Bitcoin and Bank Architecture

When Franklin Roosevelt signed the Banking Act of 1933, he destroyed bank architecture in the United States. Customers of banks insured by the newly-created FDIC no longer had to worry about bank solvency. As a result, the steps banks had previously taken to reassure customers of their solvency were no longer necessary. Chief among these was the construction of a large, ornate, and expensive building, which could always be sold off in the event that the bank’s loan portfolio failed. Almost all of the most beautiful banks in the United States were constructed before 1933. Today, many banks are located in strip malls.

These days, whenever I look at these old, pre-New Deal bank buildings, I think of Bitcoin, the increasingly popular cryptocurrency. There are some strong parallels between the Bitcoin economy now and pre-deposit insurance America—most notably, that Bitcoin balances are not insured by the federal government. The market for Bitcoin financial services is an unregulated Wild West. I always knew this at some level, but I learned it the hard way in 2011 when MyBitcoin, one of the first online “wallet” services, got hacked and had most of its Bitcoins stolen. I had much of my (quite modest) Bitcoin holdings in MyBitcoin—and no Bitcoin version of the FDIC to bail me out.

Those who kept their Bitcoins on their own hard drives were not necessarily safer. Around the same time that MyBitcoin was compromised, the first computer viruses that explicitly targeted Bitcoin holdings were discovered. Users who did not trust eWallet services were now vulnerable as well. It was as if a wave of home burglaries broke out targeting those who kept cash in their mattresses rather than in untrustworthy banks. Users were told that if they wanted to manage their own Bitcoin holdings, they would be well served to encrypt their wallet files, which is not unlike buying a home safe.

In an intriguing turn of events, Bitcoin financial services are now arguably enjoying something of a resurgence—and the reason has to do with the discovery of trust mechanisms not that dissimilar to those used by pre-Depression banks. Banks used expensive architecture as a way to post a bond, to ensure that customers would get something back if the bank folded under mismanagement. Newer Bitcoin wallet services still don’t have buildings, but they have much nicer websites. In fact, some of them have good design and elaborate, well-thought out programming interfaces. While this is not exactly a bond that the service posts, because it is not property that can easily be auctioned off in the event of a bankruptcy, it is a costly signal of intent to stay in business for the long haul.

Think about it: would you hire a team of expensive programmers and designers to build you a fancy website, and then shirk on security, potentially inviting a breach that would cause that whole initial investment to go to waste? Of course not. Consequently, “ornate”—or at least verifiably expensive—web design is a way to signal an intent to take security seriously, just as unnecessarily ornate bank architecture was a way to credibly commit to solvency.

Coinbase is a recent entrant into Bitcoin wallet market that has a comparatively elaborate web presence. In addition to operating as a wallet service, they offer merchant tools, an API for developers, two-factor authentication, and the ability to link to a US bank account to exchange dollars to Bitcoins (for a commission). It seems unlikely that Coinbase went to all this trouble to shirk on security, and indeed, their security procedures seem well thought out. For example, they store 90 percent of customer funds offline in a bank vault. In addition, to generate trust, the company lists well-known investors and proudly trumpets the fact that its exchange services are generating substantial revenue—both facts make it seem less likely that they’re going to abscond with customers’ precious Bitcoins.

Although much of the Bitcoin sector of the economy is either unregulated or beyond the reach of law, there has been a deepening of Bitcoin-denominated financial services. In addition to improved wallet services, there are stock exchanges, futures markets, and prediction markets. There are even services that are unique to Bitcoin, such as “mixing services,” essentially money launderers. Alongside this maturation of the Bitcoin financial sector, there have, to be sure, been Ponzi schemes, sudden disappearances, and other thefts. But on the whole, the Bitcoin economy is successfully solving many of its problems, just as 19th century bankers managed to solve many of the problems of trust and security that they faced. This is not bad for a four-year-old cryptocurrency, and although I am by no means certain that Bitcoin will be a long-run success, it should be interesting to observe for the next four years.