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


* Cost-sharing plan could breach Bitfinex terms and
conditions

* Lawyers say its compensation token also open to challenge

* Hackers stole $72 mln of bitcoin from Bitfinex user
accounts

* Some users say Bitfinex plan could still be best option

By Clare Baldwin

HONG KONG, Aug 15 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 said.

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 breach.

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

The exchange’s tokens could also be problematic, said Zach
Zweihorn, a lawyer at DavisPolk who specialises 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 licences
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.

“ROBBED”

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 said.

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

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