Waking From the Bitcoin Dream

NEW YORK (TheStreet) -- There was always something utopian about bitcoin, the idea that you could have money without government.

It attracted libertarians like an Ayn Rand seminar, a Ron Paul speech and a Rand Paul bumper sticker rolled into one.

The U.S. had nongovernment money for almost 80 years. From the fall of the Second Bank of the United States under Andrew Jackson in 1836, to the rise of the Federal Reserve under Woodrow Wilson 100 years ago, money in the U.S. was backed exclusively by gold.

When the government ran out of gold, as it did in 1895, it had to go to the market just like any other deadbeat. Those who protested this "cross of gold," such as William Jennings Bryan, were politically crucified on it.

But that pregovernment money was subject to sudden collapse, if the bankers backing it faced a sudden run by depositors. This happened repeatedly in the 19th century. It happened to bitcoin this week when the Mt. Gox exchange suddenly went dark.

Jens Finkhauser, who works at spriteCloud in Germany, says the Mt. Gox failure was a technical event, calling the Bitcoin protocol, "the worst documented of any I have seen in my career." Bitcoin blogger Ryan Selkis, writing as Ryan Galt, suggested something more nefarious was going on.

Other bitcoin players put out a statement at The Coinbase blog, saying they would coordinate to reassure the market, and calling for a higher bar on market makers:

"including appropriate security safeguards that are independently audited and tested on a regular basis, adequate balance sheets and reserves as commercial entities, transparent and accountable customer disclosures, and clear policies to not use customer assets for proprietary trading or for margin loans in leveraged trading."

The collapse even caused Sen. Tom Carper (D., Del.), a virtual currencies enthusiast, to go poetic with a statement calling on the government to "steer the boat away from nefarious actors," while industry partners "row the boat into law abiding waters."

What it all comes down to is this. For any medium of exchange to work, it needs a strong hand to back it up. Gold had J.P. Morgan, not the institution run by Jamie Dimon but the real man, in the flesh, rosacea'd nose and all.

Bitcoin doesn't have that.

SecondMarket, formerly Restricted Stock Partners, online traders in illiquid assets such as private company stocks, has set up what it calls the Bitcoin Investment Trust, which it says lets investors "gain exposure to the price movement of bitcoin without the challenges of buying, storing, and safekeeping bitcoins."

Bitcoin Investment Trust can be a bank of bitcoins. But if there is a run on the bank, CEO Barry Silbert is no J.P. Morgan.

Silbert, an active Tweeter in his mid-30s and graduate of the Emory School of Business in Atlanta, says in his profile that he has made investments in 20 bitcoin-related companies, but his own finances are as opaque as those of the bitcoin market itself. If his exchange gets overextended, what is a trader's recourse?

Back in the 19th century, banks built palatial offices to assure the public of their financial stability. But when the private system collapsed again, in 1929, those palatial offices were worthless. Today some old vaults double as bars, and your local bank office is probably in a strip mall.

What your money has behind it is a store of value backed by the full faith and credit of the U.S. government. As we found in the 2008 financial crisis, the Federal Reserve stands ready to toss money from helicopters onto member banks in order to maintain the stability of the system. Traders are willing to buy that guarantee.

What bitcoin needs to succeed is its own pot of gold, its own real reserves of value, its own Aladdin's cave that will back a virtual currency with enough financial might to create trust.

In the 19th century J.P. Morgan, the man, had that. In our time the Federal Reserve has that. The question is, can bitcoin create that?

At the time of publication the author had no shares in companies mentioned in this story.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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