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07 August 2016

The Bitfinex Bail-in

What "we" (I have absolutely zero privileged or inside information, though I did have less than a bitcoin on "deposit at Bitfinex") don't know, that frames the discussion a lot about this is:

What does Bitfinex's balance sheet look like?

One strong argument that I see made is:

Basically they are insolvent and the thing to do is hand custody over, liquidate, and try to make customers as whole as possible. Creditors should be screwed before depositors. But who are the creditors? How much debt should be crammed down before we get to depositors? I'm guessing that number is vanishingly small.

Note: The rest of this comment basically assumes that the best "model" for this is that Bitfinex is a bank. It is the situation for which there is the most precedent, and what I think that this most resembles. If we choose a different model, then the scenarios look a bit different, but I still think the best outcome remains the same.

When we think about 2008, when basically EVERY bank found themselves in this position, the "solution" was to force a sale of that bank, bigger bank, that would absorb the losses (usually with a government guarantee). The biggest banks got to write IOU's to themselves, and everything moved on.

In this specific situation though, since we don't know what their balance sheet looks like, let's look at a couple scenarios for their cash position/flows, and speculate about what could be best. I am assuming that they do not have substantial structured debt (they likely have not issued bonds).

1: They are cash-flow positive and have some money in the bank.

They should use their cash on hand (their capital) to try to make depositors whole. Liquidation is not necessary, since there is a path to make depositors whole (I think this is the most likely current scenario).

2: They are cash-flow negative with a short runway.

a) They shutter operations, which costs more than their current runway (unwinding this is going to be a nightmare), and all depositors lose > 36%.

b) They go into receivership, possibly sold to another, bigger exchange that can... Oh wait, they are too big to... what? Oops. Good job us.

3: They are cash-flow negative with a big runway (a couple million dollars)

Use an appropriate amount of cash on hand to try to make depositors whole, issue the haircut, and we all hope they can earn out.

4: They somehow have more than $70mm in capital

a) They pretend this whole thing never happened. Take the loss against the capital, and move on (these companies lose money to fraud EVERY SINGLE DAY, this is how most of the cases are handled).

5: They decide to pull a cryptsy/gox and just delay and pray.

We're all screwed, unless we're not. This strategy was widely employed through 2008-(today?) by gobs of banks.

Banks lose their customers money and fail all the time: FDIC Failed Bank List

A couple guys at the top get fired, the branches change the signs on the buildings, the FDIC buys a bunch of pizza, everyone moves on.

Banks in the US buy big insurance policies for in case this happens. Small customers (under $250k) are protected. What seems "special" here is that the small-time depositors are getting the same treatment as bigger depositors would in a similar scenario. The "democratization of high finance" aspect of bitcoin that appeals to me most almost makes me proud to get put into this position. Achievement unlocked. Of course the absolute value of the money is not going to ruin me, since that would be reckless to have on an exchange (or frankly, in bitcoin at all), so oh well. I've had trading days where I lost double-digits in my portfolio. 36% is annoying, but I'm over it.

I may also be 100% wrong about all of this, since I don't have intimate knowledge of their financials. If someone has better info on that front that makes all this just ridiculous, I'm happy to hear it.