It’s been a rocky month for crypto-currencies. China banned initial coin offerings (ICOs, a.k.a. token sales), a move followed by several other Asian governments. China also banned crypto exchanges, probably in order to prevent its citizens from using digital currencies to send money abroad.
To add insult to injury, a chorus of senior financiers in the U.S. attacked Bitcoin. J.P. Morgan Chase’s CEO, Jamie Dimon, declared it a fraud, while Bridgewater founder Ray Dalio said Bitcoin valuations were in massive bubble territory.
Their comments were specific to Bitcoin. Proponents of crypto-currencies and the blockchain technology that underpins their validation should also welcome remarks by Christine Lagarde, head of the International Monetary Fund. She praised blockchain and envisaged a future in which digital assets play a major role.
DigFin presents three views about whether Bitcoin, or crypto-currencies in general, will prevail. The theme linking all three is trust, be it in our status-quo institutions, in regulation, and in our own individual ideas about value. Read on to understand the fundamental questions underpinning the fate of digital assets.
Like it or not, we still trust traditional finance – and fiat money
By Frank Troise
“…Render therefore unto Caesar the things which are Caesar’s; and unto God the things that are God’s” —Matthew 22:21
Financial luminaries Ray Dalio, Jamie Dimon and Howard Marks have made public comments regarding Bitcoin that have come under significant market criticism. Are they right? Or as established incumbents, are they protecting their base?
I want to discuss here today five variables which traders, prop desks, and hedge funds openly discuss; focusing mainly on the hegemony of the US dollar as a reserve currency.
- Why is there Bitcoin volatility/appreciation in the market wherein all other asset classes have seen volatility decline (hence the advent of risk premia)? The answer is simple. There are four primary investors in today’s market: the Federal Reserve, Bank of Japan, European Central Bank, and People’s Bank of China. One could easily argue that Bitcoin’s volatility, and sudden appreciation, are a consequence of a lack of central bank participation.
- How do we define money? As Richard Jerram, chief economist at Bank of Singapore, aptly wrote: “Money must have three characteristics: a medium of exchange, a unit of account, and a store of value. At the moment crypto-currencies fulfill none of these roles.
- Why do we trust money? Yuval Noah Harari in his book Sapiens defined this well by saying:
“Money is the most universal and most efficient system of mutual trust ever devised…What created this trust was a very complex and long-term network of political, social, and economic relations. Why do I believe in the gold coin or dollar bill? Because my neighbors believe in them. And my neighbors believe in them because I believe in them. And we all believe in them because our king believes in them and demands them in taxes, and because our priest believes in them and demands them in tithes.”
- Will the U.S. and other sovereigns give up their status as a reserve currency? No. Anyone espousing a position against this point is politically and economically naïve. China today is leading this charge as it protects its sovereignty by banning ICOs and crypto exchanges.
- What are the penalties for failure? With true money (and by default taxation), the penalties are severe. While the Silk Road was a fascinating crypto-blockchain technology endeavor with a sordid business model, who ultimately paid the price? Only one individual.
The Great Financial Crisis taught us that despite whatever skepticism we may have in the financial system, we trust it; maybe because we have to.
To quote Harari again:
“Take a dollar bill and look at it carefully. You will see that it is simply a colorful piece of paper with the signature of the U.S. Secretary of the Treasury on one side, and the slogan ‘In God We Trust’ on the other. We accept the dollar in payment, because we trust in God and the U.S. Secretary of the Treasury.”
Despite my personal political misgivings today, I trust the financial system (and the U.S. military) with my children’s college savings. Can “bitcoin” provide that?
Frank Troise is head of innovation at Synpulse Singapore. The views expressed here are his own.
A thought experiment: gold as currency!
By Arthur Hayes
Imagine yourself part of an early human civilization thousands of years ago, before gold was accepted as money. Your tribe or village uses shells as money. The shells are sufficiently rare that they hold value. They are easily recognized and hard to counterfeit. However, it is hard to store the shells in vast quantities, and over time the shells degrade. Carrying a large quantity of shells is also quite difficult.
