Bitcoin is like Tinkerbell: If people stop clapping, it’s going to die

February 25, 2014

(Jim Urquhart/Reuters)

The Bitcoin world is in shock at the moment because of rumors of large-scale theft and insolvency swirling around the prominent Bitcoin exchange Mt. Gox, which has at least temporarily ceased operation. Bitcoin enthusiasts see this as a temporary setback rather than a long-term problem, believing that the elegance of Bitcoin and the enthusiasm that it inspires among technological sophisticates will give it staying power.

The problem is that Bitcoin is a currency. If it is going to thrive and be used by the general public it needs to be not only technically elegant but also able to pull off a kind of confidence trick. It has to get the general public to believe in it. In a sense, all currencies are confidence tricks. They have value only because people believe they have value. Currencies don’t have to be issued by governments. In the early 19th century, there were many different dollars in the United States, issued by different private banks (with exchange rates between them). But people have to believe in currencies, either public or private, if they are to prosper.

James Buchan’s “Frozen Desire” is perhaps the best book on money written in the last 50 years, and certainly the most beautifully written. It describes the system devised by the economist John Law to create what was effectively a bubble of imaginary money. This made Law, for a brief period in the 18th century, the richest man in the world. Law’s “Mississippi System,” like Bitcoin, was ingenious, and Buchan argues that it was technically plausible. Under different circumstances, it might have worked. But as soon as people began to lose confidence in Law’s scheme, a self-reinforcing disbelief began to spiral — and a vast, technically lovely scheme collapsed into utter ruin.

The lessons for Bitcoin, and other such utopian schemes to create modern Mississippi Systems are clear. Technical ingenuity and engineering prowess can help to retain people’s confidence in a currency by reassuring them that the obvious forms of theft and speculation will be difficult to carry out. Yet confidence, even so, is likely to remain fragile, and easily broken. We’ve yet to see whether Mt. Gox’s difficulties will cause a disastrous spiral of disbelief. But unless Bitcoin somehow pulls off the trick of getting the general public (as opposed to libertarian-minded techies) to believe in it, it’s always going to be vulnerable.

Henry Farrell is associate professor of political science and international affairs at George Washington University. He works on a variety of topics, including trust, the politics of the Internet and international and comparative political economy.
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Dan Hopkins · February 25, 2014