Bitcoin Beware – The Empire May Strike Back

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It has been a tough week for Bitcoin. China continued to crack down on virtual currencies, prompting a major Bitcoin exchange to shut down. And Jamie Dimon, head of JP Morgan, called Bitcoin a fraud and said it was only “fit for use by drug dealers, murderers, and people living in places such as North Korea.”

Although Bitcoin has skyrocketed in value over the last four years, there are a few prominent critiques of such digital currencies. At the risk of piling on, the list of problems is even longer than many might think.

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The first familiar critique is that Bitcoin exhibits classic signs of a bubble. A bubble, roughly, occurs when people buy something not because of its intrinsic value, but because they expect the price to go up. Dimon made reference to the classic bubble in tulip bulbs in the 1600s. Bulbs’ intrinsic value lies in the beauty of the flower they produce, but at one time the bulbs grew to be worth more than houses. More recently, a Bitcoin worth $120.82 in late August of 2013 was worth $4,672.82 in late August of 2017. The problem with such bubbles, is that they can wreak financial havoc when they burst.

A related, but distinct, problem is the question of how digital currencies might be regulated. The Commodity Futures Trading Commision in 2015 defined Bitcoin and digital currencies as commodities. The U.S. Securities and Exchange Commission in July 2017 announced that it was investigating whether digital currency endeavors are de facto unregulated securities.

A third critique, as described by my Forbes colleague Panos Mourdoukoutas, is that governments dislike competition in the issuance of currency. There is money to be made by making money. This perk that accrues to the issuer of a currency is known as seigniorage – the difference between the value of money a government produces and the cost of producing it (often, literally, the paper it is printed on). Digital currencies can represent unwelcome competition (though so can credit cards, for example, since they allow people to make payments without holding currency).

Two additional arguments may be even more potent. One is a twist on the government dislike of competition – it’s government dislike of embarrassment. This is particularly acute in China. The Chinese are likely not as worried about the loss of seigniorage as they are about the possibility that a parallel currency can provide a quick and public verdict on Chinese economic policies. In theory, that could be true of any currency other than the renminbi; if Chinese citizens get worried about the efficacy of policies from Beijing, they might try to trade into euros or dollars, for example. But those exchanges are already controlled by the Chinese government. The renminbi does not float freely against the other major world currencies. Further, China applies capital controls that limit the ability of Chinese investors to move money offshore (and they have tightened these controls in recent years).

To the extent that digital currencies circumvent these restrictions on currency and capital movement, they can provide awkward negative verdicts on state actions. One would expect the Chinese to shut that down when it got to be noticeable – and they did.

The final, more serious concern has to do with crime and counterterrorism. The idea to “follow the money” when tracking down crime is hardly new. After all, in the 1930s the notorious gangster Al Capone was ultimately convicted on tax evasion charges put together by the U.S. Treasury. The modern counterpart to that, which became much more serious after 9/11, involved tracking international crime and terrorism through money flows. There is a large office of the U.S. Treasury now devoted to Terrorism and Financial Intelligence.

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