Heard About Bitcoin? Nah, Been There, Done That

Between the dramatic collapse of Mt Gox, the recent news that a Canadian exchange lost $100,000, the daily reveal of all the new things you can buy (villas, space flights, etc.) and the growing debate about whether it is a currency or a commodity, Bitcoin threatens to fatigue us all into submission.

Given the chatter -- online and in print -- you would believe that this is an unprecedented paradigm shift in the evolution of currency. If you are a supporter, this is the digital Messiah. The recent volatility and misdemeanors are all part of building the brave new world, the broken fortunes of a few paving the path to good money for us all. If you are a detractor, this is an irrational delusion and the tool of choice for the modern cyber criminal. It will destabilize our attempts to forge a more robust economy and our only hope lies in effectively corralling Pandora's new technology genie before it can do too much harm.

I do not know if Bitcoin is a flash in the pan or if it is the future, though my tendencies are more to the latter. But I do know this is a rerun that we've all watched before. Twenty years ago, the Internet was going to produce hypergrowth, destroy the business status quo, and create a world without boundaries. It changed the world eventually, just not quite then and not as dramatically.

A century earlier, both sides of the Atlantic underwent a bicycle boom as mechanized transport threatened to replace horses. In a chauvinistic world, there was talk of hypergrowth as women could ride these, making the market instantly twice as large. The first major roads were built between towns in anticipation of the hordes of future cyclists. In the end, the car overtook the bike before it could reach this apex.

Both are evidence of how human emotion can extrapolate hints of promise today into near certainty tomorrow. Hyperbole is the clearest evidence of a bubble in the making, as we all get seduced into believing there are fortunes to be made and status to be minted.

Bitcoin enthusiasts today are very much recreating the digital equivalent of the California Gold Rush. The currency is the answer to all our modern day problems, they claim. It is "challenging the financial infrastructure of the whole global economy, and even more, it is challenging entire generations of established political and economic theory that that infrastructure is built on". It is anonymous, infinitely divisible, decentralized and capable of retaining value.

I hear all that. It is still a rerun, because it is human.

On July 27, 2007, Ginko Financial -- a small nondescript bank of insufficient standing to grace the broadsheets --suspended cash withdrawals abruptly. The head of the bank, Nicholas Portocarrero, made a statement announcing that Ginko's "reserve has been depleted" and that he had been forced into drastic measures because as soon as he replenished the reserve, people emptied it again almost immediately. "It's a bank run in essence," he concluded.

A per-day withdrawal cap was introduced, though that fell by the wayside within hours. The next day, allegations of fraud began to make the rounds, despite Ginko's claims that it had total deposits of $192 million. In retrospect, the interest rate of 61 percent promised on the account looked a bit too good to be true.

On July 30, the bank's main ATM started working again. Word spread like wildfire and a disorderly queue of people formed to withdraw the $10,000 they were allowed per day. In desperation, Ginko launched an unsuccessful IPO to raise further equity, with the aim of making an ambitious acquisition -- a large stock exchange named AVIX.

It was a bailout by any other name. Tragically, the IPO raised just $25,000 and was abandoned shortly afterward. Portocarrero took to the airwaves to reassure investors, asking them to be patient. "We have both tangible and intangible assets we have spent money to acquire or develop," he said. "But they cannot simply be turned into cash for people to withdraw."

On August 6, Ginko offered depositors two choices: Either continue to wait to get their funds back, or take the equivalent amount in perpetual bonds that might someday be tradable. Three days later, the choice was made for them. Ginko stopped taking deposits, froze all withdrawals, and converted all its deposits into perpetual bonds. Anybody who wanted to get cash was still free to ask, but would get back only a fraction of their claim. Ginko had collapsed.

The chances are you will never have heard of Ginko Financial. The numbers above are paltry compared to some of the other numbers thrown about at the time. And there was a lot else going on in the real world for it to register on a crowded horizon.

And that is what makes Ginko remarkable.

This was a bank run not in the real world of flesh and paper, but one in cyberspace. The numbers above were all virtual dollars -- so-called Linden dollars -- in an online world called Second Life. However, there were real losses. The Linden dollar, named after the company that owned Second Life, was convertible into U.S. dollars, and the nearly 200 million Linden dollars lost equated to $750,000 in cold, hard cash.

Bitcoiners, like the rest of us, have short memories -- even for events that occurred only a few years ago. There are differences; as history rhymes rather than repeats. But the underlying emotions driving us forward are still the same.

Money is a testament to human ingenuity. Money is a social construct. History shows us anything -- wooden sticks, huge stones, coins, gold, boxes of detergent and now, bits of enigmatic computer code -- can function as money.

Second Life and today, Bitcoin, are proof that we can create an economy and speculation out of thin air if we want -- as long as there are other people and transactions to be done. Ginko Financial proved that in time, where you have people and where you have money, our natural biases and yearning for status will lead inevitably to speculation and its critical consequences.

Once these genies of money were unleashed, Second Life's economy evolved the way any other economy does. People realized that they could make more money by facilitating and leveraging off others.

Some users employed teams of fellow programmers to create new alluring digi-luxuries for sale from furniture to clothes, set up sports events, wrestling promotions and so on. This was commerce.

Others took it one step further and aided the ambition of others by providing them arenas of exchange and lending them money. This was finance.

Eventually, there were those who, impatient to rush ahead, began to play the changing emotions, the ebb and flow of confidence, and the flows of money around them. This was speculation.

Rampant speculation is the domain of an advanced and complex economy, that has realized -- even if subconsciously -- that money is a fluid concept and can be manufactured readily in arbitrary quantities by the confluence of human ingenuity and mass belief. As long as there is confidence and trust, there is money and status to be minted.

The shifting sands of perception lead to their own bubbles. Bitcoin is but another case in point. Its journey to better or to worse will pass through boom and bust despite best intentions.

The reason is simple.

No financial market is truly rational. The term is just a collective noun for the hopes, greed and fears of countless participants, jostling to get ahead. And that emotion will always overload even the most mathematical of formulations.

It's an old movie -- finance's equivalent of It's a Wonderful Life -- and this is the latest perennial rerun. Grab the popcorn and enjoy the show.