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I believe MtGox users have unfortunately learned the definition of "counterparty risk". This is one of the major overlooked risks that almost took down the glo

by steven2012 13y ago

I believe MtGox users have unfortunately learned the definition of "counterparty risk". This is one of the major overlooked risks that almost took down the global financial system in 2008. People would hedge their worthless bonds using AIG as a counterparty, and once things blew up, these people realized their insurance policies were completely worthless because AIG was about to go under itself, causing them to almost go bankrupt as a result. Unfortunately, in a world where none of the bitcoin exchanges have any sort of regulation, there's no way that BTC use can expand via BTC financial institutions until people have full confidence they can get their money back in the case of another collapse like mtgox.

drcode 13y ago
Fortunately there's ways of proving available deposits when using bitcoin. In theory at least, this can address the issue of counterparty risk. Hopefully all the exchanges will start adopting this.
- steven2012 13y ago
  Not really. If the exchange says "We have 500,000 BTC" and they publish their wallet, but their actual customer liabilities are 2M BTC, everyone can still lose a lot of money. What they really need is to be externally audited and undergo consistent regulation.
  - drcode 13y ago
    I'm talking about a more sophisticated solution that addresses this- See https://github.com/olalonde/blind-solvency-proof https://github.com/olalonde/blind-solvency-proof
    - runako 13y ago
      Disclaimer: I only skimmed this solution. However, it looks like you don't/can't address all of the counterpart's liabilities. So salaries, tax dues, rents, loans, and other obligations denominated in fiat currency don't appear in the calculations. But any of these can destroy a counterparty as surely as insufficient reserves. Crucially, depositors don't really care where the risk is, they care that there is some external entity (like the SIPC or FDIC) that can insure that risk.
      - drcode 13y ago
        You are right, those other factors cannot be accounted for with this approach, it only proves that the business is not running with fractional reserves.
  - rch 13y ago
    You can only lose what you give them, which should be no more than is necessary to complete a set of near-term transactions.
nostromo 13y ago
The collapses we've seen with traditional currencies stem from the inherent risks of fractional-reserve lending. Is this a risk with Bitcoin? According to my limited understanding, it doesn't seem to be. That should in theory reduce the need for things like FDIC and complicated risk calculations, like counter-party risk. MtGox doesn't seem like a "bank failure" or "bank run" to me. It seems like a bank that forgot to lock the doors at night.
- res0nat0r 13y ago
  At least if your money is held in an FDIC insured bank and the bank goes under, you can rely on the government to insure your investment. With bitcoin you have no such thing.
  - contingencies 13y ago
    That sounds very smart, however if your money is held in an FDIC insured bank, then it's likely to be in a national currency that is systematically devalued by the issuing institution through progressive year-on-year inflation. (Note that I use the term institution instead of government as two major issuers, the Federal Reserve and the Bank of England, are private organizations). PS. I'm not characterizing inflation as bad, nor am I a goldbug. I am merely pointing out that the entire population of FDIC-insured banks are paying constantly for the mystical "it might happen some day" promise of a bailout, due to an inflationary system that reserves priveleged access to a central clique - ie. it's not like the conservative viewpoint of "faith in <the national central bank>!" comes without strings. (I am most aware of this perspective as someone who used to live with someone on the interest rate committee for the Bank of England.)
    - res0nat0r 13y ago
      I'll bet on the long term stability of the US government over that of MtGox or Coinbase anytime.
    - fivethree 13y ago
      Inflation isn't bad and the only people that think it is are goldbugs with no understanding of economics. Asset backed currency have had MANY more crashes than fiat currencies. Bitcoin is a wonderful experiment in how long it will take people to learn the lessons the world learned over the previous 200~ years.
dllthomas 13y ago
I've been wondering if the systemic portion of this risk mightn't be helped by allowing judges the power, during bankruptcy proceedings, to magic a small percentage of the balance owed into existence for the lender if the lender also forgives some (larger portion) of the balance provided that the loan is determined to have been a real loan made in good faith. This could help inject liquidity precisely when and where it's needed, while the requirement of someone undergoing bankruptcy, forgiveness of some of the debt, and judicial discretion would help check abuses.

drcode 13y ago

Fortunately there's ways of proving available deposits when using bitcoin. In theory at least, this can address the issue of counterparty risk. Hopefully all the exchanges will start adopting this.

steven2012 13y ago
Not really. If the exchange says "We have 500,000 BTC" and they publish their wallet, but their actual customer liabilities are 2M BTC, everyone can still lose a lot of money. What they really need is to be externally audited and undergo consistent regulation.
- drcode 13y ago
  I'm talking about a more sophisticated solution that addresses this- See https://github.com/olalonde/blind-solvency-proof https://github.com/olalonde/blind-solvency-proof
  - runako 13y ago
    Disclaimer: I only skimmed this solution. However, it looks like you don't/can't address all of the counterpart's liabilities. So salaries, tax dues, rents, loans, and other obligations denominated in fiat currency don't appear in the calculations. But any of these can destroy a counterparty as surely as insufficient reserves. Crucially, depositors don't really care where the risk is, they care that there is some external entity (like the SIPC or FDIC) that can insure that risk.
    - drcode 13y ago
      You are right, those other factors cannot be accounted for with this approach, it only proves that the business is not running with fractional reserves.
- rch 13y ago
  You can only lose what you give them, which should be no more than is necessary to complete a set of near-term transactions.

nostromo 13y ago

The collapses we've seen with traditional currencies stem from the inherent risks of fractional-reserve lending. Is this a risk with Bitcoin? According to my limited understanding, it doesn't seem to be. That should in theory reduce the need for things like FDIC and complicated risk calculations, like counter-party risk. MtGox doesn't seem like a "bank failure" or "bank run" to me. It seems like a bank that forgot to lock the doors at night.

res0nat0r 13y ago
At least if your money is held in an FDIC insured bank and the bank goes under, you can rely on the government to insure your investment. With bitcoin you have no such thing.
- contingencies 13y ago
  That sounds very smart, however if your money is held in an FDIC insured bank, then it's likely to be in a national currency that is systematically devalued by the issuing institution through progressive year-on-year inflation. (Note that I use the term institution instead of government as two major issuers, the Federal Reserve and the Bank of England, are private organizations). PS. I'm not characterizing inflation as bad, nor am I a goldbug. I am merely pointing out that the entire population of FDIC-insured banks are paying constantly for the mystical "it might happen some day" promise of a bailout, due to an inflationary system that reserves priveleged access to a central clique - ie. it's not like the conservative viewpoint of "faith in <the national central bank>!" comes without strings. (I am most aware of this perspective as someone who used to live with someone on the interest rate committee for the Bank of England.)
  - res0nat0r 13y ago
    I'll bet on the long term stability of the US government over that of MtGox or Coinbase anytime.
  - fivethree 13y ago
    Inflation isn't bad and the only people that think it is are goldbugs with no understanding of economics. Asset backed currency have had MANY more crashes than fiat currencies. Bitcoin is a wonderful experiment in how long it will take people to learn the lessons the world learned over the previous 200~ years.

dllthomas 13y ago

I've been wondering if the systemic portion of this risk mightn't be helped by allowing judges the power, during bankruptcy proceedings, to magic a small percentage of the balance owed into existence for the lender if the lender also forgives some (larger portion) of the balance provided that the loan is determined to have been a real loan made in good faith. This could help inject liquidity precisely when and where it's needed, while the requirement of someone undergoing bankruptcy, forgiveness of some of the debt, and judicial discretion would help check abuses.