This is an opinion piece by Mickey Koss, graduated from West Point with a degree in economics. He spent four years in the infantry before moving to the Finance Corps.
History may not repeat itself, but it certainly rhymes once in a while. As overwhelmed cryptocurrency platforms like Celsius and Three Arrows Capital go insolvent, a benevolent billionaire steps in to save BlockFi and Voyager. But why? Due to the incentives; that’s right, stakeholder capitalism at its finest. The virtue of greed is playing out before our eyes.
Knickerbocker Crisis: Banking Panic of 1907
In 1907, the financial system of the United States was nearly brought to its knees by a series of defaults on stock market margin loans. Rampant speculation led to an over-indebted system, eventually resulting in a cascade of liquidations, the stock market crash and the insolvency of the Knickerbocker Trust Company.
As the contagion spread, individuals and banks began withdrawing their deposits from banks, reducing reserves at a time when banks were actually required to keep some of their deposits.
Fortunately, JP Morgan staged a private bailout of some banks by providing their own personal capital to shore up balance sheets and secure liquidity. Although Knickerbocker was the third largest bank trust in New York City at the time, it was liquidated in a relatively orderly fashion and went bankrupt.
While it might seem strange to think why these greedy fat cat capitalists would risk their own capital to save banks they didn’t own, it makes perfect sense if you think about it. If the contagion was allowed to spread, it risked spreading to their own banks and businesses. It was not altruism. It was pure, profitable self-interest: stakeholder capitalism. Save your competitors to save yourself, because holding a stake in a failing system means your stake is also at risk of failing. And guess what? It worked to some extent.
Lender of last resort
The cryptocurrency space has no central bank or lender of last resort. Without the ability to print his own money, Sam Bankman-Fried (SBF) risks his own money to prevent the collapse of others. If BlockFi or Voyager goes down, SBF could end up with hundreds of millions of dollars in losses.
His reasoning must no doubt be similar to that of JP Morgan in 1907. Panic and contagion are not good for business. SBF only follows the prompts. By rescuing companies he deems viable in the long term, he helps stave off the panic that could lead to more pain and more losses for the industry. By allowing defunct business strategies to fail, it mitigates the risk of new dangers in the future.
Save the system to save yourself. Private markets are incentivized to step in when there is no other alternative.
bitcoin fixes this
The fiat system is currently backed by a central bank that promises to support banks with unlimited liquidity. The result is a system forged with moral hazard. For the most part, banks don’t have to answer for their mistakes when they can be covered up with printed money.
The longer this goes on, the more deadwood accumulates, increasing the risk of a veritable financial apocalyptic wildfire.
By adopting bitcoin as a reserve currency, central banks can return to a sound monetary standard. By removing the ability to create unlimited liquidity, central banks will no longer be able to save the entire system from collapse. They can no longer support zombie companies and encourage irresponsible risk taking. Losses can no longer be socialized while banks privatize profits after their bailouts.
Scarcity is not only a key property of hard money, it is also a necessity for a strong and stable value system. By adding scarcity and consequences back into the system, we can stop the cycle of moral hazard and bad investment. We can eliminate dead wood and pave the way for a better future.
This is a guest post by Mickey Koss. The opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc. or Bitcoin Magazine.