Saturday, 7 December 2013

How to start a crypto-bank run

First published 7th December 2013
Updated 10th February 2014

A friend who is a crypto-currency evangelist gave me a Bitcoin a few years ago, which I jokingly accepted as a 'store of value' until the price bubbled* to over $1000. When I heard that China was banning direct trade in Bitcoins, I sold up and suggested my friend did, too. Yes, the flash-crash was China's fault. For a while I was tempted to roll the crypto-dice, buying Litecoins in expectation that Mt.Gox would start trading them; or arbitraging the exchanges**.

But I find it difficult to believe there is a 'natural price' or that 'par' will emerge from the chaos: I think insiders will profit and outsiders will lose. To exchange my Bitcoin I paid FOUR sets of fees: a percentage to the trading platform; a fixed spread to the settlement platform; an exchange rate fee from USD to GBP; and a transfer fee to a 'recognised' UK holder of GBP: total fees were over 10%.

Crypto-currencies have seen the most unexpected people jump into bed together: drug dealers, geeks, crypto-anarchists and libertarians. On the left, their anger is directed at private interests; on the right, it is directed at government.  But crypto-currencies look like Wildcat banking to me, with an unregulated network of international crypto-banks. There are multiple currencies and trading platforms, and you can buy derivativeslend and borrow.

Without anyone to uphold 'par' or regulate the crypto-banks the most obvious lesson is to have stronger regulation of the exchanges and crypto-banks. Today (10th February 2014) there was a flash crash on the BTC-e exchange where a Bitcoin was briefly worth $102. I think I had a lucky escape.




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* This post on Bitcoins makes a good point about their self-reinforcing nature. The basic foodstuff of crypto-banks is the Bitcoin. If derivatives are settled in Bitcoin, and crypto-banks and firms are bought and sold in Bitcoins, their scarcity drives up the price and perpetuates the bubble. There are similarities here with GBP and USD, which might become less scarce if more trade were settled in other currencies.

** There is also an analogy with the 'carry trade'. For long periods there have been profits to be made if you buy on the Eastern Europe and Chinese exchanges and sell on MtGox (USD). This works best for insiders who can avoid bank fees (7% on PayPal).