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.

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.

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.)

> 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.

Which may be a good reason to limit currency holdings to what you need to use as currency (that is, short-term medium of exchange for things of value), and invest the rest in productive assets, whether those are stocks, bonds, real estate, or digital collectibles like internet funbucks. But if you aren't directly holding those productive assets yourself but are trusting them to account held by someone else who promises to transfer them to you on demand or dispose of them at your direction, you probably want to do some consideration of their ability to keep them securely and execute the trust you are placing in them.

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.

I'll bet on the long term stability of the US government over that of MtGox or Coinbase anytime.

Just to add to some of the other great responses here:

The British empire was built on the back of the Pound -- the first truly international, modern fiat currency. It reigned until it was muscled out by the fiat Dollar.

An immense amount of wealth has been generated for humankind on the backs of fiat currency.

And one more thing...

Bitcoin is also a fiat currency in the sense that it does not contain intrinsic value. It is only as valuable as its network effect. If the network falls in love with a different coin, bitcoin dies.

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.

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.

I'm talking about a more sophisticated solution that addresses this- See https://github.com/olalonde/blind-solvency-proof

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.

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.

You can only lose what you give them, which should be no more than is necessary to complete a set of near-term transactions.

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.