With Mt. Gox Surfing The U-Bend, Whither Bitcoin?

By Tim Worstall , written on February 25, 2014

From The News Desk

The overnight news that Mt. Gox has gone down is naturally leading to swathes of speculation about what this means for Bitcoin. So, despite my having been consistently wrong about the currency since 2011 (when I first confidently announced its final end), here's my addition to it all.

The end result is going to depend upon whether Bitcoin is actually doing anything useful or not.

Leave aside all of the technical (and technological) issues for a moment and concentrate on the problem that the currency actually claims to solve. Which is how do we make sure that a digital currency is only spent once? Once we have indeed cracked that problem then yes, it's entirely possible that there are times and places when we will want to use such a currency: insert your techno-libertarian fantasies of choice here. The general story about Mt. Gox is that they got spoofed into allowing double usage of coins and thus find themselves 700,000 odd short. So perhaps we've not quite solved the original problem as yet, or perhaps it's a problem in this specific implementation rather than the currency.

Yet the important word in the above paragraph is the "possible." Maybe Bitcoin or other alt-currencies are a solution to a real world problem and maybe they're not. If they are they'll survive this or any other such problem or breach of faith, if they're not, they won't.

To illustrate allow me to make an analogy with fractional reserve banking. This is, on the face of it, an entirely stupid way of dealing with the world. A bank, by definition, borrows short and lends long. Our paychecks go in and we can take them out whenever we like: but the bank has bundled up the balance and lent it out on 25 year mortgages. They only keep a fraction (thus the "fractional") of the money on hand for when we want it back. And if too many of us turn up on the same day then they can't pay us back and we get a bank run. This is true even if they're honest and sound, if those loans going out are all going to get paid back. A bank can be, by its very nature, entirely solvent and yet at the same time fail because it is illiquid.

So, why the hell do we put up with such a system? Thousands of banks have gone bust over the centuries on just such a basis taking the savings and deposits of millions with them: that's without even counting the crooks that have taken advantage. The reason is that this frb system solves a real world problem. How do we perform maturity transformation? How do we collect up the short term balances of us all and transform them into the long term loans that people desire in order to be able to go build things? By having an intermediary that is borrowing short and lending long. Any system that does that has just reinvented that fractional reserve banking. Which is why it has been invented and reinvented many times over the years.

Sure, we've got to lash it together with the Fed, with depositor guarantees, we have capital requirements and so on, but all of these are sticking plasters over the inherent great gaping wound at the heart of the system. A bank can, and will, go bust if too many people turn up at the same time. The reason we put up with this is that despite those failures we're a much richer society overall as a result of having this maturity transformation.

So it will be with Bitcoin. There are two general views out there currently. One is that it is the harbringer of a bright new world where we are free of fiat currencies and the expenses of money transfer. Could be -- although that's not the way I personally am betting. The other is that it's a great and wondrous scam that depends upon the Ponzi principle of selling to the greater fool before the crash. I don't quite sign up to that either, regarding it at present as a Schroedinger's Currency that could go either way when we finish the experiment and open the box.

I have absolutely no doubt at all that there's a bubble in alt-currencies: The existence of how ever many hundreds of them that there are now is proof enough of that. Recall, the proof of the South Sea Bubble was not that the Company's stock soared, it's that someone was able to float a stock with the prospectus "a company for carrying out an undertaking of great advantage, but nobody to know what it is."

That there is a bubble here tells us nothing at all about the long term success or not of the adventure. Bubbles can lead to nothing (the Mississippi land bubble in France) or to economic effects that are still with us now. The Dutch Tulip Mania was very definitely a bubble but the world's cut flower market is still run from a couple of sheds just outside Amsterdam. Dotcom Mania funded all sorts of monstrosities as well as Google and Amazon.

So an alt-coin bubble (or not, as your belief may be) doesn't tell us whether Bitcoin itself is going to survive Mt. Gox. That depends instead upon that original point above. Is it actually solving a real world problem? If it is then it, or something like it, will survive any number of disasters along the way just as fractional reserve banking has done. If it isn't, or if the problem is either trivial or can be solved in another manner then it won't. It will be revealed as being based purely upon that principle of sell it to the next guy before the peak and that will be that.

The really interesting thing about all of this is of course that which of those two does happen depends upon what all of us now do in aggregate. Most certainly not upon the scribblings in some journal like these but on what you, I, we and they are prepared to do with their cash. Which is where we come back to the cat in the box, or perhapsĀ  Tinker Bell, Bitcoin will live if we collectively believe that we wish it to, and not otherwise.