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This is an opinion editorial by Mickey Koss, a West Point graduate with a degree in economics. He spent four years in the Infantry before transitioning to the Finance Corps.
History may not repeat itself, but it sure does rhyme from time to time. As overextended cryptocurrency platforms like Celsius and Three Arrows Capital go insolvent, a benevolent billionaire steps in to rescue BlockFi and Voyager. But why? Because of the incentives; this is true, stakeholder capitalism at its best. The virtue of greed is playing out right before our eyes.
Knickerbocker Crisis: Banking Panic Of 1907
In 1907, the United States financial system was nearly brought to its knees through a series of defaults on stock market margin loans. Rampant speculation led to an over-leveraged system, ultimately resulting in a cascade of liquidations, the stock market crashing and the insolvency of the Knickerbocker Trust Company.
As contagion spread, individuals and banks alike began to withdraw deposits from the banks, lowering reserves at a time when banks were actually required to hold a portion of their deposits on hand.
Luckily, J.P. Morgan organized a private bailout of select banks by providing their own personal capital to shore up balance sheets and guarantee liquidity. Even though Knickerbocker was the third largest bank trust in New York City at the time, it was liquidated in a relatively orderly fashion and allowed to fail.
Though it may seem strange to think why these greedy capitalist fat cats would risk their own capital to save banks they didn’t own, it actually makes perfect sense if you think about it. If contagion was allowed to spread, it ran the risk of spreading to their own banks and companies. This was not altruism. This was pure and profitable self-interest: stakeholder capitalism. Save your competitors to save yourself because holding a stake in a failing system means that your stake risks failure as well. And guess what? It worked to an extent.
Lender Of Last Resort
The cryptocurrency space has no central bank and no lender of last resort. Without the ability to print his own money, Sam Bankman-Fried (SBF) is risking his own money to prevent the collapse of others. If BlockFi or Voyager goes down, SBF may be left with hundreds of millions of dollars in losses.
His reasoning undoubtedly must be similar to that of J.P. Morgan in 1907. Panic and contagion are not good for business. SBF is just following the incentives. By saving the businesses he assesses are viable in the long term, he is helping to stave off panic which could result in more pain and more loss for the industry. By allowing for the defunct business strategies to fail, he is mitigating the risk for further hazard in the future.
Save the system to save yourself. The private markets are incentivized to step in when no other alternative exists.
Bitcoin Fixes This
The fiat system is currently propped up by a central bank that promises to backstop banks with unlimited liquidity. The result is a system wrought with moral hazard. For the most part, banks don’t have to answer for their mistakes when they can be papered over with printed money.
The longer this is allowed to occur, the more deadwood piles up, increasing the risk of a truly apocalyptic financial forest fire.
By adopting bitcoin as a reserve currency, central banks can move back to a sound money standard. By removing the ability for unlimited liquidity creation, central banks will no longer be able to save the entire system from collapse. They can no longer prop up zombie companies and incentivize irresponsible risk-taking. Losses will no longer be able to be socialized while the banks privatize profits after their bailouts.
Scarcity is not only a key property of hard money, it is also a necessity for a sound and stable system of value. By adding scarcity and consequences back into the system, we can stop the cycle of moral hazard and malinvestment. We can clear out the deadwood and pave a path for a better future.
This is a guest post by Mickey Koss. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc. or Bitcoin Magazine.