-
**
Adam Gurri posted: "Speculation about the future of Bitcoin has never
been higher---in both the financial sense of people buying it up in case
its value increases over time, and in the analytical sense of words being
written about why its rise must or must not be a bubble. A"
New post on *The Ümlaut*
<http://theumlaut.com/?author=6> Bitcoins,
Free Banking, and the Optional
Clause<http://theumlaut.com/2013/05/06/bitcoins-free-banking-and-the-optional-clause/>
by
Adam Gurri <http://theumlaut.com/?author=6>
Speculation about the future of Bitcoin has never been higher---in both the
financial sense of people buying it up in case its value increases over
time, and in the analytical sense of words being written about why its rise
must or must not be a bubble. At the heart of people's concerns is the wild
volatility that Bitcoin has displayed during its short history. The problem
is that Bitcoin's future, like so many things, cannot be discovered by the
use of reason. History is full of examples of clever mechanisms that only
emerged as a result of stressors placed on the system.
There are many apparent shortcomings to Bitcoin as it exists today. One
piece argues <https://medium.com/money-banking/2b5ef79482cb>, persuasively,
that Bitcoin prices appear highly sensitive to media attention. His
argument is that there's a short term positive feedback loop that happens
in which some event triggers media attention, which encourages more
speculation, which increases the price dramatically, triggering more media
attention, and so on, until it all comes crashing down to Earth again.
I actually view all this volatility and sensitivity to attention to be a
good thing---Bitcoin is being stress-tested. If it cannot adapt to the
fickle nature of media-generated attention, it will never become a
realiable store of value or unit of accounting---though that doesn't
necessarily mean there wouldn't be any role
<http://bitcoinexplainer.com/>for it at all.
There's something to be learned here from the history of free banking, in
Scotland in particular. One of the arguments in favor of central banks is
that the pre-central bank era in the United States was plagued by
irrational runs on the bank that destabliized the whole system. In *The
Theory of Free
Banking*<http://oll.libertyfund.org/?option=com_staticxt&staticfile=show.php%3Ftitle=2307>,
and elsewhere, George Selgin demonstrates that the real problem with the
19th century banking system in America was that banks were hamstrung by
regulations that didn't allow them to develop any defensive mechanisms
against runs on the bank.
In Scotland in the second half of the 18th century, no such regulations
existed. Banks would issue their own currency in the form of promisory
notes for a specific amount of gold. If they issued more currency than they
had gold to redeem, they would be just as vulnerable to runs as a more
modern bank that has fewer dollars in its vault than the total value of its
deposits.
And indeed, in the early days of the Scottish free banking system, many
banks had to close their doors entirely, or hold on to huge amounts of gold
if they wanted to continue to operate. Eventually, however, they developed
a mechanism for defending against runs on the bank. It was called the
"option" or "optional" clause, which anyone signed with the bank when doing
business with them. It stated that the bank reserved the option to defer
payment for a period, usually up to six months. This gave the bank enough
time to liquidate its balance sheet to make payments, meaning that the
fundamentally sound banks did not go under. In order to show customers that
this option would not be invoked by default, the clause included the
condition that banks had to pay the highest interest rate that was then
allowed under Scottish law---5 percent. Had a higher rate been allowed,
it's quite possible the penalty would have been even greater.
As a result, Scottish banks had a big incentive to build up a lot of
capital, and did so much more than modern banks do. There was no need for
capital requirements, and because the optional clause plus a big balance
sheet gave consumers a lot of reason to trust the Scottish banks, runs were
rare and the system was able to take advantage of all of the positive
aspects of fractional reserve banking.
Interestingly, the chief cause of the development of the optional clause
was not a lot of runs on the banks by consumers. Instead, established banks
would hoard enormous amounts of currency from new banks, and then bring
them all due at once in order to try to bankrupt their competitors. The
modern impulse to that sort of anti-competitive behavior would be to call
in the FTC or some other regulatory body to reign it in, but that would
have resulted in a far less optimal equilibrium than the optional clause
made possible. Because this anti-competitive behavior put so much stress on
the system, the system was forced to adapt in order to survive, and the
result was a much healthier banking system overall.
Right now, Bitcoin is enduring the enormous stressor of sudden speculative
interest. It's quite possible that it will come crashing down again, and
it's also possible that such a crash will only be momentary (recently a
serious crash lasted only a single
night<http://spectrum.ieee.org/tech-talk/computing/networks/bitcoin->).
It seems clear to me that the stressors that Bitcoin faces today will lead
to the development of new defensive mechanisms in the future. Even if it is
not Bitcoin itself that develops those mechanisms, a future competitor
could learn from Bitcoin's shortcomings and come up with a more reliable
solution.
The notion of a distributed crypto-currency is very new, and the practice
is even newer. Though a lot of thought went into Bitcoin's design and a lot
of thought has gone into criticism of it, it is ultimately rote trial and
error that will get us to a more effective virtual payments system, if such
a system is indeed possible.
*Adam Gurri <http://theumlaut.com/?author=6>* | May 6, 2013 at 6:00 am |
Tags: antifragility<http://theumlaut.com/?taxonomy=post_tag&term=antifragility>,
emergent
behavior<http://theumlaut.com/?taxonomy=post_tag&term=emergent-behavior>,
free banking <http://theumlaut.com/?taxonomy=post_tag&term=free-banking>,
George
Selgin <http://theumlaut.com/?taxonomy=post_tag&term=george-selgin>, monetary
history <http://theumlaut.com/?taxonomy=post_tag&term=monetary-history> |
Categories: Bitcoin
<http://theumlaut.com/?taxonomy=category&term=bitcoin>| URL:
http://theumlaut.com/?p=294
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