You might have noticed the world has been facing a bit of a fiscal and monetary problem of late. Bitcoin devotees are certainly aware of this as it has been the search for solutions which has stoked much of the recent interest in Bitcoin.
To some of these problems Bitcoin does offer a real solution. To others, not so much.
Bitcoin's big advantage is in addressing the ills of fiat currency and the inevitably ensuing inflation . Inflation is a longstanding and nasty problem that clandestinely impoverishes. The majority of people have their purchasing power of their earnings and savings gutted through no fault of their own by inflation. Meanwhile, well placed, and politically connected, interests like the big banks and their favored customers receive the first issuance of the newly invented money. This allows them to prosper by using the magic money to buy at pre-inflated prices, leaving everyone else to pay the inflated prices with their devalued currency.
Bitcoin is a helpful remedy to this problem. Where fiat currency's value is determined by the issuer (i.e., government), through monetary supply and interest rate control, Bitcoin's value is decided by the market. A real, rather than fiat, currency is evaluated by the market for benefits, such as providing a reliable medium of exchange or store of value.
This is Bitcoin's strong suit. As no individual or organization controls, and therefore none can manipulate in their own interest, the supply of the currency, Bitcoin resists the inflationary pressures characteristic of fiat currencies.
Unfortunately, the world's economic problems are not all traceable to fiat currency. Another major culprit is not so easily remedied by market valued currencies like Bitcoin. Fractional reserve banking, whereby the banks magically multiply the money supply themselves, is another matter.
This bit of banking black magic results from the practice of lending to loan clients of the bank the majority of the funds placed in the bank by depositors. This would be a legitimate risk-reward consideration for depositors if there were honest book keeping involved. Instead, though, the banks perpetuate an illusion that in fact the money is still available for depositors to withdraw. People boringly burdened by reality can't help noticing that the same money can't be simultaneously in the depositor's bank account and in the hands of the borrower.
These fractional reserve banking practices are defended, with some validity, as fueling the economy. Such practices do increase liquidity, and entrepreneurial borrowers can benefit in the process. The first rule of economics, though, is always to look for the trade-offs. In the case of fractional reserve banking they're considerable.
First, the practice contributes to inflation, by magically multiplying the money supple. Second, it contributes to exaggerated business cycles, as borrowers are misled about the actual availability of resources, due to artificially suppressed interest rates resulting from illusionary large money supply. The inevitable result is eventually recession - if not depression. Third, it eventually leads to bank runs: as the somewhat ponzi-like scheme eventually collapses. When everyone wants their money back at the same time, it just isn't there.
To this problem, Bitcoin provides no answers. That fact is evident in the suspension of Bitcoin account withdrawals at Mt. Gox, a Tokyo-based exchange. The global leader in U.S. dollars and Bitcoin trades, Mt. Gox has been effectively acting as a fractional reserve bank. Clients create accounts and Mt. Gox has been lending against those deposits. Now, though, Bitcoin depositors are being thwarted in attempts to withdraw their funds.
Officially Mt. Gox attributed the suspension of Bitcoin redemption to what it is calling a technical malfunction. This story however seems calculated to obscure the reality that Mt. Gox has been involved in a low profile, high volume convertibility suspension for a year. Up until now, different ruses have been cited to justify its actions. All pretenses though, now, appear to be over.
What we're seeing with Mt. Gox is the first ever digital bank run. And the response has been the same as that of banks through history: bar the door! It's now looking doubtful whether those with Bitcoin accounts at Mt. Gox will get all - or possibly even any - of their money out.
A solid, market based currency is wonderful and welcomed, but not a panacea for poor investment decisions. The interest from fractional reserve banking is alluring, but willful myopia to its risks puts your savings in grave danger. Bitcoin's virtues do not include a financial redo.
To some of these problems Bitcoin does offer a real solution. To others, not so much.
Bitcoin's big advantage is in addressing the ills of fiat currency and the inevitably ensuing inflation . Inflation is a longstanding and nasty problem that clandestinely impoverishes. The majority of people have their purchasing power of their earnings and savings gutted through no fault of their own by inflation. Meanwhile, well placed, and politically connected, interests like the big banks and their favored customers receive the first issuance of the newly invented money. This allows them to prosper by using the magic money to buy at pre-inflated prices, leaving everyone else to pay the inflated prices with their devalued currency.
Bitcoin is a helpful remedy to this problem. Where fiat currency's value is determined by the issuer (i.e., government), through monetary supply and interest rate control, Bitcoin's value is decided by the market. A real, rather than fiat, currency is evaluated by the market for benefits, such as providing a reliable medium of exchange or store of value.
This is Bitcoin's strong suit. As no individual or organization controls, and therefore none can manipulate in their own interest, the supply of the currency, Bitcoin resists the inflationary pressures characteristic of fiat currencies.
Unfortunately, the world's economic problems are not all traceable to fiat currency. Another major culprit is not so easily remedied by market valued currencies like Bitcoin. Fractional reserve banking, whereby the banks magically multiply the money supply themselves, is another matter.
This bit of banking black magic results from the practice of lending to loan clients of the bank the majority of the funds placed in the bank by depositors. This would be a legitimate risk-reward consideration for depositors if there were honest book keeping involved. Instead, though, the banks perpetuate an illusion that in fact the money is still available for depositors to withdraw. People boringly burdened by reality can't help noticing that the same money can't be simultaneously in the depositor's bank account and in the hands of the borrower.
These fractional reserve banking practices are defended, with some validity, as fueling the economy. Such practices do increase liquidity, and entrepreneurial borrowers can benefit in the process. The first rule of economics, though, is always to look for the trade-offs. In the case of fractional reserve banking they're considerable.
First, the practice contributes to inflation, by magically multiplying the money supple. Second, it contributes to exaggerated business cycles, as borrowers are misled about the actual availability of resources, due to artificially suppressed interest rates resulting from illusionary large money supply. The inevitable result is eventually recession - if not depression. Third, it eventually leads to bank runs: as the somewhat ponzi-like scheme eventually collapses. When everyone wants their money back at the same time, it just isn't there.
To this problem, Bitcoin provides no answers. That fact is evident in the suspension of Bitcoin account withdrawals at Mt. Gox, a Tokyo-based exchange. The global leader in U.S. dollars and Bitcoin trades, Mt. Gox has been effectively acting as a fractional reserve bank. Clients create accounts and Mt. Gox has been lending against those deposits. Now, though, Bitcoin depositors are being thwarted in attempts to withdraw their funds.
Officially Mt. Gox attributed the suspension of Bitcoin redemption to what it is calling a technical malfunction. This story however seems calculated to obscure the reality that Mt. Gox has been involved in a low profile, high volume convertibility suspension for a year. Up until now, different ruses have been cited to justify its actions. All pretenses though, now, appear to be over.
What we're seeing with Mt. Gox is the first ever digital bank run. And the response has been the same as that of banks through history: bar the door! It's now looking doubtful whether those with Bitcoin accounts at Mt. Gox will get all - or possibly even any - of their money out.
A solid, market based currency is wonderful and welcomed, but not a panacea for poor investment decisions. The interest from fractional reserve banking is alluring, but willful myopia to its risks puts your savings in grave danger. Bitcoin's virtues do not include a financial redo.
About the Author:
Anyone hoping to be part of the Bitcoin renaissance in global finance, you need to stay on top of events by getting the scoop at the Bitcoin Profit Calculator blog. Wallace Eddington has been storming the blogosphere with his recent work. See particularly his popular piece on Bitcoin exchange trading funds .
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