tied up for years.
Thus the choice is this:
- Get 64% of your funds back in a matter of weeks, with a chance of getting some or all of the rest of it back in the future.
- Get 0% of your funds back in a matter of weeks, with a chance of getting something less than 64% of your funds back after a few years. And by the way, this option will cost you thousands of dollars in legal bills upfront.
I can’t fathom a reason to go for Option 2 unless you believe the Bitfinex leadership is evil and trying to scam everyone. I have seen zero evidence that this is the case, and frankly instead of throwing in the towel and allowing the enterprise to dissolve into bankruptcy court, the company is thinking creatively how to actually make users whole, or as whole as possible. Not everyone would do that. Many would give up and let the courts sort it out.
From what I know of the Bitfinex team (I know Phil and Giancarlo to some degree), they are good people. You don’t need to trust my judgement (indeed you don’t know them like I do so why would you?), but please avoid witch hunts when there does not appear to be any evidence of evil intent.
In full disclosure, Phil and Giancarlo (via Bitfinex) invested in ShapeShift’s round, though the amount invested is less than what me & ShapeShift are owed now as victims of the loss. If you want to know my motivation for this post, it’s not subtle: I want my money back, and I see both a possibly good outcome, and a horrible outcome that I’m currently living via the MtGox bankruptcy.
When life hands you lemons… tokenize them.
Beyond my self-interested desire to get as much of my money back as possible, there is another important facet to this discussion, however.
Bitcoin, or more specifically blockchain tokenization, is what enables the proposed Bitfinex Strategy: to tokenize the customer debt as an IOU, and let market participants hold, trade, and price that debt. This is innovative, and, if executed well, could be profoundly influential on the business world of the future.
If executed well (not guaranteed, of course), a successful BFX Coin resolution to the Bitfinex hack will separate this event from the Goxing of a few years ago. In both cases, ungodly losses as the genesis of a crisis. With Bitfinex and the tokenization of the debt + the operation of a profitable business in a growing industry, however, we can see how blockchains can be used in the real world to improve the lives of actual people. In this case, the blockchain will allow a debt to be more fully paid to a victim, far faster, with actual liquidity to address the time-preference of the debt-holders (remember, BFX Coins will be sellable for those who prefer immediate cash now).
If the Bitfinex strategy goes poorly, we’re all out 36%.
If the Bitfinex strategy goes well, we’re made mostly whole, and a unique, economically-valuable use-case of Bitcoin is demonstrated to the world.
If Bitfinex isn’t able to pursue its strategy – ie if some victims force the company into bankruptcy – we’re all screwed for the next few years, and the loss will be significantly greater than 36%.
With all that said, if Bitfinex doesn’t enable withdrawals of the remaining user funds within a reasonable timeframe (and reasonable may be a couple weeks or a couple months even), then the above analysis changes. Bitfinex needs to be transparent about plans and dates for withdrawals, and plans for resuming operations and earning profits to pay back BFX Coin holders.
As a victim of the hack myself, I will be making the personal choice to give some breathing room to Bitfinex to see if this strategy can be executed.
As a selfish creditor, given the reality of the loss, the Bitfinex Strategy is the best outcome I can reasonably expect. I don’t want the entirety of my account held up in court for years as carrion meat for lawyers. Goxing sucks, and that’s the alternative if Bitfinex is driven into receivership.
As an industry designing the future of finance, we can prevent Goxing from happening this time. We can explore a productive solution with the tools of the blockchain in front of us, or we can crawl back into the cold swamp of corporate litigation, and await the sinewy residue leeched from the carcass.
EDIT Aug 10 2016: Updated Gox legal fee estimate to $5.5m (had mistakenly heard it was $55m, apparently decimal mistake).