On August 2 Coindesk reported a hacker stole some $60 million worth of Bitcoin from the Bitfinex exchange. Altcoins such as ETH, ETC, LTC on Bitfinex were not stolen by the hacker.
Bitfinex decided to “socialize” the losses in what they claim would be similar to a bankruptcy liquidation.
All account holders on Bitfinex at the time of the hack received the newly created BFX tokens equal to roughly 36% of their pre-hack balance in place of the losses.
The tokens were issued at a one token to dollar parity. For crypto currency balances the value was based on prices announced by Bitfinex.
Interestingly before trading was live the ticker already priced BFX at .80 per token–a 20% discount.
As of writing tokens are trading down around $.36.
But this low price creates an opportunity for the exchange Bitfinex. They could buy their own tokens back at a huge discount and then forgive their own debt.
Debt Buyback: An Example
Let’s say you borrow $100 from your friend Robert. You give Robert a piece of paper promising to pay him back (an “IOU”).
You fall on hard times and Robert is convinced you won’t make good on your promise to pay him back so he decides to cut his losses.
He sells the IOU to Susan for $25. Robert figures $25 is better than $0.
Susan holds the IOU for a little while but then decides she wants the money. She offers to sell the IOU for $30.
You could buy your own IOU back for just $30 and then forgive the debt to yourself.
In other words you’ve just gotten $100 for $30.
See where I’m going with this?
While no one voluntarily loaned money to Bitfinex in exchange for the BFX tokens my hypothetical example above is very similar to the position Bitfinex finds itself.
Bitfinex public relations man Zane Tackett claims they do not buy their own debt on the exchange.
I have no evidence that Bitfinex is buying their own tokens. But there is a strong incentive for them to do so.
BFX Token Losers
From my perspective the tokens are a huge disappointment.
The tokens pay no interest, no dividend, and there is no timeline on when the tokens will be repaid or even if they will ever be repaid.
“However, no property held back will be used to pay dividends to current shareholders unless and until our customers are repaid.” Emphasis Added.
The best people like me who were assigned the token can hope for is Bitfinex will pay the face value back in full as soon as possible.
I don’t see how the BFX tokens will ever be worth $1 or more via trade. If Bitfinex releases a legally binding repayment plan I could see the token value approach $1. For example, if Bitfinex announced BFX tokens would be repaid on 8/14/2016, they might trade up to $.99 per token leading up to the payout for people to make .01 per token in one day.
Why is that the case? Because a rational investor will not voluntarily buy an instrument today for the promise of the same (or less) amount in the future. A rational investor wants to be compensated for the time value of money.
Plus there is a lot of risk that the amount will never be repaid. The BFX tokens are reward-free risk for anyone assigned the token.
It beats just taking the full 36% loss, but falls far short of my hopes for interest, equity, tradability (for US clients) and a set maturity.
Presumably the tokens could be held to “maturity” at which point Bitfinex would buy them back at face value but if maturity is 1 or 100 years from now, tomorrow or never, no one knows.
That could be a long time with no interest which is a big fat loss both in terms of lost opportunities to invest the money elsewhere and purchasing power lost due to price inflation.
BFX Token Winners
As mentioned earlier in this article, if Bitfinex were to buy back their own debt at current token prices they would be saving 64% on their outstanding debt.
Other winners could be risk loving speculators. With the token trading at just $.36 speculators who believe that Bitfinex will buy the tokens at face value could buy BFX tokens at a huge discount.
For example if I could buy BFX tokens for $.36 each and I knew I’d get a dollar for them in a year it’d be a no brainer investment.
But since their isn’t any interest, no set maturity, and no guarantee if the tokens will ever be repaid, the BFX tokens are little better than putting your money on red at the roulette table.
Roulette or BFX Token: Which is riskier?
What is a Bitfinex Client to do?
If you were assigned BFX tokens at face value and you’re a US resident you’ve only got two options. The first is sell the BFX tokens to cut your losses. The second is to hold onto them and hope they go up in value or are repaid.
If you’re not in the US you could double down and buy BFX tokens to decrease your BFX token cost basis, but I think this is super high risk.
