Life is Like a Box of Bitcoin
Whether the evaporation of popular Bitcoin marketplace Mt. Gox (which may have nothing to do with the Gox in Dr. Seuss’s beloved One Fish, Two Fish, Red Fish, Blue Fish[1]) is due to fraud, hacking, incompetence, or some combination of all three – it appears it may have been hacked three years ago, and have been insolvent since then before vanishing from the Internet last night – doesn’t really matter. Either way, investors/speculators with money at Mt. Gox got MFGlobaled. The money wasn’t segregated (if it was money at all, and if it can be segregated at all), there was no audit (if there can be an audit trail for something that doesn’t have a known origin or destination), and the firm was not overseen in any fashion (if it is even possible to oversee something that exists mainly because it is difficult to oversee).
Like Schrödinger’s cat, it was kinda there, until someone actually looked and discovered it was dead.
I have carefully eschewed writing about Bitcoin in the past, though people have asked me to do so. I chose not to write about it because I had no wish to be filleted by one side or the other in the argument. But what I would have said would have been a series of simple observations that have nothing to do with how Bitcoin is mined, managed, or mishandled:
- This is hardly the first currency that has been outside of government control. Currencies existed outside of government control before they existed under government fiat.
- Historically speaking, there is a reason that government-sponsored currencies won, and it wasn’t because they were backed with gold. It was because people trusted the government when it said the currency was backed with gold.
- Trusted banks were issuers of currency for a long time. The coin of the realm has always been trust – and even if a currency is limited, or backed by limited metal, or whatever, you still need trusted institutions through which the coin flows, or it doesn’t work. Where is the trusted institution in Bitcoin’s case?
- So what’s the big deal?
This isn’t schadenfreude. I don’t care if Bitcoin succeeds or not; I don’t think its success or failure has anything to do with whether fiat currencies succeed or blow up. I don’t think Bitcoin is a “safe haven” any more than gold is a safe haven.
But at least I can touch gold. At least I know that gold will have some value in exchange, whereas I don’t know that Bitcoin will, tomorrow. And now, indeed it may not. Surely no institutional investor can now invest in Bitcoin deposits without answering the following question to the satisfaction of its board: “How can we be sure that our money won’t go the way of Mt. Gox?” And institutional acceptance is a huge hurdle for the future success of this substitute currency. Ditto firms using Bitcoin for transactions – a daylight overdraft that can go to zero overnight is a big risk for a bank.
And so, what I think was always the not-so-subtle problem for Bitcoin or any crypto-currency remains: for it to succeed, a trusted institution needs to be involved. Trust can’t be distributed across a network. And if an institution is involved, then the idea of a “people’s currency” loses weight. Bitcoin wasn’t the first of these attempts, and it won’t be the last, but in my mind that is the challenge. You can’t make money that only is used by the credulous and the gullible. It must be used by the incredulous and the suspicious. It is adoption by those people which defines the success or failure of a currency.
(Unfortunately, this puts certain elements at my alma mater in the former category. In our January 2014 alumni magazine was an article on Bitcoin. In the information bar “Bitcoin Dos and Don’ts”, the first point was “Do your research first! More information is available on Bitcoin.it, a wiki maintained by the bitcoin community. For Americans, the most popular and trustworthy place to buy and sell Bitcoins has historically been mtgox.com.” Whoops! Do your research first – popular does not imply trustworthy unless the thing is popular with people whose trust is hard to win!)
[1] “I like to box. How I like to box! So, every day, I box a Gox. In yellow socks I box my Gox. I box in yellow Gox box socks.”
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In the “you can’t make this stuff up” category:
> Mt. Gox began life as an online platform to trade Magic cards. Yes, those magic cards. In fact, the name of the site is an acronym that stands for “Magic: The Gathering Online Exchange.” – http://www.marketplace.org/topics/tech/bitcoin-mystery-mt-gox
Your statement that a trusted central institution is needed is false. A regulartory body that enforced completion of transactions through distinct institutions for all parts of the process. Just as in the process for stocks, you have the exchange, you ahve the clearing firm and then depository. Mt Gox was operating as all three, and that is where the problem was. Mt Gox should not have been allowed to operate as its own clearing firm, as it clearly broke the rules of confirmation, and then and exchange should not be allowed to operate as a depository or wallet.
The bitcoin protocol allows for operating using no single point of trusted source, yet that is what was happening with MtGox being allowed to operate in that way. No deposits should have existed at the exchange, and the clearing of transactions should have been completed before the deposit of funds at an external depository. The problem is not the bitcoin protocol.
The trust in the system is the the bitcoin protocol, no external single trust party is needed. The trust comes from the public transaction audit trail, and limited supply. Mt Gox broke the trust by obscuring the transparency behind its exchange/depository facade.
A regulartory body that enforced seperation of transactions, clearing and deposits is all that is required. In the case of MtGox, it would have been simple to solve the problems by enforcing seperation of processing entities.
As much as I do not like and do not want to participate in any crypto currencies myself, this trust crisis still fairly early in the life of the currency actually now makes it much stronger as regulartory bodies will now be formed that enforce the separation and address the trust issues. Through the failure of MtGox, bitcoin just became a much stronger currency alternative.
Sorry for the numerous spelling and grammar mistakes. I should have proof read it before posting it.
I understand your point, but you just imposed a trusted institution – the regulatory body. And as you point out, the beauty of bitcoin is supposed to be that it needs no institution at all. Unless you want to invest, earn interest, or transact with someone who wishes to (or is required by law to) know his counterparty.
When you introduce a regulatory structure – which will have to be done by a trusted institution, and in all probability a government since otherwise where does the funding come from (you can’t very well tax bitcoin) – then you can get trust back. Eventually, once the body is proven. But I think you’re underestimating how hard it is to get institutions involved in something that has a taint like bitcoin now does. And I still think that, if you interpose a government body, you’re vastly narrowing the difference between bitcoin and other currency, or some other asset that is supply constrained, like gold. Or water. A friend of mine came across a guy who is trying to securitize water.
An essential reminder of the true function of a currency and what its characteristics must be. My only quibble is your use of the term “invest” in relation to Bitcoins. Bitcoins are the perfect example of a speculation, as described by traditional economics and market commentators, for reasons that you enumerate and should be perfectly obvious to all.
I am convinced that 30 years from now, someone will be reading in the equivalent of John Kenneth Galbraith’s The Great Crash, the cautionary tale of a magical digital coin that fooled so many self-important (and unfortunately many ordinary) people including the Winklevii. Like JKG’s own vignettes, it will be priceless.
Yes, I admit that I penned “invest” with distaste. It’s clearly a speculation. But I wanted to limit the vitriol I would receive. 🙂