Official attention will make or break bitcoin

March 31, 2014

By Daniel Indiviglio
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Official attention will make or break bitcoin. Scrutiny from tax authorities like the U.S. Internal Revenue Service and financial regulators around the world may deter off-the-grid types from using the digital money. Yet interest from investors and even creators of derivatives could start drawing bitcoin into the mainstream.

An easy, relatively anonymous way to store value and make online and cross-border transfers has appeal both for those who don’t trust governments and those whose nefarious activities require them to avoid oversight. The bitcoin world for now remains volatile, opaque, and – as the disappearance of a big stack of them from Tokyo-based exchange Mt. Gox demonstrated – not fully secure.

Even so, serious investors are becoming converts. Netscape co-founder Marc Andreessen took on bitcoin-skeptic Warren Buffett on Twitter last week. Andreessen sees in bitcoin a smart application of technology that allows transfers over the internet in a way that leaves both sender and recipient confident there’s little scope for fraud and avoids the cost of paying a middleman like a credit card issuer. That could be very valuable.

Andreessen’s venture capital firm has invested about $50 million in related companies, like Coinbase. Even the volatility of bitcoin – the value of each unit has gone from over $700 to peak near $1,000 only to dip to about $500 over the past three months – may be amenable to smoothing. Tera Group on March 24 announced what it claimed was the first standardized bitcoin swap.

Moreover, the controversy surrounding bitcoin is forcing mainstream government entities to take note. Last week, the IRS determined that bitcoin holdings would be treated as property, not currency, for tax purposes. That means that intangible moolah is now concrete enough to blip across the tax radar.

It’s also under discussion at the Commodity Futures Trading Commission and other U.S. regulators, while EU financial watchdogs have warned users about the risks of bitcoin and China’s authorities are clamping down.

If all the interest doesn’t kill off bitcoin, it will gradually legitimize it. Then the digital dough could become as commonplace as PayPal or even a credit card swipe. Despite the enthusiasm of Andreessen and others, the jury is still out. But one thing is clear: whichever way it goes, bitcoin’s days in the shadows are surely over.

Comments

Why publish uninformed “opinions” like this? Bitcoin (et al) is of no interest to “off-the-grid types”, since they all rely on a *public* ledger of all transactions (the blockchain). What attracts people to Bitcoin is that it permits fast, secure exchange without trust – exactly anyone would want in a payment mechanism. (Remember that MtGox was a failure of a spot market, not of Bitcoin itself.)

Posted by markhahn | Report as abusive
 

There is a dual flaw at the heart of the Bitcoin episode that won’t go away. At its core it is a speculative digital commodity, aspiring to be a currency. To be a currency it needs to be a unit of account, a store of value and a means of transaction. On the surface it appears to be all three, and that has prompted the speculative market in the Bitcoin. It has also attracted a hoard of “fellow traveler” Bitcoin community service providers, doing much as Levi-Strauss did supplying rivet pocketed pants to gold miners in the California gold rush. The gold rush is history but Levi-Strauss sails on. Some of those services providers are looking to what they can learn, and how they can position themselves in online financial services, in the next big thing after the demise of the Bitcoin.

So, what are the flaws in the Bitcoin. They are two, they are very simple. They do not prevent a short term speculative market in Bitcoins. As economist John Maynard Keynes said about successful speculation: “All you have to do is out speculate the speculators”. This is as true in Bitcoins as it was in the Dutch tulip bulb bubble.

The Bitcoin flaws are not the imposition of government commodity market regulations, or taxation schemes. Neither of those has killed markets or speculation in other commodities. The first flaw is that the Bitcoin is nowhere legal tender. This looks minor but it is not. Even the weakest of national currencies has a legal standing for payments somewhere in the world. In the absence of hyperinflation that puts a floating bottom (albeit a weak floor) on the currency’s exchange value in foreign markets. The other flaw is that there is no outside Bitcoin value barometer that traders (those using it to buy/sell goods and services) can look to as they can with legal tender currencies.

Contrast this with: What is the Botswana Pula worth and where is it likely to go? Exchange rate markets look at national trade balances (imports/exports), capital flows, and central bank foreign reserves (or gold holdings), as well as national monetary policy with regard to interest rates and money supply. Other than a short term speculator trying to outguess other speculators, where is that barometer?
There is nothing other than speculative expectations to give the Bitcoin an exchange rate. When the press reports that someone bought a fancy car or expensive apartment with Bitcoins one can be assured that the other side of the transaction has already arranged to Bitcoin-fiat currency swap that follows in nano-seconds. The Bitcoin has assured acceptance, and no floor. Those are fatal flaws.

Is there a future for digital currencies? Yes, but it will travel a path more like that of the U.S. Dollar in the 20th Century, as it went from being a national currency to a global fiat commodity. One might speculate that China is in a position to mount a digital currency backed by gold (given its gold reserves). Consider what could but won’t happen here. China could peg central bank purchases and sales of Bitcoins to 10 grams of gold (today about $450US) and the Bitcoin would have a reference price – the price of gold. In time China could move the peg over to the Yuan, and (as per Nixon) drop the link to gold. It could of course do this without the Bitcoin. There is a hole in the Bitcoin bubble, and there is no way to plug that hole.

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