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Bitfinex – What next?

August 4, 2016

Wow.  Someone seems to have stolen 120k bitcoin from Bitfinex.  This blog post will assume that you have read something else about the details, and will go into what happens next.

So what next?  I think in the end decent things are going to happen.  There are two big differences with the Mt. Gox situation.  The first is that the Bitfinex management is basically honest whereas the Mt. Gox management wasn’t.  The second is that Mt. Gox was located in Japan, rather than the BVI, and BVI has a legal system for handling this sort of thing that’s much more widely known than in Japan.

Now just a quick note.  My interest in this is that I had a small amount of fiat on Bitfinex, and I’m trying to figure out what I need to do to get all of it back.  One of the basic questions that is in this situation is will the bitcoin losses be spread among all account holders, or just with the bitcoin holders.  Obviously I’d prefer the latter.  Now one thing that I try to do is to play both offense and defense and try to argue both sides.  Now in the course of thinking about things both ways, I’ve come up with a few legal strategies and arguments that might work if I was on the other side, but it’s not in my interest to make things easy for you if you happen to be on the other side of the table, so keep in mind there are a few things that I’m not mentioning.

OK.  First some definitions.  People tend to use the term “bankruptcy” to mean something much broader than it means legally.  The legal situation is “insolvency” (i.e. you don’t have the money to pay your bills.  Bankruptcy is one possible way of dealing with insolvency, and it means something different in US law and English law.  In US law, bankruptcy is part of saving the company.  In English law, bankruptcy is the process of dealing with a company that’s dead.  It turns out that all of the jurisdictions that Bitfinex is involved with follow English law.  If you use the definition of “bankruptcy” under English law, then I’m about 75% sure that Bitfinex can avoid a bankruptcy.  By contrast if it was a US company, it’s likely that someone right now is filling out a bankruptcy petition which would be filed in the next two to three days.  Bankruptcy just has a different definition.

Now the first question what law applies.  It turns out that there is a standard operating procedure which was come up by one of the few parts of the United Nations that actually does something productive.  There are some model procedures which were come up by the United Nations Commission on International Trade Law (UNICTRAL).  Basically you start with the place where the company does most of its business, and the courts in that location are the leaders of the insolvency process, and if there are legal proceedings in other places, those courts try to cooperate.   So based on where Bitfinex is doing business it looks like they can either have the BVI courts take the lead or the Hong Kong courts take the lead.  Personally I’m hoping that they can do this in HK, because resolving issues like this is something that HK is good at doing.  From a legal point of view, it doesn’t matter if it happens in BVI or Hong Kong because both places use more or less English law and it’s more or less the same.  Now if it turns out that they want to deal with this in Germany or Poland or Saudi Arabia, then what I say next doesn’t matter.

One reason people like to do these sorts of things in BVI or Hong Kong is that since its more or less English law, there are a lot of lawyers that can figure out what’s going on.  One difference with Mt. Gox is that because Mt. Gox was in Japan, you had to use Japanese law and that’s a problem if you don’t live in Japan.

So the first question is who owns what…..

Now the legal situation, under English law, is that when I gave Bitfinex fiat to deposit, that money didn’t become Bitfinex’s.  There was an understanding that if I deposit US dollars with Bitfinex they wouldn’t do anything with the money other than deposit in some place for US dollars.  This means that Bitfinex doesn’t completely own the money, Bitfinex manages the money, but I’m the beneficial owner, so you’ve created a trust.  Note that this relationship is completely different than a bank.  When you deposit money in the bank, you are letting them do “bank stuff” with your money, and so they become the owners of the money, and they owe you money.

This matter because it so happens that Bitfinex took my money, put it into a bank account, and that money is still there, and since I’m the ultimate owner of the fiat, it’s my money and I should get it.  The fact that bitcoin was stolen from Bitfinex hurts the people whose bitcoin was stolen, but Bitfinex can’t take my fiat and cover the losses of the people whose bitcoin was stolen, because Bitfinex doesn’t own that fiat.

An analogous situation would be if two people left luggage at a storage locker, one suitcase gets stolen.  The storage locker can’t take one person’s luggage and give it to another.  This involves bailments rather than trusts, but the legal principle happens to be the same.

Note that this relies on the fact that we are dealing with English law.  If you have the same situation with another legal system, the outcome could be completely different.  Also, this seems to be a strong legal case, but there might be some loophole that I haven’t seen by which you could argue that there wasn’t a trust relationship.

OK.  So assuming that we are dealing with English law, I think its likely that I’m going to get all my money bank, but what about the people that held bitcoin.  Here there is a well defined process.

The first thing that happens is that you try to get everyone in a room and agree to some resolution to the problem.  This is called a “work out.”  It works for companies with a relatively small number of creditors, but this won’t work for Bitfinex because you just can’t get everyone in a room.

The next step is called a “scheme of arrangement.”  You come up with a proposal and go to a judge.  The judge schedules a meeting, and then you divide the creditors up into groups, each group having a common situation.  All the groups have to agree by a 75% vote weighted by amount owed plus a 50% vote by number.  If the creditors agree, the judge will order the restructuring of the company.

In this situation, the people that are owed bitcoin will have to agree to the plan, and they will have to accept some loss.  The reason that they would agree is that the alternative is worse.  If they vote no, then the company will be liquidated, and they will have only the amount of non-stolen bitcoin.  What’s worse, suppose the company is liquidated, and then magically someone finds the missing bitcoin.  Since the creditors have already been paid off, they won’t get any of that.

In order to get the bitcoin holders to agree, Bitfinex may offer some sweetener.  For example, maybe shares in the company, or a share of any lawsuits against third parties, or something like that.  But Bitfinex has to come up with a plan, there is a meeting and a negotiation, and ultimately some judge has to approve.

OK.  Suppose that doesn’t happen.  At that point, you go full bankruptcy.  A judge appoints a liquidator, the company’s assets are auctioned off, and the creditors get whatever they can.

One thing that I haven’t mentioned is where the judge is.  It could be BVI, but I’m really hoping its Hong Kong, because I’m hoping that people can see that Hong Kong is the place where people deal with corporate issues sensibly.  It turns out that this process will likely last a few months, and while lawyers will make money off this issue, lawyers in Hong Kong are relatively speaking inexpensive.  It turns out that HK lawyers are relatively inexpensive, because the law is usually pretty clear and sensible.  Also the judges know how to manage the court room so they try to make things efficient.

There is one important thing that I’d like to point out here.  We’ve had a major exchange fail,  but it’s not the end of the world.  We’ll spend the next few months working out the situation, but something sensible will happen, and the bitcoin world keeps going.  This should be compared to what happened in 2008, when one bank failed and then there was a domino effect that cause the world to collapse.  The other thing is that one reason the system works is that the money doesn’t go into a black box.  If you give Bitfinex US dollars, it’s with the understanding that they will just keep those US dollars as cash.  Same with bitcoin, if you give Bitfinex bitcoin, it’s with the understanding that they keep it as bitcoin.  It turns out because people aren’t treating things like a black box, the rules for what happens when something goes wrong are pretty clear.

Compare that with a bank.  When you put your money in a big bank, do you know what they are doing with your money?  I think there are some lessons to be learned here.

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