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May 14, 2015
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May 14, 2015

The Bitcoin Dilemma

By U. Mahesh Prabhu 

Since time immemorial currencies have continued to be business of political governments, across the world. And while the US has a history of private currencies before the creation of the Federal Reserve, the fact remains that in the modern world, too, governments control currencies. This online digital, or cryptocurrency, currency – BITCOIN – came out of virtually nowhere to become a global phenomenon before gaining significant momentum, in 2013. This was owing to four specific reasons:

  1. Limited anonymity, or pseudonymity: your wallet is anonymous, but its address and transaction records are kept public and can be flagged and traced
  2. Independence from traditional financial organizations; unless you need to exchange your Bitcoin for dollars
  3. Decentralization — nobody controls the “main switch” or “emergency brake,” unless the open source client software is compromised
  4. Fast, reliable, and cheap money transfer between any locations in the world.

But then it has some significant downsides as well:

  1. Unlike credit cards, Bitcoin transaction fees are paid by senders.
  2. Fraudulent transactions cannot be disputed or reversed.
  3. Bitcoin wallets can be hacked.
  4. An uncertain mechanism of calculating the transaction fee is one of the factors that is negatively affecting Bitcoin’ main stream acceptance.

There was time when many were pretty sure that governments around the world would just ground it much before it gains any popularity. What happened of course is the contrary; many governments saw value in it!

Not that it was taken kindly by all the governments; China has taken a particularly harsh stance in an attempt to control the virtual currency’s use within its jurisdiction. In December 2013 China’s central bank, the People’s Bank of China, banned all its affiliated financial institutions from handling Bitcoin transactions, sending the virtual currency’s value plummeting in the aftermath of the news. It must be understood that due to the nature of its very structure, banning Bitcoin is to be of no use. But what such governmental moves will do is make it impossible for law-abiding individuals and businesses to use it — and thereby render it practically useless. So the false sense of security the, admittedly, irrepressible network provides Bitcoin will really not count for much, if there is a concerted move to restrict the Bitcoin market. And this is something that all the businesses trying to consider bitcoin payments for their products and services must consider.

Experts believe that likening Bitcoin to the internet helps to understand the problem regulators face, with Bitcoin being a method of sharing payment information rather than general information. Various countries, such as Cuba, North Korea and China, have tried to regulate the internet, but only with moderate success, and regulators seeking to regulate Bitcoin should take heed. People always find ways around such regulations and the virtual currency industry is similar to this. While some countries may try to tightly regulate, ban or limit access to the technology, ultimately, determined individuals and businesses will find ways around it.

China, US and Swiss, these three countries have taken three different approaches towards regulating Bitcoin: China is firm on its stance against Bitcoin use by its domestic financial institutions; the US is all for a tentative monitoring approach; and Switzerland’s proposal in parliament is to have Bitcoin treated as any other currency towards assessing Bitcoin’ as an opportunity for the Swiss financial institutions. It is still unclear as to where India is headed even though the governor of Reserve Bank of India (RBI) has advised Indians against taking it much seriously.

Going by the conventional wisdom it’s advisable for Bitcoin to accept and embrace some degree of regulation, although it will be counter-intuitive to many of its followers, if only to prevent an even worse reaction from governments that are not pleased to see their money printing monopoly challenged. It’s a cardinal rule in the financial world: Anything that can be regulated – is sure to be regulated! So it’s only a matter of time before Bitcoin gets used to such regulations and, thereby, get its ticket to real acceptance and success.

Currently, Bitcoin is still a very small part of the economic system and hardly poses any threat to more established currencies. But if it overcomes regulatory issues, it will be embraced much faster. Today, Bitcoin is being increasingly used by migrant workers to transfer money back home, and is therefore beginning to serve really genuine purposes, not just ideological ones, which is promising to see.

There are at least 80 known similar initiatives like Bitcoin out there, and of course most of them are bound to fail. But there are a few projects in the design phase that are better constructions, and will be able to obtain rapid distribution, making them real competitors to Bitcoin.

At its core Bitcoin represents a technology that enables a whole new payment system to be developed. Former Federal Reserve chairman Ben Bernanke has said that more than Bitcoin as a currency, Bitcoin represents a promise of a more secure, safer and cheaper payments system than those we currently have. He explains that banks have effectively built a legacy transfer system that is expensive to use, and, while MasterCard and Visa have also tried to develop something more efficient, “they can only get cost down to 3% or 4% of every transaction. PayPal has also tried to create something, but there are costs involved. Bitcoin represents the next generation of how payments flow through the internet – it is the equivalent of Google developing Gmail so that people could email for free and not have to pay for email services from companies such as AOL.”

There are also a section of observers who think that Bitcoin could be closer to a commodity or a security than a currency – a position taken by, among others, the Bank of Finland, which decided in January to treat it as a commodity, arguing that a currency should have an issuing authority such as a central bank. This is a challenge as there are instances when Bitcoin seems like a security or instances when it seems like a currency. In most cases it feels more like a commodity and yet the US’ Commodity Futures Trading Commission (CFTC) has shown little interest in doing anything about it. It is almost like the agencies are playing hot potato with what they are going to call it and the real issue is that Bitcoin is fast becoming all three of these things.

Strange enough, CFTC was absent from a US Senate hearing held by the Homeland Security and Governmental Affairs Committee in November 2013 entitled Beyond Silk Road: Potential Risks, Threats and Promises of Virtual Currencies and attended by the Securities and Exchange Commission (SEC), the Department of Homeland Security and the US Treasury department even though CFTC has not been entirely silent on the issue of Bitcoin. In May 2013, the agency told various publications that it was exploring was to regulate Bitcoin. Then-commissioner Bart Chilton said the agency was not looking to regulate Bitcoin itself, but the derivative on the currency. But even then Bitcoin’ status as a commodity is not so straightforward. For example: if you are purchasing a Bitcoin what you are actually purchasing is a private key that gives you the right to manipulate a ledger that you control.

In July 2013, the US’ Securities Exchange Commission prosecuted a Bitcoin seller, named Trendon Shavers in a Texas federal court for allegedly defrauding victims of $60 million in Bitcoins via a virtual-currency Ponzi scheme. Contrarily Shavers’ attorney argued that as Bitcoin was not legally money, the investments in question did not qualify as securities, thus it was not legally possible for him to have committed securities fraud as a security must legally involve an investment of money. The court concluded in a decision in August that Bitcoin was a currency or form of money and the prosecution went ahead. So Bitcoin has already been legally identified by one US court as a currency.

But then the US government has other challenges to deal with where Bitcoin is concerned. The US government has classified Bitcoin sellers as money service bureaux (MSB) and MSBs are primarily regulated by states rather than the federal government. And therefore Bitcoin operators have to operate between two sets of rules – state and federal – thereby adding to complications in obtaining clarity.

So you see accepting Bitcoin as a payment or investing in it has significant risks involved. But then again, with great risk comes great opportunity. There are always people making great sums of money, and there are people with significant losses as well.

U. Mahesh Prabhu is Founder & CEO of TECHNOVED (www.technoved.com) and Hon Director of Center for Global Research & Initiatives (www.cgri.in

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