Occam's Razor

Dorothy in The Wizard of Oz learned from Glinda that if she clicked her ruby slippers, closed her eyes and kept repeating “there’s no place like home” that she would magically return to Kansas. So simple! BitCoin adherents are a lot like Dorothy. Dorothy at least made it home from her fantastical journey. True believers in BitCoin, the libertarian currency, got a splash of cold water across their faces this week instead. Mt. Gox, the Tokyo-based BitCoin exchange, has gone belly up, along with about $300M in BitCoins. Most likely someone stole those BitCoins, either someone inside the firm or some shadowy hackers. By any standard, this was quite a heist. Looking at history, you’d have a hard time finding any instance of a similar theft inside what amounts to a bank.

In any case, sorry you BitCoin suckers. Real banks and exchanges still have vaults, but they don’t carry much of their assets in cash. Much of it is commercial paper, bonds, mortgage deeds, promissory notes and Federal Reserve Notes. Whether in paper, assets on an electronic register somewhere, or gold bars in a vault, these assets are quite tangible. Someone with a car loan who defaults on their payments is likely to find their car repossessed. Those who defaulted on home loans during the Great Recession found their houses foreclosed and if they had ready cash assets, they were put under legal assault. BitCoin owners with their BitCoins in Mt. Gox now have nothing and the police just aren’t interested in serving them justice.

This was not supposed to happen to this libertarian currency. Freed of its tie to governments, it was supposed to soar above inflation and always retain a finite empirical value. It was all secure and such through the power of math. After all, exchanging a BitCoin involves keeping a record of who its next owner is. Unless, of course, it just disappears. Undoubtedly these stolen BitCoins were converted into a real currency, just unbeknownst to its owners, and perhaps with the help of some money laundering exchange, perhaps Mt. Gox itself. BitCoin is after all the preferred currency of drug dealers, at least until their fingerprints have disappeared and they can convert the digital money into something more tangible and fungible, like U.S. dollars.

I keep my cash in a couple of credit unions and a bank. It’s unlikely that a credit union like Pentagon Federal, where I have a couple of accounts, is going to go under like Mt. Gox. In the unlikely event that it does, I’ll get my money back because it is backed up by what amounts to the full faith and credit of the United States. Mt. Gox was backed up by the full faith and credit of, well, Mt. Gox. It’s like asking the fox to guard the henhouse.

And there’s the rub with BitCoin exchanges. When you create a currency detached from a government that will assert and protect its value, there is no one to complain to when your BitCoin bank goes bust. The government of Japan is looking into the event, but it is mostly hands off. It never promised to underwrite Mt. Gox, and Mt. Gox never asked it to. In any event, Japan underwrites its Yen, not BitCoins. Japan has a vested interest in keeping its currency solvent. It has no such interest in keeping another currency, particularly one it cannot control, solvent.

An exchange like Mt. Gox could of course seek out local governments for underwriting of their exchanges. Those BitCoin exchanges and banks that want to remain viable are going to have to do something just like this. Good luck with that. In doing so though they are of course defeating the whole purpose of BitCoin. BitCoin is about a libertarian ideal; it’s about money having a value independent of government apron strings. Affiliate the BitCoin currency in a BitCoin exchange with a government, and you tacitly admit that BitCoin is not a libertarian currency after all. In short, you have to give up the notion that money can be decoupled from government control.

It’s unlikely that many governments will be willing to protect BitCoin exchanges. It is reasonable to protect assets that you can actually control: your national currency. For a government to protect a BitCoin currency, it is reasonable to expect that they would also be able to control the amount of BitCoins in circulation and set rules for their use and misuse. They can’t do that, which means that they would be asked to put the good faith and credit of their country against an erratic currency that could prove digitally worthless at any time. This strikes me as a foolish thing to do, but there may be entrepreneurial countries out there, say, the Cayman Islands, that will take the plunge. The risk might be worth the rewards.

I don’t think you have to worry about governments like Germany, England, Japan, China and the United States doing something this foolish. If there is any organization that might see profit in this, it will probably be the Mafia, or other criminal syndicates, many of who are already using BitCoins as a mechanism for money laundering.

Doubtless other BitCoin exchanges will work real hard to sell trust that is now deservedly absent from these exchanges. As I pointed out in an earlier post, it’s going to be a hard sell given that BitCoin’s value is essentially based on faith in its mathematics and algorithms.

Absent from the minds of BitCoin true believers is an understanding that money must be tied to a governmental entity to be real money. It’s tied to governments for many reasons, but primarily because governments are required to govern, and this includes having the ability to enforce its laws and to collect taxes. Money is based on the idea that entities can force everyone to play by the same rules, including using the same currency as a means of exchange within the country for lawful debts. The truth is, there are no rules with BitCoin other than its math. It is a lawless currency. That Mt. Gox’s treasury of BitCoins can be plundered with impunity proves it.

Libertarianism is built on the idea of caveat emptor: let the buyer beware. No warranties are expressed or implied, but even if they are expressed they depend on the trust of the seller. No one can force the seller to do squat. The best a buyer can hope for is to track the thief down and take justice with his fists or a gun. That’s no way to run an economy, which is why libertarianism is an ideology that simply does not work in the real world.

Again, a word to the wise: just say no to BitCoins.