Bitcoin and Regulation

Bitcoin is Fundamentally Decentralized

Even though Bitcoin functions mostly as a commodity these days, it still serves as a means of exchange, where goods and services may be traded for various amounts of Bitcoin. Bitcoin therefore serves as money, even though it is not an official currency and its use is beyond the reach of central banks whose primary role is to manage currency and the money supply.

Bitcoin and RegulationTransactions with Bitcoin are managed by users so to speak, what is termed the blockchain. Since Bitcoin is a digital currency, there are no physical bitcoins to track, like there are with coins and bills. The paper trail with cybercurrencies is a purely digital trail, and while most money these days consists of numbers held on computers, the difference with cybercurrencies is that the computers aren’t central databases, they are decentralized networks of those involved in the day to day use of the digital currency.

Bitcoin therefore, in essence, exists because there is a network of computers around the world that says it does. There are several advantages to this, but one of the big ones as far as regulators are concerned is that it is the currency itself that is tracked, not the persons using it or what the transactions are used for.

This is by design, as one of the things that Bitcoin and other digital currencies seeks to accomplish is to achieve user anonymity. Whenever one does a transaction with traditional currencies, if the transaction is a digital one, it is tracked, and both parties in the transaction are transparent.

For example, if you make a purchase using a card, there is a transaction in the system that denotes the person making a purchase for instance and the merchant or person accepting the digital payment.

Back in the days when all transactions were in cash, things were much more anonymous, even though certain cash transactions still needed to be reported, larger ones, especially deposits and withdrawals.

So even cash wasn’t really anonymous, and the digital era brought us even more scrutiny, much more in fact, and the challenge for those who seek to avoid this was to come up with a currency which was off the grid so to speak, which was tracked at an even higher level for the purposes of verification but in a manner in which the privacy of users was protected.

The Concerns of Regulators

There is always a balance that is sought between privacy and the state’s desire to be informed of people’s activities. An example would be in the case where police cannot just enter your home or tap your phone without some sort of special authority, a search warrant for instance.

The police would probably want the ability to violate your privacy as they pleased, because their goal is not to protect privacy but to gather information for law enforcement purposes, to catch people breaking the law in other words.

In the digital era, the ability to impose upon our privacy has increased dramatically, especially when it comes to maintaining privacy in our financial transactions. While it is no doubt the case that criminals would always prefer to be as anonymous as possible, there are others who simply prefer to have more anonymity in their transactions as a matter of principle, and therefore may find Bitcoin and similar digital currencies appealing.

The privacy afforded by cybercurrencies of course worries law enforcement officials, who already battle hard to fight people hiding the proceeds of crime, and use their efforts in detecting these activities to track down and seek to prosecute criminals.

If criminals can freely use Bitcoin to conduct business, and the source of Bitcoin transactions cannot be tracked, this is going to be very worrisome to them.

Another big concern is that people will use Bitcoin to circumvent taxation. People already use cash for this, for instance someone performing services and earning income from them, and being paid in cash, which can serve the double purpose of avoiding charging income tax and saving the purchaser money, as well as the provider not declaring the income for income tax purposes.

Bitcoin allows this to happen with non-face to face transactions as well, for example buying something on the internet. A good example of this would be the way that online gambling sites accept Bitcoin as methods of deposit and withdrawal and those in countries where governments have made it quite difficult to make financial transactions with gambling sites, such as the United States, now have an easy and effective means of doing so anyway.

Another concern, one that isn’t so obvious but ultimately is seen as quite important indeed, is the government’s ability to manage money supply. This is done primarily by managing credit, but in doing so, it is important to know what the money supply is, to know what needs to be managed.

We know how much hard currency and also have an idea of how much money is in the system in all forms, when we just have to measure a country’s currency. With cybercurrencies, we can measure how much of it is out there but we cannot know how much is held in any given region or country.

More importantly, central banks cannot directly influence the supply of cybercurrencies like Bitcoin, and Bitcoin in itself isn’t centrally managed at all. The goal of currency management is stability, but Bitcoin and other cybercurrencies are exposed to the full brunt of the market, and the best that central banks can achieve is to participate in the market itself, as they do in the gold market for instance.

