Making Money: Bitcoin and Virtual Currencies (Pt. 2)

Most press coverage on Bitcoin almost exclusively focusses on either online fraud (most recently: the malware Cryptolocker which forces its victims to pay a ransom in Bitcoin in order to get access to their computers again) or on excessive ups and downs in Bitcoin exchange rates (like in 2011, when rates dropped from around $33 in June to $2.50 in October). But we are missing the best part of the story! In this mini-series we want to talk about the broader picture: the benefits that Bitcoin has to offer to society at large and the way governments should best deal with the new currency.

In part 1 we explained why Bitcoin is necessary to create a real digital economy (an economy that benefits people and not just Google & C:o), and how people in the countries of the developing world can profit from it. In this second part, we start off with answering open questions.

No reason for consumers to be afraid

One issue is this: Bitcoin is a purely digital currency. It is not backed up by gold nor by the government. If people would decide to opt out of the currency, then it would indeed lose all its value. (To be fair: regular banks would also face severe problems if people withdrew their deposits all of a sudden.) What reason is there to think that this is not going to happen with Bitcoin?

A short answer is that Bitcoin hasn’t been designed as an investment tool in the first place. Thus, the insecurity of the currency can be considered as a welcome counterbalance to the fact that Bitcoin offers plenty of incentives not to spend, but to keep the currency. Remember: the exchange rate has climbed from a mere thirteen US-dollars in January up to over $1,000 lately.

But there is also a longer answer. Nowadays, more and more people are using Bitcoins. Not just single individuals. A whole financial industry is evolving around it. There are traders and services for electronic wallets (such as Bitcoin-Central), there are commercial news channels (like Coindesk or Bitcoin Magazine) and mediators (like BitPay). Everyone involved in the industry will do his or her very best to convince customers to use Bitcoin – with words as well as with technology. Sooner or later, Bitcoin will probably run behind the scenes. We will be using it without having to explicitly buy Bitcoins: There’ll be the same user interface as today for digital payments with PayPal or Visa, but Bitcoin financial technology working in the background. (Just read Nicolas Mendoza’s piece on AlJazeera or watch LeWeb London 2013 on Youtube to get an impression of what’s going on.) All this makes it highly implausible that Bitcoin will lose all its value overnight (see also Sean Lynch’s site on Quora for an account by a converted sceptic).

Bitcoin in European law

There are still other signs which tell us that Bitcoin is becoming more and more an element of the normal economy. In December 2012, the Bitcoin wallet service Bitcoin Central became a Payment Service Provider under European law, with an International Bank ID number (thus being able to issue debit cards and to conduct transfers to other banks). Also, the German Ministry of Finance announced in August 2013 that it would recognize Bitcoins as legitimate financial instrument. By doing this, Germany became the first country in the world setting clear-cut rules for Bitcoins and Bitcoin related companies. These rules including licensing and supervision by the German Federal Financial Supervisory Authority (BaFin) and an initial capital of 730,000 Euros. For customers and citizens who are using Bitcoin related services (such as electronic wallets), this is good news, as it gives them more security.

All these recent developments show: The cryptocurrency Bitcoin is far away from representing a radical alternative to the financial system we are used to. Sure, peer to peer-currency does enable a new form of finance technology. But it is unlikely to bring about such revolutionary change in society, as some of its advocates (many of whom being self-confessed libertarians) think. Like this one:

“Instead of trying to change governments with a useless vote, or pathetic pleading, we merely abandon the government’s powerbase – the power derived from control of exchange and currency.”

(See also Nicolas Mendoza’s older piece from 2009 on AlJazeera).

True: Nobody knows how Bitcoin is going to evolve in the long term. For sure there will have to be made some adjustments as popularity grows. (One example: Bitcoin Monitor will not function any more if everyone uses the currency.) Maybe one of Bitcoin’s competitors (like Litecoin or PPCoin) will take over. But all this doesn’t speak against using Bitcoin in the short run.

All market. No monetary policy. No law enforcement.

Which doesn’t mean all is fine with Bitcoin. Generally speaking, the Bitcoin economy represents a sector of the economy where governments can hardly take any action. There just cannot be such a thing as monetary policy for Bitcoin. It’s technically impossible. Bitcoin-advocates from the libertarian camp cherish exactly this “hands off from our money” approach. We should be careful to join in to their appraisal of an economy that cannot be influenced by democracy. So far, the slogan “It’s the economy, stupid!” is, in many cases, a mere stipulation. Markets can be shaped be politics. With Bitcoin, it’s different. There are hardly any possibilities for politics to set and to enforce rules within a Bitcoin economy. This, indeed, does represent a problem – not only in cases of financial crisis.

Take trust. Inventors of Bitcoin proudly claim, that with Bitcoin, trust in persons and institutions isn’t needed any more. What they offer instead, is a fully transparent software code by which the behaviour of the Bitcoin-system can be predicted. That’s fine for those who have the technical understanding to „trust the code“. Concerning the rest of us, we have to trust some specialists who claim to be benevolent cryptographers. Are they really benevolent? Why should they? Bitcoin-specialists certainly do have vested interests. Many of them own a large amount of Bitcoins. Theyprofit enormously from rising prices of the currency. Besides that, if mistakes happen, nobody is liable in any legal sense. The same is true if someone manages to create fake Bitcoins or to mess around with the system. He’ll be fine. He has done nothing criminal.

New perspectives for cybercrime

Then there is the issue of cybercrime. Law enforcement agencies like the German Federal Criminal Police Office (BKA) have already announced to take a closer look at Bitcoin because, in combination with TOR-Software for anonymous online communication, Bitcoin enables financial transactions which cannot be traced by investigators. Therefore, it can be used for cybercrime like selling illegal drugs and other things. (The online black market Silk Road used Bitcoin.) Another example already mentioned: recently, victims of a computer virus attack were asked to pay a ransom in Bitcoins order to get access to their computers again (see the Cryptolocker case)!

But cybercrime with Bitcoin isn’t restricted to selling and buying illegal narcotics. Whoever installs Bitcoin-software on his computer, has to be very careful to protect it against attacks. Bitcoins can actually be stolen! Now, imagine many people are keeping Bitcoins on their personal computer. What an incentive for cybercriminals! We will hardly be able to use our computers the way we do today, because we are so busy protecting ourselves against digital robbery. (Sure, this situation can be avoided if one uses a wallet-service like MtGox. But then, it’s not truly peer-to-peer any more.)

Bitcoin is a tax heaven

Even more important than the online-market for illegal drugs and other forms of cybercrime is tax evasion. With Bitcoin, one could, in theory, make a living which is basically invisible to the tax authorities! Owners of online-shops (which, according to business analysts, will by the year 2025 represent one quarter of the total retail sector) who sell to customers via Bitcoin could deliberately choose whether or not to report their sales to the tax authorities. At least, there is no way tax authorities could find out about it! (See also the the recent report “Are Cryptocurrencies ‘Super’ Tax Havens?” by the University of Florida.) Governments have hardly started to deal with this issue.

Benefits which Bitcoin has to offer are considerable. But so are the risks. The time for “see and wait” is over by now. It might not be clear which – if any – actions regulatory agencies should take. But at least we should launch programs for a detailed technology impact assessment regarding Bitcoin. Bitcoin is not a nerd thing. It will affect all of us.