Bitcoins, Stage 2: "Bring in the Feds!"

Reality Check

When you think "Mt. Gox," think "Enron."

When something this devastating happens to the biggest exchange in an experiment designed by anonymous Japanese programmers, the industry is not going to recover rapidly. Other firms in this industry now have a real marketing problem.

The disappearance of the Mt. Gox bitcoins exchange is a major setback for the future of bitcoins. It will keep out serious money until the industry is regulated by major governments. The move toward regulation has already begun. This will accelerate it.

Representatives of surviving bitcoins firms assure us that this is just a minor setback. But it is not a minor setback. When the biggest bitcoins exchange in the world goes belly-up, and it takes an estimated $409 million worth of investors' funds with it, the market cannot attract new investors easily. The sheep have now seen what can happen to them. The official assurances from rival firms do not deal with this fear: "It can happen again. Investors will be left with nothing." How can the survivors prove this is wrong? No one even knows what happened. There is o recourse. It was all private. It was all based on trust. Those who trusted some kid have lost their money.

From day one, bitcoins were sold to libertarian investors on the basis that they are unregulated. This, we were assured by promoters, would make bitcoins into worldwide libertarian money. Now, the "new, improved" bitcoins will be regulated by the Securities and Exchange Commission and the Federal Reserve. Faith must be restored in bitcoins. The solution? Bring in the Feds!

The biggest promoters of bitcoins are the Winklevoss brothers, the guys who sued Mark Zuckerberg, and got rich doing it. They have bought shares in bitcoins companies. They are starting an ETF for bitcoins. They have decided to name it Winkdex.

These boys are not marketers. First, Winkdex sounds like something you clean your windows with. Anything that cleans your windows may also clean your clock. Second, for older people, it sounds like Winky Dink, a TV cartoon character of the 1950's.

Nobody understood the whole bitcoins thing from the beginning. People understand gold. They do not understand algorithms. When an algorithm is created by a Japanese programmer or team of programmers with a fake name, you're not going to get major support from the financial community. The financial community is not going to put its money into this, because an industry has to be regulated by the government to attract big money. You have to go to the Securities and Exchange Commission, as the Winklevoss brothers did last year. You have to come under Federal Reserve scrutiny. Plans are ready to create a market for bitcoins. Banks will be involved. The government will regulate it.

But what about the libertarians' dream of bitcoins a separate currency outside the central banking systems? That was utter nonsense from day one. We are now seeing the federalization of bitcoins. No libertarians need apply.

A MILLION NAIVE TRUE BELIEVERS GOT SHEARED

This market is new. It was hyped. It was hyped by programmers. They thought this was the next killer app. It was, indeed. A million trusting investors got killed.

How could anyone with a nickel's worth of common sense not have seen what was wrong with Mt. Gox? Take a look at this:

This poor kid has now lost 100% of the bitcoin portfolios of a million investors. He will be sued. Lawyers' fees will eat him alive. Can he declare bankruptcy and get it over with in Japan?

He was just some kid who did not know what he was doing. But a million silly people believed him. "Here: take our money!" He took it. He converted it into digital pixie dust. The poor suckers are lined up carrying signs: "Where's our money?" It's in Neverland.

A million people thought: "No problem! This kid looks reliable to me!" They were wrong. The missing kid and his unnamed colleagues flushed $400 million down the toilet. Yet defenders of this debacle still say: "No problem! You can trust us! We're not like Mt. Gox!"

How can they prove it? How can they prove it to people with serious money, which is what an alternative currency needs to replace the dollar, the yen, and the euro? You can prove anything to some techie kid with a few bucks to blow on fantasies. How can you prove it to serious inventors? Simple. Call in the Feds!

Bitcoins is a plaything of programmers. The kids are running the show. But to make this work as a replacement currency, the Establishment must participate. They will, but only if they regulate it, shape it, and tell the programmers what to do. It will be allowed to function. But any suggestion that bitcoins are a threat to the existing system is silly.

There's another major problem in marketing this product. It was small potatoes. Mt. Gox had about $400 million in it, as far as estimates are concerned. Yet we're talking about an alternative currency. The value of the exchanges in the Forex currency futures market is well in excess of $5 trillion a day. Bitcoins are piggy bank investing.

Mt. Gox operated just as a Ponzi scheme does. You put your money in, which could not be pulled out. This has been visible for almost a year, but nobody mentioned it in the bitcoins media world. It was considered too embarrassing. "No problem." I labeled this thing a Ponzi scheme, and that is exactly what turned it out to be for a million investors in Mt. Gox.

How are you going to restore faith in this scheme with people who have any money? Yes, programmers will invest a little of what little money they have remaining, but I'm talking about serious money. What about Pareto's law? How do you create an alternative worldwide currency if, by the very nature of it, people with big money will not touch it?

THE SOUND OF DERISIVE LAUGHTER

People do not want to be laughed at. Anybody who went into Mt. Gox is now a laughingstock. People are laughing behind his back if he talked about his profits. People don't want to be laughed at behind their backs. They don't want to be perceived of as fools. They don't want to be perceived of as suckers who got into a Ponzi scheme. They are not going to go into this, precisely because they fear being laughed at.

If they tell their friends they made a lot of money, and then the thing turns into Mt. Gox, there will be snickering. People like to tell their friends that they have made money the smart way. They want to show that they are smart. But, if you told people you were smart by investing in Mt. Gox, you are now considered a sucker. TMaybe they feel a little sorry for you, and they shake their heads and say to their wives, "Poor baby." Well, people with money do not want to have other people shake their heads and say, "Poor baby."

With any investment, you have to have an exit strategy. The people who got into Mt. Gox could not get out. There was no exit strategy. They didn't figure this out until the very end, and now it is gone. This is the characteristic feature of a Ponzi scheme. People cannot get out. Then, one fine day, the whole thing collapses.

Who is to say it is not going to happen with the next bitcoins exchange? Who will believe the assurances? Yes, I know: programmers with little money. I am talking about serious people with serious money. An international currency has to have very rich players. There has to be a huge volume of currency in use. We're talking about trillions of economic exchanges a year. This is not done with virtual money in an exchange that nobody understands.

From this point on, everybody who is asked to invest in bitcoins is going to have this disaster in the back of his mind. Why will he invest in this? Why will rich people put $10,000,000 into this investment? Why will this be picked up on a broad basis and used by millions of businesses? Why would a small business, or any business, put its money into an exchange that may turn out to be the next Mt. Gox?

CONCLUSION

Libertarian true believers hyped this experiment as a the beginning of a new currency system that will replace the Federal Reserve System and the other central banks. They thought anonymous digits would deliver them. Reality has intervened. The industry is calling in the Feds, just as the big banks did in 2008. "Save us from ourselves!"

Most of the recently sheared investors got into this for the same reason that people get in the Ponzi schemes. They didn't understand it. They only saw there were tremendous gains. They saw the possibility of getting rich. This is the mentality that creates demand for Ponzi schemes.

From the beginning, this was a crapshoot. It still is. From a marketing point of view, this is a bad situation. What if one more exchange goes belly-up?

Think "Enron." Then buy some gold. Not digital gold. Not virtual gold. Gold.

A little silver wouldn't hurt, either.