Legal tussle looms for bitcoin holders

After this week’s hack of nearly 120,000 bitcoins from Hong Kong-based Bitfinex exchange, attention is turning to how victims of the fraud will be compensated, if it all.

A key question for account holders concerns their legal rights after a loss in the region of $ 70m. Bitfinex is yet to announce details, but Zane Tackett, the company’s director of community and product development, has been posting messages on online forums suggesting some losses will have to be socialised among users.

“We are still working out the details, so nothing is set in stone; however, we are leaning towards a socialised loss scenario among bitcoin balances and active loans to BTCUSD [bitcoin US dollar] positions,” Tackett wrote on the Reddit forum early on Friday.

For the legal profession, however, the pivotal factor rests on whether the title of the lost bitcoin belonged to the customers or to Bitfinex when it was stolen. A secondary condition that must also be determined is whether the bitcoins were commingled or segregated when the theft occurred.

The best legal precedent to date is that of the liquidation of Mt. Gox in February 2014 when nearly 850,000 bitcoins worth some $ 450m were lost. In that case the company was held accountable for losses because title had been transferred to the exchange and funds had been commingled. Victims are still pursuing their claims over the remaining estate.

Lawyers say the situation in Hong Kong may be different.

“With Bitfinex, user wallets were segregated. As a result, the relationship was seemingly more custodial in nature. In other words, the hack resulted in the theft of users’ property,” one lawyer specialising in cryptocurrencies told the Financial Times.

If that is the case, the theft will have resembled a thief stealing contents from users’ safety deposit boxes rather than the contents of their bank accounts, meaning victims may not have legal rights over Bitfinex’s remaining assets and will have to bear the losses directly.

“This matters because in the bank account situation, losses are necessarily socialised whereas socialising deposit box losses would be theft,” the lawyer added.

Victims may still retain a lien — a right to keep possession of property belonging to another person until a debt owed by that person is discharged — over the coins, allowing them to pursue claims wherever they end up if they can prove how they were sourced.

“If I am [a] user, because of the segregation of accounts, I would be watching where the coins went,” the legal expert said.

The downside of pursuing a successful claim via the onward paper trail is that it could undermine bitcoin’s fungibility, impacting its effectiveness as a medium of exchange.

Lawyers say the legal situation is murkier when it comes to balances held in Bitfinex margin trading accounts, which allowed users to lend funds or bitcoins in exchange for fees. According to the company’s user agreement some accounts may have been controlled by Bitfinex, indicating a commingled status. This could open the door to the socialisation of losses.

The CFTC fined Bitfinex $ 75,000 in June for failing to hold bitcoin in segregated wallets in its margin accounts. According to the latest user agreement available online, their balances were held in encumbered accounts, potentially implying segregation.

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