I’m still sitting on my BFX tokens to see what happens. At some point I may cut my losses and sell them but I haven’t made a decision yet.
If you feel like gambling and you’re not a US resident you could buy BFX tokens and hope Bitfinex pays them off. But with no set maturity, no guarantee of repayment and no interest it’s certainly not investing.
I’m going on record: US Stocks and Bonds are in a Bubble
What is a ‘Bubble’?
A bubble is an economic cycle characterized by rapid escalation of asset prices followed by a contraction. It is created by a surge in asset prices unwarranted by the fundamentals of the asset and driven by exuberant market behavior. When no more investors are willing to buy at the elevated price, a massive selloff occurs, causing the bubble to deflate.
In recent history, there was the “dot-com” bubble which burst in 2000 then the housing bubble which popped in 2008. I think we’re close to a third bubble imploding.
I don’t think this is very controversial or insightful but I don’t hear many people talking about it.
Sometimes an insight is just stating the obvious when no one else will.
Now I can’t take credit for this prediction. My views have been formed by folks like Peter Schiff, Simon Black and others who have been making this prediction for years. But I want to get the word out to anyone in my audience not familiar with these figures.
By way of some background, lets take a look at how US stocks and bonds in general have performed.
How have US Stocks Performed?
Since 2000, the Down Jones Industrial Average is up nearly 68%, the S&P 500 is up 55% and the NASDAQ is up just shy of 31%.
Since 2008, the Down Jones Industrial Average is up over 98%, the S&P 500 is up 125% and the NASDAQ is up 203%.
How have Bonds Performed?
Using the Vanguard Total Bond Market Index Fund (VBMFX) as a proxy for the total bond market, we can see since 2000 Vanguard’s bond fund is up 11%.
In the depths of the housing crisis in 2008, this fund was trading around 9.58. The index is now trading at 11.08.
That is a modest 15% return spread over 7.5 plus years.
Who inflated this Bubble?
The reason bonds and stocks have gone up in value since the 2008 crash is because the United States Federal Reserve “The Fed” has done three rounds of quantitative easing (where they go out and buy bonds including US treasury securities as well as mortgage backed securities, etc. on the open market) and the Fed continues to reinvest in bonds when they mature. The Fed balance sheet is now over $4.4 trillion.
So like the last two financial crises the bubbles have been inflated by the US Federal Reserve.
According to the Bank of International Settlements, as of Q4 2015 the total outstanding US government debt securities amounted to about $16.2 trillion.
Of the Fed’s $4.4 trillion balance sheet about $2.5 trillion is treasury securities.
The US Fed owns about 15% of US government treasury securities. So by gobbling up 15% of all US treasuries, the US Federal Reserve has inflated the bond bubble and causes bond prices to rise.
By lowering the so called “risk free” rate of return of government debt, investors and speculators have piled more money into the stock market in search for yield. Additionally, any entities who trade on margin, thanks to the lower rates, can borrow and speculate with more money at near zero cost.
It isn’t just the US Fed—central banks around the globe have taken unprecedented action to lower interest rates and buy government debt.
In fact the Swiss national bank holds $62 billion in US stocks.
The fundamentals of US government debt instruments have never been worse
Buyers of US government debt are making unbacked loans to a government already $19 trillion in debt with tens of trillions more in unfunded liabilities.
US Government debt pays no real yield
A 10-year Treasury pays just over 1.5% interest. 1.5% over 10 years. The government’s own numbers say that price inflation is at 1% per year.
This means that even if you take the government numbers at face value you are guaranteed to lose purchasing power. The only way not to lose money on these bonds is if someone else buys them at a higher price.
Now I think prices are rising faster than 1-2%. I think prices are easily rising at 3-5% per year–maybe higher.
The fundamentals of the US stock market are not stellar either.
Corporations have been issuing bonds and using the money they bring from the bonds to finance share buy backs. They also use non-standard accounting tricks to look more profitable than they actual are.
Corporate profits have started declining since 2014, labor force participation is at multi-year lows.
Stock prices have gone up in anticipation of a recovery not because of one.
