It would be pretty ironic if the Cyprus bailout of 2013 will noted in history books as the event that lead to the collapse of 21st century banking (next up bank runs). Is it probable? No. Is it possible? Maybe.
This eerily reminds me of the bank run on Northern Rock, in August 2007. I was working for a mortgage broker at the other side of Europe at that time, and I was saying to myself: "hey, that's bad for those poor fellows, but it cannot have that big of an impact on the rest of us, it's just a bank in some god-forsaken corner of the UK". One year later Lehman went bust.
Option 2: Panic and make rash decisions
The second option would almost certainly lead to civil unrest, because it would probably mean that teachers, doctors and other public employees (also pensioners) wouldn't get payed next month. Of course, the first option might also lead to civil unrest ...
Allowing the haircut will lead to bank runs which will cause the banks to go bust anyway. There's a high change that it will also cause bank runs in other countries like Spain, Italy and Portugal. Spanish people are already in the streets protesting. "Trust" will be gone. Cyprus is systemic, whether they want to accept that or not.