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Lessons From the Bitcoin Fraud

The huge Bitcoin fraud at Mt. Gox has raised some serious questions about Bitcoin as a form of money.  Almost a year ago I touched on some of the interesting elements of Bitcoin as a form of money.  One of the crucial elements I discussed was the topic of trust.  After all, modern money is mostly credit.  And credit is based on a foundation of trust.  If there is no trust then the money has no credibility.  When I first talked about Bitcoin I said that this was a major problem for Bitcoin because it brought the element of fraud into the picture:

“I think there’s a certain missing element of trust in an online money that has no oversight.  One of the key ingredients that stabilizes and maintains the US payments system is the backing of laws that enforce and regulate the proper use of bank deposits.  Banks can’t just issue deposits (loans) without working within the regulatory structure of US government law.  And the users of bank deposits can’t use this payments system for things that the US government might deem inappropriate.  When you legally exchange goods and services on the US payments system there is a certain level of trust derived from the fact that you have a legal system protecting your rights to use that system in a particular way.  In other words, the government helps embed a certain element of trust within the system by ensuring that its users operate within strict guidelines and by providing those users with certain protections against fraud, misuse, etc.  It’s by no means perfect (some might even argue the government has too much control over the laws binding the payments system), but having an institutionalized form of money helps to solidify the trust that is one component of its viability.  Bitcoin has no such integrated legal protections or oversight, which is both liberating, but worrisome in some regards.”

This is the crucial element about fiat money that is lacking in a privatized form of money like Bitcoin – it is not properly regulated.  Of course, it’s designed to be decentralized so it has to essentially regulate itself.  Which sounds great in theory, but obviously doesn’t work as planned.  One of the advantages of fiat money is that it is backed by a structured regulatory system.  This embeds a certain level of trust in the system.  If electronic monies are going to become viable they must overcome this element.  Otherwise, there is no hope for them….

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