Now despite these potentially troubling trends I’m not worried. Why?
I Don’t Own (Many) Bonds
I don’t own hardly any bonds. One of the mutual funds I own is 36% bonds, which amounts to less than $2,000 bond exposure. But that is it.
If bonds are extremely overvalued, as I believe they are, that means my exposure to this bubble is limited.
Now just because I don’t own many bonds doesn’t mean I’m protected. If the bond bubble were to pop and the value of bonds were to plummet this would cause a panic and asset prices of stocks and other assets would likely crash as well.
I don’t think that is going to happen.
Federal Reserve will buy as money bonds (and other securities) as it takes to keep a collapse from happening. We’ve already seen this in countries like Japan, where the Bank of Japan owns 33% of the Japanese bond market and about 55% of Japan’s ETFs.
The Yen has been destroyed by the BOJ. The Federal Reserve has already done a lot of damage to the value of the dollar but could still do a lot more damage.
I believe that the Federal Reserve will destroy the purchasing power of dollars in order to prop up government bonds and stocks. So people who own bonds and stocks will do okay, but savers and individuals on a fixed salary will be impoverished.
“But I’ve Made a lot of Money in Stocks!”
Oh you have?
It’s true the US stock market has been on a great bull ride since the 2008 lows.
If I had to buy US stocks and I had a crystal ball I would have sold all my stocks in October 2007 before the housing crisis, bought back in at the lows in March of 2009 and then I would sell at the market top (if we haven’t already passed it).
However, I haven’t been able to figure out how to time the market.
I don’t think I can just take the approach of selling when the market starts to tank.
Because I don’t think I am going to be fast enough to be able to sell if people start dumping stocks.
If everyone heads for the exists at the same time not everyone can get out at the same time. If everyone sells stocks at the same time they not everyone can sell at the same price.
Plus if everyone is selling who is going to buy?
When the stock and bond market bubbles are pricked the bubbles could deflate rapidly before the US Federal Reserve and government step in to try to stop the bleeding.
I’ve been in situations in the last two years when there was significant market volatility and I could not even login to my broker platform.
Even if I can login to sell stocks brokers and exchanges could halt trading to try to limit the panic (which would probably cause more panic).
In order to actually keep the stock market from crashing the Fed is going to have to create so many dollars that most of the rise (or failure to fall) of nominal stock prices will be offset by price inflation.
I think I’ll be better off outside of the US stock market and dollars.
That’s why I’ve been an investor and advocate for physical gold and silver, Goldmoney (formerly BitGold), foreign stocks, and yes even bitcoin, although the recent volatility and hacks further demonstrate the risk in bitcoin.
You won’t hear too much about these alternative investments from mainstream sources, unless it is to deride them.
These investments are risky, and frankly I can’t advise anyone to own any of these asset classes. They might not be suitable for you.
But I see the risk in US stocks, bonds, and dollars as much greater and so I’ve chosen to diversify into alternative investments.
And while past performance is no guarantee of future performance this chart shows that gold (shown in Dark red) has already been doing quite well against US stocks, being up 379% since 2000.
Update 11 September 2016 1:23 AM EST
The following was announced on the 9th:
We are pleased to provide an update on our partnership with BnkToTheFuture. As we announced on August 22nd, we are coordinating with BnkToTheFuture to launch a Special Purpose Vehicle (SPV) that will allow the conversion of BFX tokens to equity stakes in iFinex, the corporate entity behind Bitfinex. We expect to release final details and terms on or before Sept. 15, 2016.
As previously reported, we have signed a letter of intent with BnkToTheFuture, an online investment platform, to provide an SPV through which BFX token holders can exchange their BFX for a beneficial interest in iFinex. Since then we have worked on adding functionality to facilitate these exchanges within the Bitfinex platform. Redemption of BFX for the beneficial interest in iFinex will be done at BFX’s face value of $1 US Dollar.
Participation in the SPV will be limited to holders of a minimum of 1,000 BFX tokens. It is principally designed to compensate Bitfinex customers who suffered losses resulting from a security breach that occurred against the company on August 2, 2016.
