A Bloomberg report published April 26, 2019, posits that retail investors stand to lose the most in the aftermath of the recent Bitfinex-Tether fiasco. Sources told the publication that small investors’ crypto funds are at a significantly higher risk vis-à-vis multimillion-dollar portfolios of institutional investors.
Retail Investors at the Bottom of the Crypto Totem Pole
One of the primary goals Satoshi Nakamoto wanted to achieve through bitcoin was to disrupt the status quo by toppling Wall Street banking and financial conglomerates. This vision, however, seems to have got lost amid the transformation from a silent underground project to the premier digital currency which today commands an enviable market cap of $93 billion.
Substantiating on the Bitfinex-Tether debacle, a report by Bloomberg suggests that even in the cryptocurrency industry, retail investors are at a greater risk of losing their funds compared to multimillion-dollar accounts of institutional investors.
This practice of investment-based treatment of customers is not too different from that followed in traditional financial firms where securities are divided into tranches based on their financial health and the risk of them committing a default. Finance journalist Michael Lewis in his book The Big Short chronicled how this practice was one of the factors that shaped the 2008 global financial crisis.
Two people close to Bitfinex told Bloomberg that while institutional digital asset funds are protected under the custody of prominent Wall Street banks, crypto-assets owned by smaller investors receive less assurance, with their funds being toggled across the world.
The New York Attorney General (NYAG) on April 25, 2019, filed a civil suit against iFinex Ltd., the parent company of both Bitfinex and Tether alleging that the two entities conspired to hide the loss of $850 million in client and corporate cash.
However, the lawsuit doesn’t speak in detail about the Panama-based payments processing firm Crypto Capital Corp. which is reportedly responsible for handling Bitfinex’s retail funds.
NYAG Letitia James stated in her report that Bitfinex customers transferred more than $1 billion to Crypto Capital in 2018.
According to the civil suit, this happened after Bitfinex officials began to suspect that the Panamanian firm had “lost, stolen, or absconded with the money.” Because Crypto Capital is essentially the custodian of retail funds for Bitfinex, it is likely that the exchange’s small investors will be exposed to the enormous loss and not its institutional clients.
In response, Bitfinex states that client funds with Crypto Capital are not lost but have been “seized and safeguarded.”
However, this statement should be taken with a grain of salt as it contradicts the NYAG’s suit which states that Bitfinex attorneys “do not believe Crypto Capital’s representations that the funds have been seized.” Further, the exchange has also declared that the NYAG’s accusations were made in “bad faith” and that the same will be “vigorously challenged.”
When the dust settles, it is likely that the industry will have yet another cautionary tale akin to the unending labyrinth that is QuadrigaCX.