By David Howden
Friday, March 7th, 2014
A currency is only as safe as the bank that stores it. Nowhere is this more apparent than in the recent turmoil in the bitcoin community.
One the primary advantages of bitcoin, perhaps even the greatest advantage of the cryptocurrency, is the ability to do away with traditional banking institutions. By providing an option to transfer payments peer-to-peer at low cost and with great ease, bitcoins allow the currency user full autonomy in not only how he uses his cash, but also how others use it along the payments system. Indeed, the initial marvel of the bitcoin protocol from a purely technological point-of-view was the solution to the double-spending problem when making payments using a peer-to-peer system.
On 7 February of this year, Mt. Gox – a bitcoin exchange which essentially functioned as a depository (i.e., bank) for bitcoins – halted all withdrawals in the crypotcurrency. At the time I wrote two articles making a pretty clear case for Mt. Gox operating like a run-of-the-mill fractional-reserve bank (here and here).
Fractional-reserve banks that existed before the advent of deposit insurance were constrained by some real pressures as they decreased their reserves. As depositors became less sure that they would be able to access their deposits on demand, they would start demanding the fractional-reserve bank’s services at a discount to its competitors. As depositors started withdrawing their funds and endangered the liquidity and eventual solvency of the bank, the bank would react by either halting withdrawals outright (as Mt. Gox did on February 7), or temporarily delaying them while remunerating the client with an interest payment (i.e., enact a “option clause”, something Mt. Gox effectively did by charging clients an extra fee if they wanted their withdrawals expedited.)
Read the rest of the article here.
