The collapse of Mt. Gox, once the leading Bitcoin exchange, has been widely covered and documented already. It appears that only now have many people woken up and realized that Bitcoin rests entirely on software, with all that that entails.
Yes, most of the money that we have also depends on software. Your bank, for example, keeps track of the value of your account on a computer. But your money doesn't depend entirely on software. It's also backed by a trail of transaction information (backed up in multiple places), by the law, by the Federal Reserve, and by the U.S. government, which would not tolerate the sudden evaporation of every American's bank account.
The fact that Bitcoin is software all the way down is, in fact, the thing its boosters are so excited about. This is Marc Andreessen, just a month ago:
"Bitcoin gives us, for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate."
This all may be true in some theoretical sense. I don't know. I'm not a computer scientist. But all software design requires implementation. All implementation requires human beings. And human beings make mistakes.
In this case, Mt. Gox was an online exchange for Magic trading cards before it was an online exchange for bitcoins, and it would be surprising if it had been built by the kinds of programmers and security specialists you would want for the future currency of the world.
So now Andreesen and Co. are clinging to the idea that Mt. Gox was just a bad implementation, and the rest of the Bitcoin infrastructure is sound. That may be true. But there are two problems with this argument. First, the rest of the Bitcoin infrastructure was also built by, you know, people who make also mistakes and design imperfect code that can fail or be hacked by other people.
Second, how do you know it is sound? This is only a rough analogy, but in the banking world we rely on the FDIC and the U.S. government. If a bank has FDIC insurance, we assume the FDIC is guaranteeing it, up to $250,000. And we know that if the FDIC made a mistake and the insurance fund runs out of money, the government will step in to bail us all out. How are people supposed to verify the soundness of the Bitcoin infrastructure they are using without some trusted third party? Alan Greenspan would say that the market can police itself, but who wants to be the person to lose her life's savings so that everyone else knows to stay away from some bad operator? Andreesen himself said that Mt. Gox was to Bitcoin as MF Global is to dollars, but that's hardly comforting. What that implies is that Bitcoin needs regulators, statutory liability, and insurance funds, which is not what its advocates want.
Part of the underlying problem is an unwritten law of software competition: Security, performance, and reliability all cost money, but features are cheap and popular. So in the short term, it's a rational strategy to race ahead with feature development, skimp on security, and hope that you don't get caught with your pants down. This is why it's hard to expect high quality software when you're in the middle of a technological land grab, which is exactly what's going on with Bitcoin. This is especially true when the customers you're trying to attract are unsophisticated individuals sucked into the excitement of a speculative bubble. All the other Bitcoin exchanges may be safe as Ft. Knox—but that would be a surprise, given the incentives involved. Instead, we should expect shoddy development to be the norm.
More generally, there is no such thing as a technological utopia. No matter how perfect a technological concept is, when it enters the world of human beings, it becomes imperfect. Bitcoin is no exception. In addition to everything else, apparently Mt. Gox's problems are due in part to a Bitcoin vulnerability that has been around since 2011—but that humans didn't get around to fixing.
This is why we have laws, and regulators, and insurance, all of which would make Bitcoin more like ordinary money. Bitcoin may yet become a lasting part of our financial infrastructure, in part because it offers the promise of lower transaction costs. (As far as anonymity goes—well, look what the U.S. government is doing to Swiss banks.) But it will not usher in some kind of libertarian paradise.
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