This may actually come to pass at some point, where central banks may actually hold Bitcoin, as odd as this may sound to those whose goal was to look to completely circumvent these institutions. As well, in the philosophy of if you can’t beat them, join them, we may see centralized currencies evolve into more hybrid versions where central banks have a role in its management but it also may be subject to blockchaining like Bitcoin is, with decentralized verification and such.

What Regulators Can Do

It is interesting to see that a lot of countries these days have emphasized the fact that Bitcoin is not legal tender, as this should be pretty obvious and is not really an impediment to Bitcoin as they imply it is.

Of course, people are not forced by law to accept Bitcoin as they are a country’s legal currency, which is what legal tender means. Given the nature of Bitcoin transactions, the law doesn’t really play a role in them anyway, as they are off the grid so to speak and out of reach of the law really.

Pointing out that Bitcoin is not legal tender and legally prohibiting it are two separate things therefore, and a few countries have gone as far as prohibiting it, although the ability to enforce these laws is pretty limited.

A country can declare it illegal to operate businesses related to Bitcoin, mines or exchanges for instance, and with the physical presence that these business have, they could be rooted out and shut down, but the same is not true of users.

It is just not practical to monitor everyone’s internet activity and detect certain internet transactions such as those involving Bitcoin, even if governments had the ability and authority to do so. Even if they could, one could just connect to a virtual private network which offer complete anonymity on the internet.

What governments can do though is ban their regulated institutions from processing transactions which may be Bitcoin related, for instance sending or receiving money from a Bitcoin exchange. People convert back and forth from Bitcoin and hard currencies all the time, and this is a necessary feature, because Bitcoin is not that widely accepted, and to spend it, you need to convert it back for the most part.

There are just too many ways around this though for this to be much more than a threat to Bitcoin users, as third-party processors could be set up to get around this. In particular, the money in question can simply leave the country and be sent elsewhere, outside the scope of the regulators.

Regulators are also quick to remind Bitcoin users that they are required by law to report capital gains related to Bitcoin holdings, although their control and monitoring of this is more limited than if the transactions were performed in ways that could be more easily audited, as is the case with investments in regulated exchanges where income is reported to the government.

There is no doubt though that Bitcoin and other cybercurrencies present some real challenges to regulators, and while many countries have lined up in opposition to it, to various degrees, some are more neutral  and some even are looking to make the best out of the situation by perhaps even getting involved themselves to some degree.

Part of the concerns of regulators is to look to protect investors and users, and while this does tend to be on the overbearing side, especially in the securities industry, regulation is not always bad or even overly restrictive and has proved to be necessary in some cases.

For instance, regulators may want to shut down operations that are seen as committing fraud, and this is especially the case with new coin offerings, which aren’t always on the up and up. The recent example of the closure of BitConnect is a good example of what is sought to be avoided.

Regulation has served to scare the Bitcoin market to some degree anyway, and whether or not fears are well based, fear does influence markets to be sure. As regulators seek to gain a better grip on Bitcoin and other cybercurrencies, this may give some people at least pause for thought, as well as instigate downward movements in price.

Given that Bitcoin is completely momentum driven, with no intrinsic value beyond the sheer demand for it, anything perceived as a negative can and already has served as an bearish impetus, although some may claim that these moves serve to drive Bitcoin further back down to earth, more toward what it would be valued if not for the extreme mania that has developed.

As this all plays out, we will seek out some sort of balance between the free market conditions that Bitcoin gave birth to and the tightly regulated strategies we normally see with currencies, and the Empire will always try to have its say regardless.

Cybercurrencies are here to stay though regardless, and it will be very interesting to see how they will continue to evolve in the changing landscapes, particularly the regulatory one.

Andrew Liu

Editor, MarketReview.com

Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.

Contact Andrew: [email protected]

Areas of interest: News & updates from the Consumer Financial Protection Bureau, Trading, Cryptocurrency, Portfolio Management & more.