Bitcoin and other crypto-currencies: their demise is inevitable


An assessment about their usefulness and problems concludes that regulation and taxation will – and should – kill this idea of privately issued money.

Following recent weeks’ soaring price (and volatility) of Bitcoin, media attention to the phenomenon of crypto-currencies has increased again. Unfortunately, as more people weigh in, the confusion about what a crypto-currency is (and is not) and what its future might be all seem to deepen.

In short, crypto-currencies, including Bitcoin, are the latest and by far the most sophisticated attempt by private individuals to circumvent the authorities’ monopoly on issuing money. Like all previous attempts, it’s almost certain to fail.

Money has three functions: it serves as a unit of account, a store of value and a medium of exchange.

Originally, society would rely on a fine and rare metal, like gold or silver, to serve as its money, minted as coins. As trust in the ruling structures of society developed, rulers managed to generate income for themselves by issuing coins with a higher face value than its production cost, a process called seigniorage. In modern society, the central bank is mandated with the privilege of issuing money under two conditions: it manages this process in a way that secures the real value of the money within a pre-determined acceptable range (typically specified as an inflation target), and it surrenders its seigniorage to the fiscal authority for the good of society as a whole.

Since money printing is extremely profitable, history is littered with examples of private people attempting the enterprise, usually via illegal structures. While there is nothing to suggest that Bitcoin or any of the other crypto-currencies is based on anything illegal (although it’s curious that the founder of Bitcoin has insisted on remaining anonymous), it’s still a private attempt at creating money. And, ultimately, that’s a failing proposition.

No crypto-currency fulfils the first requirement of being money, namely serving as a unit of account. Indeed, the few firms that do show their prices in Bitcoin do so at a stated conversion rate to (typically) dollars, and the price in Bitcoin is almost constantly adjusted to the changing price of Bitcoin, measured in “real money”. Crypto-currencies also have a questionable record of being a store of value, because of the volatility in their prices. By contrast, Bitcoin and a few other crypto-currencies have achieved a decent success in terms of being a medium of exchange, although this is almost certainly only a temporary success.

So what’s the source of this (still relatively limited) success for crypto-currencies, and why is it only temporary?

The success so far of crypto-currencies, and in particular of Bitcoin, most likely rests on four factors:

First, society has seen a general erosion of trust in public institutions, as reflected in the popularity of anti-establishment parties. In parts of the world, this erosion of trust also applies to the central banks, following the substantial increases in their balance sheets, or money creation (even though they haven’t delivered inflation). Given the decline in such trust, a private and technology-based type of money seems attractive to some.

Second, crypto-currencies are based on a new and attractive technology (blockchain), which may have rubbed off on the product, the crypto-currency, even though there is no connection between the value of the enabling technology and the end-product.

Third, Bitcoin has proven most successful as a medium of exchange, or transfer of payments. At a time of increased public regulation and reporting of assets and transfers of money (to battle tax evasion, money laundering, payment of illegal activities and capital flight) transfers via Bitcoin are untraceable, making it attractive precisely for the types of payments of which the authorities are trying to gain visibility.

Fourth, anything that gains value rapidly, and is reasonably liquid, easily earns a reputation of its own as something people want to participate in, hoping to make quick and easy profit. This is now probably more true than ever, given the present abundance of liquidity in the world and historically high valuations of many key assets.

But the success of crypto-currencies will be temporary for three reasons:

First, as the global economy continues to recover, chances are that the key public institutions will gradually regain most of their historical trust. At the end of the day, people ought to recognise that for monetary policy to play its useful role in smoothing the business cycle, money supply is better determined by a college of appointed experts (even if mistakes are occasionally made) than by an arbitrary formula, created by an unknown private individual.

Second, society is unlikely to accept a major shift in payments of illegal activities to an unregulated platform, not least at a time when central banks are in the process of removing big denomination notes precisely to complicate such payments. There are even central banks, including the Swedish Riksbank, which are contemplating a removal of all cash to replace it with e-currencies (not to be confused with crypto-currencies).

Third, as discussed above, money creation generates seigniorage and it ought to be unacceptable for society to surrender the benefits of this privilege to self-selected private individuals (namely those who mine the crypto-currencies), rather than capture it for society as a whole. To begin with, a sizable tax should be imposed on profits from mining.

Hence, the odds are heavily skewed towards future regulation and taxation of crypto-currencies. Once that happens, the value of Bitcoin, and other crypto-currencies, is destined to decline sharply, if not even to zero.

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