We are continuing to press forward with our plan to retire as many BFX tokens as possible through the equity conversion.
Going forward, our principal objectives are to raise new capital to help redeem outstanding BFX tokens and fund investment in future growth.
The following was announced earlier:
We are pleased to announce the redemption of 1.1812% of outstanding BFX tokens. This redemption was applied pro rata to all wallet balances on September 1, 2016
Update 22 August 2016 11:16 AM EST
We have formally signed a letter of intent with BnkToTheFuture, the online investment platform for financial innovation and technology investment opportunities, to provide solutions towards compensating customers with equity in Bitfinex.
BnkToTheFuture will be providing a Special Purpose Vehicle (SPV) through which qualifying BFX token holders can contribute their tokens in exchange for an equity interest in compliance with their individual jurisdictions. Further details will be released in future announcements.
Will “qualifying BFX token holders” include US residents I wonder?
Update 17 August 2016 3:25 PM EST
In addition to providing some general information regarding the hack and assuring everyone of additional security measures, Bitfinex addressed the efforts to compensate affected customers.
We are actively engaged with efforts to convert certain qualifying token-holders to shareholders of Bitfinex and to redeeming the remaining BFX tokens through a combination of new capital and earnings. We have re-enabled most of the features on the platform and are deeply grateful to our customers, who continue to trade with and help us rebuild our brand.
Update 10 August 2016 10:15 AM EST
Today, August 10th, 2016, at 16:00:00 UTC we will be enabling additional platform features as we continue to restore service after the incident on August 2nd. Exchange trading will be enabled for all currencies and pairs, while deposits and withdrawals will be enabled for BTC, ETC, ETH, and USD – with LTC and Tether to follow shortly thereafter.
16:00 UTC is 12:00 Eastern.
Update 8 August 2016 2:16 PM EST
Bitfinex PR man Zane Tackett is relaying that US accounts will not be able to trade the BFX token.
Update 7 August 2016 11:06 PM EST
The BFX token will not be tradable for US clients. This is a huge disadvantage.
Or they “may” be tradable? Unclear.
“The trading of BFX tokens may be restricted for US customers.”
Update 7 August 2016 8PM EST
Bitfinex.com is now live and read-only to check account balances.
The situation at Bitfinex is very fluid. I’m relaying the facts as I understand them as of writing. I’m not affiliated with Bitfinex and I do not speak for them.
The source for this information (as listed below) is from the Bitfinex status page and Zane Tackett’s reddit posts. Mr. Tackett is the Director of Community & Product Development at Bitfinex.
Facts as of 6 August 2016 at 4:50 PM EST
•119,756 BTC was stolen from Bitfinex on 2 August 2016.
•The value of the BTC stolen at that time was around $60 million.
•Losses will be socialized across all account values.
•Accounts will be worth 36.067% less than their pre-hack levels.
•For example, even though no Ethereum (ETH) has been reported stolen, ETH balances will suffer 36.067% losses.
•Put differently, if someone had 1 BTC pre-hack, that account balance will now be .63933.
•If someone had 100 ETH pre-hack, that account balance will now be 63.933 ETH.
•BFX Tokens will be issued.
•BFX Tokens *could* be exchanged for equity in iFinex Inc. (Bitfinex)
We are actively discussing various strategic options with numerous potential investors as part of our strategy to fully compensate our customers. Such discussions, however, are in early stages and will likely take time to play out. In the meantime, In place of the loss in each wallet, we are crediting a token labeled BFX to record each customer’s discrete losses. Tokens will be distributed without release or waiver. The BFX tokens will remain outstanding until redeemed in full by Bitfinex or possibly exchanged—upon the creditor’s request and Bitfinex’s acceptance—for shares of iFinex Inc. We are still sorting out many details on this; we will post further updates in the coming days.
•The exchange will come back on within 24-48 hours. (This announcement was made at 11:02 AM Eastern on 6 August 2016. So 24 hours would be 11:02 AM on Sunday 7 August and 48 hours would be 11:02 AM on Monday 8 August.)
•My understanding is that when users can login to Bitfinex, it will only be to check account balances. Initially no trades or withdrawals will be available.