Failure is a fundamental component of business evolution

The MtGox bitcoin exchange failure illustrates exactly how capitalism should work.

This post originally appeared on Andreas Antonopoulos’ personal biographical site; it is republished here with permission.

In the free market, failure is always an option. The United States has one of the world’s most vibrant entrepreneurial cultures, where millions of people start small businesses, create new products and invent new technology. Part of the startup culture is the idea of failing fast, failing cheap and failing toward success by learning the lessons taught by failure. Cultures that punish even minor failure in business with shame, exclusion and stigma are far less likely to foster entrepreneurs because they prevent experimentation by making it too risky.

Recently, the US has been infected by the “failure is not an option” mantra, a toxic hubristic fallacy, disguised as a truism, which promotes the idea that risk can be removed from life; that 100% security and 100% control are possible, even desirable. Those who attempt to remove the possibility of failure, to de-risk financial systems, end up creating the probability of spectacular failure. By removing the option to fail cheap and fail fast, they instead concentrate risk and ensure we will fail hard, fail expensively, and fail across the board.

In the 1970s, the US developed a policy of forestry that espoused 100% prevention of forest fires; let’s call it “fire is not an option.” This policy resulted in the systemic suppression of small fires and eventually into very unbalanced forest ecosystems where fire is now not just an option, but a certainty of disaster. We now know that fire is a natural part of a forest’s life cycle. Without fire, the forest floor gets overgrown, making it a source for bigger and hotter fires. When fires break out in a “managed” forest where fires have been suppressed for years, they burn so hot they turn the ground to glass. Fires that were survivable by trees are now so destructive that they denude hills and wipe out the entire ecosystem. Our financial system has become much like a poorly managed forest, harboring within it the increasing probability of a systemic and destructive conflagration.

Capitalism and entrepreneurial innovation require risk, as it is a fundamental component of business evolution. When companies are allowed to fail, their resources get reallocated in the market, just like a fire that converts sparse undergrowth into fertilizer for the next generation of trees. If instead, the failed companies are prevented from failing but are propped up to maintain the illusion of solvency, they fester and consume more and more resources while creating greater and greater risk. Eventually, bailouts must be followed by even greater bailouts and then bail-ins. Finally, the systemic risk of too-big-to-fail becomes too-big-to-bail and the economy suffers a conflagration of defaults. De-risking increases the risk of failure and turns localized risk into a systemic risk.

In recent news, we saw that the long-festering bitcoin exchange MtGox failed. It is too early to tell exactly what happened and what will happen next, but I have some predictions: MtGox will not be bailed out. MtGox’s competitors will not be forced to tax their customers to support MtGox’s investors or customers. The bitcoin currency will not be inflated to provide quantitative-easing to keep MtGox alive. MtGox will not receive 0% loans for half a decade, perverting the incentives of the entire market. Other bitcoin exchanges will not find it more profitable to seek these 0% loans instead of innovating. MtGox will not be allowed to acquire smaller companies to fatten their balance sheet to hide losses, nor will MtGox be acquired by a larger exchange with loan guarantees from bitcoin miners to hide MtGox’s insolvency. MtGox executives will not be rewarded with bonuses paid by bitcoin inflation and taxation. MtGox will not receive a deferred prosecution because they are too big to jail. MtGox will not be even bigger and even less solvent in a few years. Most likely, some people involved in the MtGox failure will end up in prison. MtGox’s executives will not be invited to Davos to pal around with the leaders of government. No, those are all things that happen in the “real” economy, where de-risking is the toxic fad of the decade and too-big-to-fail is too-big-to-jail.

MtGox will simply fail. It will fail in an isolated way so that it won’t cause greater systemic failures. As we must lament the losses and tragic consequences for the customers of MtGox, let’s not lament the failure of MtGox itself. This is not a failure of the bitcoin currency or a failure of capitalism. This is how capitalism should work.

The fact that such failure appears strange and uncomfortable only shows how far from true competition and capitalism we have been led by promises of de-risking. In bitcoin, at least, failure is an option. Allowing MtGox to fail is a good thing, and it will only make bitcoin stronger. It’s much scarier to have your eyes wide open, but it’s less dangerous than keeping them firmly shut and basking in the delusional comfort of de-risked capitalism. With failure comes risk but also innovation and fertile ground for re-invention and new growth. Welcome back to the free market, where failure is always an option.

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  • Chris Mountford

    Great analogy with forest management.

    In Australia many mammal species remain endangered because their numbers are threatened by artificially fierce fire activity, a direct consequence of overzealous fire supression. Regular controlled burning shows a great benefit to the efforts of environmentalists focused on protection of endangered mammals, not to mention increased safety to human life and property.

    One question I expect to be asked in the US in particular is that if there are entities too big to allow to fail, then can’t this suggest they must be split up? This fragility is demonstrably anticompetitive in much the same way as monopolies are. Didn’t Bell get split for the common good? Is there room, politically, for this in the USA?