The recent banking crisis in the island nation of Republic of Cyprus has brought the inherent instability of western banking systems to the fore, and Bitcoin’s value has responded in a striking fashion. Could financial troubles in the E.U. launch the virtual Bitcoin currency into the mainstream?
Earlier this month The Data Center Journal looked at Bitcoin, providing a brief overview of this decentralized virtual currency (what some call a “cryptocurrency”), including its potential value in a world where governments and central banks abuse national currencies through inflation and through bullying of politically unfavored activities. Ironically, the small island nation of Cyprus (you might be hard pressed to identify it on a map)—part of the euro zone—may be a good illustration of Bitcoin’s potential.
In an attempt to save its troubled banking system through a multi-billion-euro loan, the government of Cyprus has looked at confiscating a percentage of savings from depositors. Although the precise details regarding who will be on the paying end of this “tax” are unclear, it illustrates the skewed priorities of governments when it comes to money. More ominously, The New York Times reported that “the head of the Eurogroup, Jeroen Dijsselbloem, suggested that the idea of skimming savers’ accounts to bail out banks could be considered a ‘template’ for other countries.” In other words, banks are not necessarily a safer place for money than your mattress.
How has Bitcoin responded to the Cypriot banking crisis? After reaching an all-time high in February relative to the dollar (about $33), Bitcoin’s value jumped even further, exceeding $90 on the Mt. Gox exchange.
Bitcoin to the Rescue?
Cyprus is clearly demonstrating the problem of the fractional-reserve banking system. Most people, if they heard that their government was likely to impose a substantial tax on all bank deposits, would withdraw their assets and place them in some other holding—real estate, commodities, stocks or even consumer purchases. The problem? If everybody tries to get their money at once, the baking system will crumble, because banks do not really have depositors’ money on hand. What you “loan” to the bank (currently at pathetic near-zero interest rates) the bank loans out to others at higher rates.
Even apart from forthright confiscation, governments and central banks effectively tax currency through inflation. With savings receiving effectively no interest in banks, deposits are effectively wells from which the government sips value through “quantitative easing” and other euphemistically named schemes.
Bitcoin, by virtue of having a hard limit on the amount of currency in circulation and being free from centralized control by banks and governments, sidesteps these difficulties. For instance, a Cypriot citizen using Bitcoin rather than the nation’s banking system could avoid the deposit tax, as well as upcoming capital controls. He or she would also be unaffected by the bank holiday that the nation declared to avoid a bank run (the aforementioned problem whereby depositors demand their money, but the bank runs out of available funds).
Bitcoin Follows Internet Precedent
The Internet has become a medium enabling communication that often transcends national boundaries and that bypasses government-approved media gatekeepers: for instance, you can quickly and easily find multiple perspectives on events by visiting different websites—no longer is a major TV broadcast network the only readily accessible news stream. Bitcoin is in some ways an extension of this precedent set by the Internet; just as news and information is no longer centralized, a currency can be established apart from government/bank control.
Of course, this doesn’t warrant wholesale support for Bitcoin as the unproblematic answer to all concerns about money, but the virtual currency does offer at least two benefits: it is an alternative that avoids some problems (such as those that Cypriot citizens are now suffering), and it provides an opportunity for discussion and debate regarding money and the role of central authorities in governing it.
CNBC.com cites DailyFX currency analyst Christopher Vecchio as saying, “‘Right now [Bitcoin] seems safe. Personally it wouldn’t be my preferred vehicle to trade money because it’s unregulated.’” Nevertheless, Vecchio also notes that this lack of involvement with a sovereign means the currency is not anchored to national credit problems, such as the E.U. is experiencing. Ultimately, money is at risk of theft regardless of where you put it: In a mattress, it can be stolen by common thieves. In a digital currency, a hacker could conceivably rob you from afar. But in a bank, it can be taxed, as Cyprus is illustrating. The difference is that thieves hit a few individuals for relatively small sums; governments hit everyone for vastly greater amounts. The question is where the risk is least, and the rising value of Bitcoin suggests that a growing number of people believe this Internet currency is a safer bet.
All In for Bitcoin?
Bitcoin is still fairly new, so today’s explosive growth could easily turn into tomorrow’s nightmarish decline. On the other hand, the recession of the last decade shows that any market can do the same: consider real estate, particularly as Federal Reserve Chairman Ben Bernanke calls the play in the years leading up to the crash. Moving all your liquid assets to Bitcoin is probably unwise, but you would have done well had you made a significant investment in the virtual currency last year and sold today.
Furthermore, Bitcoin’s relative freedom may quickly be encroached by governments as it gains popularity, as Zero Hedge notes. But exactly how Bitcoin (or other currencies, such as gold and silver) might integrate into—or replace—the traditional national currencies we have become so accustomed to is unclear. For those interested in a free market, it’s a wait-and-see matter that will resolve itself over time as businesses and consumers choose what’s best for their interests. For central planners, it’s a matter for yet more regulation by organizations that are hardly paragons of fiscal wisdom.
Cyprus illustrates that the traditional banking system, run by governments and central/national banks, is not the safe haven that many assume it to be. All that is required to destroy the system is for many (certainly not all) depositors to demand their money simultaneously. And given the current ridiculously low interest rates, which are depressed by central banks’ loose monetary policy, bank deposits are little better than use of the proverbial mattress. Bitcoin certainly isn’t perfect, as at least one recent problem indicates. But this currency may be the beginning of a broader look into how the Internet—which created an information revolution—can bring its decentralizing benefits to currency as well. Regardless of whether Bitcoin succeeds or fails, it is a learning opportunity for individuals and companies to explore less “mainstream” options for commerce.
Photo courtesy of zcopley