Taps Coogan – November 14th, 2022

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In one of the great ironic turnabouts of finance, Bitcoin and various alt-coins have imploded over the last week due to the failure of FTX, an exchange which was allegedly engaging in the surreptitious rehypothecation, transfer, and lending of costumer deposits.

The collapse of FTX is so ironic because the main sales pitch for cryptocurrencies has been that they eliminate counter party risk, bank runs, and various associated ills of traditional banking and fiat currencies.

Of course, for people that understand fractional reserve lending, counterparty risks, and rehypothecation, the argument that Bitcoin eliminated such risks never made much sense.

That’s because such risks are less a function of a specific asset or currency and more a function of the institutions that handle assets, like FTX.

A de facto fractional reserve lending system can be created based on pretty much anything if it can be used as collateral for a loan and then rehypothecated or otherwise used by the lender (see gold or copper rehypothecation). That is what FTX allegedly did with its depositors’ money and cryptocurrencies, culminating in the equivalent of a bank run on the exchange.

Ironically, when a bank run happens in a fiat-based fractional reserve system, the value of the fiat tends to goes up for the lucky ones that can get their money out of failing institutions or kept it in cash (deflation). With a non-fiat backed reserve system like Bitcoin, the value goes down for everyone.

Along those lines, all Bitcoin is at risk if bad behavior is happening in large amounts anywhere on the network. Because a large part of the Bitcoin network will always be in risky jurisdictions, that is the sales pitch after all, there will always be a unique kind of counterparty risk with Bitcoin and other cryptos.

It’s also worth pointing out that Bitcoin is not correlated to inflation and is not anonymous. It is a barely-pseudoanonymous immutable public record of every transaction ever made with Bitcoin and has dropped 75%+ since inflation went wild.

Bitcoin is also not a medium of exchange. Transaction fees are unavoidable and vary from $1 to over $60, making it prohibitively expensive for everyday items. Because transaction fees go up with network congestion, the more that people use Bitcoin, the less practical it gets. Plus, its value fluctuates so much that if you buy something in Bitcoin today and return it within 30 days, either you or the vendor are likely to make or lose 40%+ of the value of the item on the refund.

Bitcoin also has no yield, no cash flow, no productive output, and requires both energy and monetary inputs to keep the network running.

So what is Bitcoin? For now, it appears to be where excess liquidity goes to die. That doesn’t make it worthless, at least not all of the time, but it may be close to worthless much of the time.

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