Three months into the year and Bitcoin exchanges are having a rough start this year – considering Mt. Gox and Flexcoin’s failures. It’s important to understand that an exchange failing is not the same as a failure in Bitcoin. This is best understood by comparing a bank collapsing being separate from the US dollar’s value. It’s a problem with the bank or exchange. But, these failures obviously have a serious impact on the value of Bitcoin. People are worried about the security of their Bitcoins.
The simplest answer is to keep your Bitcoins in your own wallet. There’s no risk of default, when you’re the one holding the Bitcoin (except, if you lose it in a dumpster). But, Bitcoin exchanges are necessary for the community to grow and operate effectively.
FDIC placard from when the deposit insurance limit was $2,500. (Photo credit: Wikipedia)
The answer to exchanges failing is a Community-Backed or Community-Lead FDIC organization. This is not to be confused with insurance. The FDIC’s most important role in the banking system is often the standards it creates. Insurance is a strong component that would likely help the Bitcoin community as well, but it is not a necessary component to be included immediately.
The Issues
Centralization
Bitcoin was created so that a decentralized peer to peer currency could manifest. Wouldn’t an organization or agency similar to the FDIC “centralize” Bitcoin and go against its principles? The FDIC’s purpose in the United States’ banking system is an insurance agency that creates standards that all banks must follow by law. (Credit Unions have the National Credit Union Administration.)
Creating a Bitcoin FDIC (“BitFDIC”) would frustrate Bitcoin’s values if it was implemented exactly the same way. But, a Community-Backed or Community-Lead BitFDIC is allowed to create its own rules.
BitFDIC should be an organization that the community controls instead of any government. BitFDIC’s primary purpose is to provide standards in accounting and security for Bitcoin exchanges. An important difference is that BitFDIC establishes standards, but not every exchange is required to abide by them. FDIC standards are legally required to be met by all banks, thus it centralizes banks. But, BitFDIC is a set of community standards that “should” be met. If an exchange doesn’t agree with the standard, they’re free to continue to operate on their own guidelines. Thus, the Bitcoin community remains decentralized.
BitFDIC’s standards should focus on accounting and security protocols because these are facets that can be confirmed without human interaction or trust. Numbers should always tie and security protocols should conform to established conventions.
Anonymity
BitFDIC should not expose or affect the anonymity of any Bitcoin owner. These “audits” or “checks” can be done without asking for anyone’s personal identity because the accounts are inherently tracked by unique identifiers. We only need to know that the Bitcoin is there, who owns the Bitcoin is not our concern or goal. Thus, everyone’s identity should remain undisclosed and protected.
Cost
A problem that everyone can foresee is that increased standards usually lead to increased costs or strain on transactions. The benefit to Bitcoin is that technology allows for the “traditional” inefficiencies to become automated or irrelevant. Thus, the cost will always be there, but it’s either very low or only initially relevant. The best way to think about this is through credit card companies. Credit card companies make insane profits by taxing people that want to make fast transactions. The general public has no other option besides credit cards to conduct day-to-day business on any scale. Thus, they allow people to make fast transactions by creating a “secure” system, but it increases the cost to the system to generate their profits.
Bitcoin already allows everyone to freely make transactions digitally without burdening the system with additional transaction fees. But, Bitcoin needs to increase security so that the system is reliable enough to avoid situations like Mt. Gox and Flexcoin. We can accomplish this by using technology to conduct audits or checks on the company consistently to avoid fraud (think of this as a computerized CPA). Security can be increased by setting standards and applying new technology. One solution is computerized escrow accounts that An Ark describes. Obviously, there is no single answer to solve all the problems. But, that is exactly why a Community-Created BitFDIC is necessary to create standards that can create a solution.
The Pros
Standardization is not the same as centralization. You
- can stabilize the Bitcoin exchanges without jeopardizing its principles. Standards are best practices that are NOT required. Everyone is always free to do what they want, but setting a floor for what is acceptable makes gives everyone confidence and northstar to how things should be.
- Stabilized Bitcoin exchanges will inherently help Bitcoin increase in value. The media is constantly barraging Bitcoin on whether it’s secure. Stabilizing exchanges is the same as stabilizing banks (minus the bailouts). You can have a vibrant “currency,” if people think its fools gold. The Brazilian Real is the best example of this idea. The Brazilian “cruzeiro real” and its predecessor currencies faced massive destabilization. The reason why it stabilized is that people believed the currency was “really” stable. The circumstances may be very different, but the human element of trust and fear of risk is just as relevant.
- Running a BitFDIC doesn’t need to be a giant agency or bureaucracy. Professional associations like the Bar Association, the AICPA for accountants and Medical Boards operate as self-governing bodies. The associations can’t control everyone in the system, but it can create standards without being a governmental body.
The Cons
- Muddying the waters. There’s no question that by adding the human element into the equation through the BitFDIC, we’re going to make Bitcoin less efficient is some way. This is inherently the problem whenever we add people to the mix. But, Bitcoin is a tool that was created to help people in their interactions. It’s unrealistic to assume that Bitcoin will be able to entirely take out the human element. The only reason we’re having this discussion about stabilizing Bitcoin is because of our human fear of risk.
- It’s going to take people to come together to discuss and deal with the problem. Getting people to agree and talk about anything is nearly impossible. (Just look at American politics and I rest my case. Not that anyone else is better either!) So, I understand this is a HUGE ask.
Conclusion:
Clearly, this idea may not be the silver bullet. But, obviously something is necessary for Bitcoin to grow in the way that everyone wants it too. Some of these ideas will be included in the answer we come up with, but I have no idea what they will be.
Bitcoin companies have already begun to use insurance as a way to lower risk. Xapo has gotten a lot of attention recently because they took an insurance policy with Meridian Insurance Company to cover “hacking, bankruptcy, employee fraud, and natural disasters.” I’ve discussed insurance before as a possible answer, but I sincerely hope that there is a better option because insurance is expensive!
Disclosure:
I do not own any Bitcoins or any positions on Bitcoin. I have purposely avoided purchasing Bitcoins in order to prevent biased opinions for my personal profit.
