Should You Worry About Bitfinex?

As I write this, Bitfinex has had the following items of note in the last month:

  1. Redeemed all BFX tokens
  2. Turned off support for Washington State customers
  3. Announced first that there were dollar withdrawal problems, then
  4. Announced that their Taiwanese bank isn't accepting deposits right now
  5. ETH traded on their platform has unlinked from global market prices, hovering about 4% over prices elsewhere

So, what gives? Those of us who lived through Mt. Gox will find some parts of this list worrisome.

My guess is that at the very least 2, 3 and 4 are related, although even Bitfinex may not see all the threads.

edit April 22, 2017: as I write this, the spread is at 10% for both BTC and ETH. I would recommend withdrawing until this sorts out.

edit June 1, 2017: Both Tether and the spread have settled out, and I do not have current concerns about Bitfinex or its platform

Washington State Matters

Washington State, original home of the Bitcoin Foundation, CoinLab, Bittrex, Patrick Murck, Dax Hansen and the Perkins Coie Digital Currency Group, and site of the best mining locations in the world is also home to an extraordinarily aggressive Department of Financial Institutions, the group that regulates money transmitter businesses and therefore some digital currency activities in the state.

It also has a legislature that is often hostile to digital currency in general, (although Jinyoung Englund, longtime digital currency booster, is currently running for office in the 45th).

Most state DFI groups share information. The only state considered more aggressive than Washington DFI is New York State, home of the ill-conceived BitLicense.

I promise you that Bitfinex's operations, end of negotiations and cessation of service in Washington state is news for state DFIs, and the news has been shared with New York.

New York Really Matters

Why does New York matter? It's simple - all dollars in the world are transmitted through Fedwire, a physical network in Manhattan.

As an aside, this is why walking through Manhattan you will often see very surprising banks with what looks like only one branch, "People's Bank of Sunlight China" -- they are in town so that they can have access to Fedwire.

What does a bank do if they don't have physical access to Fedwire? They get their own account as a customer of a bank, usually a money center bank like Wells or Citi and use that to send dollars around on behalf of customers, even if those customers are both in Taiwan, say. This is called a correspondent account.

An Educated Guess on What Has Happened So Far

  1. Washington DFI got pissed off and called NY DFS, their counterpart
  2. NY DFS decided to put the screws on Bitfinex either actively or passively.
  3. Bitfinex's bank uses Wells Fargo, so Wells Fargo likely shut down at the least Bitfinex's transfers cleared through the bank's correspondent account there.

This happens all the time. It doesn't matter to a bank whether or not Bitfinex is in compliance with national and regional laws (they claim to be). Bank compliance officers routinely shut down and shut out customers they don't want to work with, and will tell you that's their legal right.

That scenario gets us to 'we can't send wires' but it doesn't take us all the way to "don't send any money to our bank".

I am guessing that BitFinex fought back somehow, protesting this treatment. As we all know, speculation about deposit balances can kill an exchange quickly. And being short on deposits can be massaged into a publicly messaged "banking problem" as Mark Karpeles so ably demonstrated before heading off to jail in Japan.

So, I'm guessing the next thing that happened is that Wells just shut off this Taiwanese bank altogether, or made it clear that they were on thin ice.

What's Probably Coming

BitFinex probably has something like $200-$300mm on deposit, presuming they are fully funded.

That's a large enough amount that I bet they find new banking. I don't know if they'll find a money center bank willing to let them trade in dollars, though.

In the interim, the easiest way for customers to get money out of such an exchange is by buying digital currency.

This is to me the easiest explanation of the 4% spread on ETH over global ETH prices -- people want money out quickly, so they buy ETH and send it out. Arbs are willing to arb the prices down to within 4%, but not closer since there are trade fees and a lot of uncertainty about when they could get cash to complete all the legs of their trade.

So I don't eyeball this and think it demonstrates widespread market panic. If Bitfinex dollars were being considered as worth a lot less than US dollars, we would see significantly higher spreads, and these spreads would show up in the BTCUSD pair -- they haven't so far.

That said, market panic is just an assessment of what other people think. I would not be holding large deposits at Bitfinex right now until I had a better understanding of the situation.

What, Me Worry?

There are reasons not to worry as well.

Bitfinex is run by a savvy group. They are the only exchange to manage through a hack they weren't funded for, and they did a good job managing it.

Bitfinex BTCUSD prices don't seem to have unlinked from global prices which is curious -- it might mean something, like there are other structural reasons for the ETH spread, or it might mean nothing.

We aren't seeing like 15-25% price spreads.

note As of April 22, we are seeing 10% spreads on both BTC and ETH.

note As of June, 2017 these spreads are normalized.

On the other hand, it seems not unlikely they're going to have to re-pair to EUR or GBP and get out of the USD settlement game altogether. This would be a huge blow to their business in my estimation. US customers don't want to think about ETH and BTC prices against EUR.

Longer term, a better solution is needed for these exchanges. But more about that another day.