Why Bitcoin should remain unregulated


Tomas is the founder of Coin of Sale, a Bitcoin POS system. He blogs at freecitystate.com.

wall street too big to fail

Aidil Zulkifli on e27.co tried to criticize the free market approach to Bitcoin (un)regulation and he based his argument on two points – that Bitcoin is the perfect tool for money laundering, and that unregulated markets caused crises such as the one in 2008.

First of all, it’s nice that Zulfikli has forgiven David Moskowitz (the author he was responding to) for overlooking the prosecution of two men for money laundering through Bitcoin, an incident which happened after David wrote his article.

What is more difficult to forgive is the fact that Zulfikli, who is a lawyer, has ignored the “innocent until proven guilty” principle. Not a single person has been found guilty of money laundering with Bitcoin, so using these examples to prove his point is blatant ignorance of the basic principles of justice.

Also, as a lawyer, Zulfikli should know that just because the Singapore dollar is the only legal tender currency in Singapore does not make alternative currencies illegal. Legal tender simply allows a currency to be used as a means of paying taxes and meeting obligations, but that doesn’t stop you from trading in other currencies. Anyone is free to open a USD account in Singapore and receive payments from its partners in that currency.

Under-regulation didn’t kill economy – over-regulation did

But my criticism is aimed mostly at the economics part of Zulfikli’s argument. He claims that financial markets were “unregulated” before the ‘08 subprime mortgage crisis.

Let’s analyze how that “unregulated” market looked like and compare it with how Bitcoin would have handled such issues. To do this, we cannot do it the populist way and just look at the derivatives which drove the subprime mortgages and the credit default swap instruments which were insuring them. We need to look at the whole process from the decision to issue a subprime mortgage, through to the setting of its parameters, to selling it on the secondary market.

As Bitcoin is a medium of exchange (not money – yet), we need to compare it with the medium of exchange which was issued against those mortgages – US dollars. The Federal Reserve – the US central bank with a board appointed by the President and confirmed by the Senate – targets the interbank lending rates, thus setting interest rates for the whole economy and effectively centrally planning the price of money for loans.

This is why both US and Singaporean interest rates are virtually zero (Singapore pegs its rate to US). This would be impossible with Bitcoin where there is no such authority with the ability to issue new currency at will and push rates below their market value.

New loans are taken from deposits of other clients who believe that their money is safely “stored” in a bank and available to them 24/7 when in fact, most of it (in the case of US, this is up to 90 percent) is lent to someone else. The amount that banks has to store without lending out is defined by financial regulations. International agreements are also in place for banks to set aside money to cover losses.

By defining these limits in a regulation, it was implied and later explicitly stated and executed that as long as banks stick to these rules, the central bank as a lender of last resort will provide liquidity in case clients initiate a bank run, an event where many customers make withdrawals at the same time but to the extent that the bank risks bankruptcy. Meanwhile, the Treasury will  provide capital in case bank’s loans go sour.

Since the damage suffered from bank runs and losses are subsidized by the government, there’s nothing stopping banks from growing the money supply and triggering credit bubbles like the one preceding the 2008 crisis or the one we’re facing now.

Deposits are further insured through the Federal government’s deposit insurance scheme, which took away the consumer’s responsibility to do basic due diligence and allowed banks to take larger risks because nobody who have money at stake was watching the banks.

Bitcoin has no cushion for negligence

foreclosure housing financial  crisis 2008

In the Bitcoin world, there’s no central bank and no treasury to give such guarantees as no one has the resources to fulfill them. The Bitcoin equivalent of banks would have to be liquid and solvent, otherwise the free market would wipe them out before they can grow too leveraged.

Remember Freddie Mac and Fannie Mae? These gigantic loan companies blowing the bubble of the housing market were created by the US Congress as secondary buyers of mortgages to support their issuance by the private sector to subprime borrowers. They are guaranteed by the Treasury too.

The result was that mortgages were given to people without any income, causing real estate prices to go through the roof because of all the speculative demand. To support anything like that in the Bitcoin world, government would have to tax everyone accordingly, because banks couldn’t simply print money for those loans. And since taxes are much more direct and transparent than inflation, people would hardly allow anything like that.

The Securities and Exchange Commission is another regulatory tool of the US government to oversee financial markets. To explain its effectiveness in protecting the general public, you just need to know that Bernie Madoff happened right under its nose.

The last, but not least – credit rating agencies. The government essentially gave an oligopoly to the “big three” – S&P, Moody’s and Fitch – for assigning credit ratings to securities which the Fed accepts as collateral against their loans to banks.

By removing the risk of competition, the US government is assured of their loyalty and the best ratings of its bonds in the time when it is practically bankrupt due to debt and unfunded liabilities worth years of output of the whole economy. And surprise, these same agencies assigned AAA ratings to mortgage backed securities and banks which were responsible for the crisis.

In a Bitcoin economy, there would be no way for governments to concoct such deals because the rules of unhampered financial markets would force it to maintain debt on sustainable level and no regulated credit agency would be able to mask it.

The boom caused the bust

As you can see, financial markets which produced the massive bubble leading to the bust were far from unregulated. In fact, it was regulations that allowed the bubble to be created in the first place.

By emphasizing more on the crash rather than the boom which was driving the economy off the cliff, Zulkifli has revealed his economics point of view more than he would probably wanted to.

There are two main differences between Austrian School economists, which I subscribe to, and those educated in different schools of economics or those who lack economic education altogether.

First, only Austrians successfully predicted the 2008 crisis because they understood its underlying reasons – the inflation and government meddling with the mortgage market.

Second, Austrian economists understand that the boom and not the bust is the real problem. During the boom, the economy is producing what people don’t really want due to the availability of cheap money, which caused rapid inflation. The result was thousands of unoccupied houses or unprofitable dotcom startups, which inevitably caused losses to all those who invested in them and who financed the ride.

The crisis is just the cleansing process unfolding the fallacy of those investments and showing us they were not really desired in the first place. It is what happened in 2008 when real estate prices in the US started to collapse or in 2001 when startups ran out of capital without producing any revenue. It is about to happen again in Singapore (luckily Singapore is a much healthier economy with less government intervention and more flexibility for restructuring efforts). Crisis is the way back to normalcy.

The world based on fiat money banking is heading into another crisis. The real estate bubble is rising again everywhere around the world, equities are near their historic highs without the underlying corporate profits, student loans in the US cannot be paid in the current – or any – economic situation, the US and European government debt bubble is larger than their respective economies and any of these are bigger than what we experienced before 2008.

This creates a perfect storm for what could be the worst financial and economic crisis we have ever seen. My biggest fear is that when this happens, those who were calling for more regulations and whose calls were listened when the Dodd-Frank Act has been enacted will be heeded by the media and politicians again even after they were and will be proven repeatedly and completely wrong.

The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression – Ludwig von Mises, Austrian School economist

(Editing by Terence Lee, images by Michael Fleshman and woodleywonderworks)

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