‘Grumpy hold-outs’ could sink Bitfinex recovery plan after Bitcoin theft

A Bitcoin (virtual currency) paper wallet with QR codes and a coin are seen in an illustration picture taken at La Maison du Bitcoin in Paris, France, May 27, 2015.  REUTERS/Benoit Tessier/File Photo
illustration photo shows a Bitcoin (virtual currency) paper
wallet with QR codes and a coin are seen at La Maison du Bitcoin
in Paris


By Clare Baldwin

HONG KONG (Reuters) – Crypto-currency exchange Bitfinex’s plan to
impose losses on all its trading clients for the theft by hackers
of $72 million in Bitcoin rests on two flawed pillars, according
to lawyers.

The Hong Kong-based exchange said on Aug. 2 that hackers had
stolen 119,756 bitcoins from some clients’ accounts, the
second-biggest such hack in dollar terms, and later said it would
spread the losses across all its customers, whether or not they
had been hacked or even held bitcoin.

It said customers would forfeit 36 percent of their holdings and
be given “BFX tokens” instead that could be redeemed by the
exchange or converted to shares in its parent company iFinex.

Both elements of the plan are open to legal challenge, lawyers

Imposing losses on customers who were not hacked appears to go
against the company’s terms of service, said Ryan Straus, a
Fenwick West lawyer who advises financial technology
companies on regulation and co-authored the U.S. chapter of a
book on bitcoin law.

The terms state “bitcoins in your multi-signature wallets belong
to and are owned by you”, which Straus said implied a special
banking relationship with clients that the Bitfinex plan would

“The depository … is obligated to return, on demand, the same
monetary objects deposited,” he said, quoting a line from his

The exchange’s tokens could also be problematic, said Zach
Zweihorn, a lawyer at DavisPolk who specializes in U.S.
securities and trading laws.

The way they are currently being described – redeemable by the
exchange or convertible to shares in iFinex – places them
somewhere between a bond and a security and makes it highly
likely that issuing them and trading them would require licenses
in the U.S. that Bitfinex doesn’t have.

“If they are issuing an equity interest in their parent company,
I don’t really think the fact that it’s evidenced through an
electronic token … really changes the analysis of whether it’s
a security,” said Zweihorn.

The U.S. Securities and Exchange Commission did not return a
request for comment.

Bitfinex did not respond to requests for comment on either issue.


Bitfinex’s website acknowledges there are “protocol level
details” still to be worked out for the tokens, and that U.S.
residents can sell but not buy them for the time being.

“I feel like I was robbed,” a 33 year-old investor who had a
five-figure U.S. dollar amount on the platform told Reuters.

He said he took a 36 percent “haircut” across all assets,
including U.S. dollar reserves, and as a U.S. trader he couldn’t
properly deal in the IOU token.

“Basically they took customers’ funds in order to try to stay
afloat. Nowhere in their terms of service did it mention that
this was a possibility,” said the user, who works in the
financial services industry.

Bitfinex is nevertheless hoping that traders will be patient and
accept that they won’t get a better deal if legal challenges
force it into liquidation.

“This is the closest approximation to what would happen in a
liquidation context,” it told traders in a blog post a week ago,
while the tokens gave them some hope of ultimately recovering
their losses.

Traders will be aware of the fate of Tokyo-based crypto-currency
exchange Mt Gox, which suffered the biggest bitcoin theft of all
time in 2014, and consequently went bankrupt. Traders have not
recovered any losses, and court proceedings are still ongoing.

“People are afraid to see their assets completely frozen if they
sue Bitfinex too early,” said 28-year-old Nathan Bourgeois, who
is based in France and moderates a 2,000-member traders’
messaging group called Whaleclub under the username dr Helmut.

He said he thought people would agree to the deal if there was a
chance of getting some of their money back.

But Patrick Murck, a fellow at Harvard University’s Berkman Klein
Center for Internet Society, said the Bitfinex plan was
unlikely to survive a legal challenge.

“It might be a pyrrhic victory. You might still end up with less
money,” said Murck, who is also co-founder of the Bitcoin
Foundation and its former general counsel, but the “odds are
fairly low” that nobody will test it in court.

“It takes one grumpy hold-out … to blow the whole thing up,” he

(Reporting by Clare Baldwin; Additional reporting by Hera Poon
and Tris Pan; Editing by Will Waterman)

Read the original article on Reuters. Copyright 2016. Follow Reuters on Twitter.

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