Sir Barken Hyena writes:

First some background. If you don’t agree with the assumptions below, you might still enjoy the rest of the post in a “what a tin hat maroon” sort of way. But one disclaimer: I have no idea what I’m talking about, I’m just a guy on a blog.

OK, the premise:

The global financial system of credit and trade will collapse, sooner rather than later. This will be triggered by US Government default and the radical devaluing of the dollar, ending its reign as a reserve currency. Unemployment will skyrocket. Loans will be almost impossible to get, for anybody. A new Great Depression will begin.

As this crash happens, there will be a panic flight of capital into gold and precious metals and other stores of wealth. Pure fiat currencies will be abandoned in favor of pegging to the price of gold.

Agree or disagree, doesn’t matter – that’s where I’m starting from. I’m not saying this will all happen, making no predictions here. It’s just one scenario of many.

So now enter Bitcoin. Could these bizarre non-things provide a store of value similar to gold, or maybe even better? I believe it could happen.

It’s really important to carefully unpack the issues around this new financial instrument to understand what’s going on. If you want some background on Bitcoin generally, this is a good place to start.

First there’s the software that runs the bitcoins themselves. This is an open source project, the code is transparent and available to any who want it. Bitcoin is the hottest emerging thing in the geek world and so has attracted the best programmers. I am convinced that the Bitcoin system is absolutely sound, that the coins are impossible to counterfeit, and are immune to manipulation. For years the best hackers have tried to break it, and what vulnerabilities were there have long since been addressed. So I trust the integrity of the coins.

Secondly, there is the software that runs the services that surround the coins. This is the layer that allows for trading and storing bitcoins, and any other imaginable application. This layer is much less mature than the bitcoin system itself, for the simple reason that it’s only needed if there is a real economy surrounding the coins. The smartest money in Silicon Valley jumped on this about two weeks after the price plunge in April was recouped and the price held at higher then pre-spike values. Clearly they think Bitcoin’s time has come. The kind of thing that is needed here is not rocket science: the geeks of the world know very well how to build the type of services and security that’s needed, it’s just a matter of getting it done. And it is getting done. So I trust that this part of the Bitcoin universe has no serious future potential for failure.

But now we come to the frayed edges of the global financial system that Bitcoin needs to work within, and of course here lies the real danger of failure. Some advocates paint a future of an all Bitcoin economy but that’s not realistic to me. Bitcoins will have to be easily convertible to other currencies to be useful and that will require the consent of the banking industry. How they will respond is the big question.

And I think they won’t respond at all, at least not until it’s too late. They won’t respond now because they simply have nothing at all to fear from Bitcoin. Partly it’s is pure hubris. Printing $85 billion a month isn’t exactly the sign of a timid and fearful disposition. It’s the opposite.

But also the legal waters have lately been greatly clarified and the major players in the Bitcoin world are scrambling willingly to comply with regulations. The regulatory entities in the US have signaled that bitcoins are to be treated as any other tradable financial instrument. This is great because it tells bitcoin traders how to work within the system. So as of now the picture to me looks like this: the banking industry has no more reason to prohibit conversion of dollars into bitcoins than it does converting dollars to yen or euro. But I’m nowhere near as confident of this conclusion as I am on the tech issues, partly because I don’t know what the hell I’m talking about. But keep reading!

So what about after the crash? If some of the money that would normally flow into precious metals in a crisis goes to bitcoins this time, there could be capital controls put in place to prevent the flight from the dollar, as there were against gold in the Great Depression, or are now in Argentina against converting peso to dollars. This would attempt to isolate bitcoins in their own closed universe.

It’s highly plausible, likely even, but that doesn’t mean it would be effective. First, US banks will be severely hampered in their control of the financial system when their only weapon to wield will be a ruined currency. Also, unlike the Great Depression when the government had cash on hand, this time the government itself will be utterly insolvent, and in a state of total chaos too probably. Remember that the government going into the Great Depression was very lean. “Lean” is not a word often used today to describe our government. And so whatever they try might not work. Similar to how the Argentine government’s efforts to prevent conversion to dollars are widely regarded as a joke in that country. The black market thrives.

And there’s another angle: if Bitcoin becomes Gold 2.0 then of course the major holders will inevitably be the same 1 percent that’s now running the banks (hopefully minus a smattering that ended up face first on the sidewalks after the crash – see? I’m an optimist). They might become it’s biggest defenders.

OK, that’s all science fiction at this point. But nevertheless, in good Anti-Fragile fashion I’ve put my own skin in this game: thanks to a life of loose and dissipated living I don’t have much in the way of assets to speak of, but what little I have I am in the process of liquidating and converting to bitcoins. The way I see it if nothing happens I still have my job and I have a good story to make fun of myself with when I’m drunk. Still time to rebuild. If the crash comes and my bitcoins are worthless, well so would be any savings in dollars and investments in Wall Street so at least I tried. And if they take off, I might just be somewhat protected from the horrors to come.

It’s all upside from where I sit.

So, going forward I suggest we keep our eyes on what happens with Bitcoin outside of the US and the advanced economies. South America, Africa and the Middle East have a lot to gain from adopting bitcoins and they may pave the way forward. And in particular Argentina.

And dissenters: please have at it in the comments, just refrain from calling me part of the Tin Hat Brigade – I’m getting that a lot from friends anyways!