Bitcoin still a very risky asset class as Bitfinex removes 36% of customer balances

The demise of Japanese Bitcoin exchange MtGox is a distant memory to most traders and FX industry professionals, demonstrating the short memory that many FinTech and trading innovators have when it comes to the potential risk of new ventures involving unbacked peer to peer asset classes.

As recently as April 2014, MtGox began liquidation proceedings as a result of 850,000 Bitcoins, valued at the time at a staggering $450 million had been stolen from the exchange’s hot wallet in late 2011.

The Chief Executive of Mt. Gox, Mark Karpelès, said technical issues opened up the way for fraudulent withdrawals and whilst legal action and criminal trials ensued, customers were left high and dry.

This has not dissuaded the development of Bitcoin technology, however, and the demise of MtGox, the first and largest Bitcoin exchange as well as the federal law enforcement agencies in the US having closed anonymous marketplace Silk Road down and arrested its operators, development of the blockchain database technology that underpins Bitcoin has continued with massive investment from banks (for their own technological development purposes) and venture capital investors.

In some respects, the attraction to blockchain as a method of automating certain procedures within financial institutions such as ledger, has been the savior of Bitcoin as the blockchain database which consists of data structure blocks which hold exclusively data in initial blockchain implementations with each block holding batches of individual transactions and the results of any blockchain executables, and is integral to and inseparable from Bitcoin.

Bitcoin exchanges continue to exist, however, and although one of the most successful examples, New York-based Coinbase, operated by Jaron Lukasiewicz, was sold recently with Mr. Lukasiewicz taking time out in California to enjoy the fruits of his (very clever) mind, leaving a handful of virtual currency exchanges in operation, one of which is Bitfinex.

Bitfinex last week was subject to a hacking incident which removed $72 million from its electronic platform.

Should traders or investors who are customers of an electronic trading company or FX brokerage which is regulated by a mainstream financial markets regulator and operates a platform that allows the trading of central bank-issued fiat currency, as per most FX brokerages experience a hack, which can indeed happen, the effects are less grave.

FinanceFeeds recently reported a fraudulent methodology in which hackers gain access to customer trading accounts and actually effect withdrawals by emulating usernames and passwords, and diverting funds to their own accounts, then the investors are protected by government initiative such as Britain’s Financial Services Compensation Scheme which covers each investment up to £50,000 in the potential event of a corporate demise or theft from the firm.

However as Bitcoin is not a centrally issued currency, there is no recourse should a hack take place.

For this reason, Bitfinex has now advised its customers that they will take a 36% hit on the assets that they had on the platform and would be compensated for the 36% reduction in balances by being given tokens.

The Hong Kong-based exchange stated to customers that losses that were sustained as a result of the theft would be shared, or “generalized”, across all the company’s clients and assets, widening the group of those affected announced last week.

“This is the closest approximation to what would happen in a liquidation context,” Bitfinex stated on its website early on Sunday. “Upon logging into the platform, customers will see that they have experienced a generalized loss percentage of 36.067 percent.”

The company said it would also give all affected clients a “BFX” token crediting their losses that could be redeemed by the exchange or for shares in iFinex, the exchange’s parent company.

This is a clear testimony to the continued interest in Bitcoin as a financial instrument by retail investors, even though the focus has generally moved toward institutional investment in technology by large banks and venture capital investors and away from the actual digital currency as an alternative asset class to fiat currencies, despite the risks associated with it.