Bitcoin Bank Run by David Howden

Bitcoin Bank Run” by David Howden.

Ever wonder what a digital bank run looks like? Nearly one million Mt. Gox users are finding out first hand.

The Tokyo-based exchange, popular amongst currency traders, has risen in prominence by offering its customers storage services in a variety of currencies. This effectively makes it act as an online bank. One such “currency” that it allows accounts to be denominated in is bitcoin.

Yesterday the exchange halted withdrawals of the digital currency, citing a technical malfunction. It promises to reopen for business on February 10th. What many news sources are missing is that this is not a particularly new development – the exchange has been rejecting customer withdrawals on-and-off for about two months.

What may be happening is a good old fashioned bank run. Like all banks, Mt. Gox is operating under a system of fractional reserves, loaning out or otherwise making use of bitcoin deposits entrusted to it. There are many more claims to the bitcoins depositors have with it than are actually in the digital “vault” at Mt. Gox. This is not unlike your bank, which has many more claims to each dollar deposited in it than it has dollars in the vault to honor.

Lest this post be misunderstood, this is not a fundamental problem of bitcoin, but one of fractional-reserve banking. Here we have an example of a purely unregulated currency succumbing to the same problems that have plagued money users for hundreds of years. When banks are allowed to function with fractional reserves, it matters not if the money is state-issued (like dollars) or market-created (like bitcoin), the outcome is the same: bank runs and depositors left with the inevitable losses.

I urge all readers to not only read the entire article, but to pass it on to all family members and friends who are using bitcoin.

Howden’s outstanding article is a testament to the practical importance of understanding Austrian school economics. While there are some self proclaimed Austrian economists who support the inherently fraudulent practice of fractional reserve banking, in general, Austrian economists are the only economists who oppose it.

The issue of bitcoin banking has been lost in all of the hoopla over questions regarding the monetary status of bitcoin. Inevitably, such questions are raised in a crisis. Howden clearly demonstrates the nature of the crisis. I would also note that such a crisis was inevitable as there is no lender of last resort to bailout fractional reserve bitcoin banks.

I also note that no amount of regulation in the current regulatory environment that affords banks a privileged legal position would address the fundamental issue of fraction reserve banking. Thus the inevitable calls for regulation are futile. What can regulators do? Can they require bitcoin banks to be 100% reserve? This could never happen as it would expose the fraudulent nature of the fractional reserve banking system supported by said government. Any other form of regulation will not address the fundamental issue of fractional reserve banking.

The good news is that as frequently happens, a crisis opens up an opportunity. Here, it is a 100% reserve bitcoin bank with verification by a reputable auditing firm. It will be interesting to see if someone pursues this.

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