As a rule, I don’t generally write about Bitcoin, because I don’t generally know much about it or care passionately either way. I have a very small “investment” I made in it about a year ago just for fun, but for the most part, I still consider myself a casual observer rather than an interested party. Libertarians as a whole are sharply divided on this issue, with some considering Bitcoin to be the greatest thing in the history of the world, while others consider it to be a giant scam that the government secretly loves and supports.
You may have heard that Mt. Gox, the biggest and most well-known Bitcoin exchange, has recently shut down, and will almost certainly be stiffing its depositors. This event is something of a scandal, and opponents of Bitcoin can be seen eagerly sharpening their knives, ready to declare this unholy creature completely and totally dead.
But we might benefit from taking a step back to examine what really happened here. The problem seems to be isolated to Mt. Gox itself, rather than Bitcoin in general. From my understanding, Gox had some crappy security, got a bunch of Bitcoins stolen from it, and, as such, was no longer able to make whole their depositors.
This type of activity is hardly unique to digital currencies. Picture, for a moment, a small bank in a frontier town in 19th century America. The main purpose of this bank is to keep secure the gold of its various customers. But the security leaves something to be desired, and the bank is robbed. A gang of outlaws absconds with the gold, and the bank can no longer return the gold to its customers. The customers are now essentially screwed – their gold is gone, and although they may be quite angry and have a legitimate complaint with their banker – they can’t get it back from him, because he simply doesn’t have it anymore. Does this event tell us anything meaningful about gold as a unit of exchange? Is this proof that gold itself is a scam? I wouldn’t say so. I would say the only real conclusion we can draw from this event is, “Gee, that bank had pretty crappy security.” And so it is with Bitcoin and Mt. Gox.
Now, back to the present day. Today, banks must be approved by the government in ordered to be allowed to exist. What happens today when a government-approved bank fails? Well, as you know, that’s sort of a trick question. Many government licensed banks aren’t allowed to fail. They’re bailed out, with taxpayer money! Even in the case where a bank itself fails and “goes out of business,” depositors are made whole via the FDIC. The “stolen gold” is returned, via premiums paid by all banks. Nobody has to suffer any losses at all!
Or, more accurately, the suffering is evenly distributed across the country. As I mentioned, the FDIC is funded by premiums paid by all banks. These premiums increase the cost of doing business as a bank generally, which results in higher charges and fees for the average banking customer. So essentially, we all pay a little bit more for the privilege of doing business with a bank, and some of that money goes into a fund to refund the depositors of any bank that fails. Like every other example of crony capitalism, the gains are privatized, and the losses are collectivized. When Bank of America turns a profit, its shareholders reap the rewards. When it over-leverages itself and is on the verge of collapse, we all have to pay to “save the economy.”
Back in 2008 during BailoutMania, libertarians and supporters of the free market were lining up left and right to oppose the bailouts. The (correct) logic was that allowing bad banks to fail was essential to the free market system, because otherwise, moral hazard would encourage further risk-taking by other banks in the future. The same is true in the case of Mt. Gox. Although it’s very unfortunate for everyone who had money there, the fact of the matter is that Mt. Gox has to fail. While we can express deep sympathy to everyone who has lost large sums of money due to this failure, it still beats the alternative – which would be everyone having to pay so that those who made the poor decision of trusting their money to Mt. Gox could have it all refunded and that a crappy exchange could continue to operate. The gold was already stolen, the bandits have already escaped. Some people made a very conscious decision to avoid Mt. Gox because of questions surrounding its stability. Should these people be forced to pay to “make whole” Gox depositors?
In a way, the failure of Mt. Gox represents both the best, and the worst, of free market economics. The worst is the sense that someone can fraudulently run off with money you entrusted to them, and leave you with basically zero recourse to do anything about it whatsoever. Gox and Bitcoin operate outside the realm of government, and no burdensome regulation also means no big bad monopoly authority figure to run to for protection. The best is the sense that although the failure of Mt. Gox is tragic for its own depositors, those who had the foresight, or just plain good luck, to avoid Mt. Gox aren’t being punished for the mistakes of others. There will be no bailout. Future BTC exchanges will not see an obvious incentive to make risky decisions and be lax on security, because the customers of BTC exchanges will now be very leery of such behavior. The overall system will improve, because the free market was allowed to properly function.