One day you discover specks of a yellow metal. Its luster entices you to pick up a few small rocks and study them. Unlike many rocks and metals you deal with, gold is quite soft. Over a hot fire, you melt some of these gold nuggets together and find it is quite easy to manipulate.
The next day you tried to remember where you discovered the gold. After a few weeks of searching you were able to locate another few nuggets. Another thought: perhaps gold is rare.
As a civic-minded person, you arranged a meeting with the village leaders and showed them your new discovery. You asked if possibly gold could replace shells as the accepted currency. They laughed at you. Everyone knows that shells are money, and shells will always be money. You feel deflated but not defeated.
Gold has its day
Yet… A woman at the meeting thought the gold would make good jewelry. It was very shiny and looked much better than the drab trinkets townspeople wore. She asked where you acquired the gold and if you could help her fashion it into jewelry.
You were able to find a location where if you dug, gold appeared fairly regularly. It was a hit. Everyone loved their new gold jewelry, it looked much better, and it held its form over time.
Given the primitive tools at your disposal, it was very difficult to find large quantities of gold. Gold jewelry began to function as a proto currency. Those who wore it were richer, as it required more and more shells each year to purchase a standard bauble.
At this point the village elders began to worry. Their wealth was stored in the form of shells. In the face of a better monetary instrument, gold, the shells depreciated in value every year. Even worse, because gold is rare, inert, impossible to counterfeit, and easy to transport, some merchants preferred to sell goods for gold rather than shells.
Because the village had a limited history handling gold, its value fluctuated wildly. No one know what it should be valued at vis-à-vis real goods and services so it still wasn’t as stable a monetary instrument as shells. The elders used this fear and price volatility to warn the plebes not to consider a pretty rock as money.
The network effect takes hold
Over time the village could not ignore that gold and metallic monetary instruments in general were technologically superior. Slowly then quickly, the value of gold versus real goods and services skyrocketed. Those who had “invested” in gold saw their purchasing power increase dramatically as the society switched to a better monetary technology.
From barter, to commodity money (gold), to paper fiat money, to cryptographic money, each one of these transitions features extreme volatility then stability. The new form of money at one point will not be able to purchase any goods and services – then all of a sudden its purchasing power increases quickly. The network effect ensures that the transition between different forms of money is chaotic.
A monetary instrument can only have value if a sufficient percentage of the network will price their goods and services in said instrument. However, no one wants to be first. The chicken and egg problem of monetary adoption ensures that once the switch happens, it occurs quickly.
Becoming the CEO of a multinational bank is incredibly difficult. CEOs like Jamie Dimon dedicated their lives to the organizations they lead and have made many personal sacrifices. Being human, it must irk them that youngins have become worth $100 million-plus in a few years due to a belief in a different way of transferring value.
It also is annoys senior financiers that these same pups’ stated goal is to dismantle the monetary system that they sacrificed everything to lead. The smart financiers are busy buying crypto assets while they publicly deride them. The dumb ones double down on the supremacy of central bank printed fiat-denominated assets.
Arthur Hayes is CEO of BitMEX, a crytpo-currency exchange in Hong Kong.
The Seventh Deadly Sin of crypto-currencies
By Jame DiBiasio
Whatever your view of crypto-currencies, there is no question that they enable a great number of users to engage in the Seven Deadly Sins. Cryptographic money is being exchanged, often via dark-web connections, in order to:
- Commit fraud
- Sell narcotics
- Traffic people
- Hire assassins
- Finance terrorism
- Dodge sanctions (e.g. North Korea)
But among these sins, it’s the seventh that will really drive regulation:
- Evade tax.
China got our attention by banning ICOs and bitcoin exchanges. As the biggest source of both mining and trading of Bitcoin, this will deprive that specific currency of the network effect it relies on. Perhaps this will prove fatal, or maybe it just means activity will shift to Japan, the U.S. or other places.
China’s priority is to maintain social stability, as defined by the Communist Party. To that end, it takes capital outflows very seriously. There was no way Beijing was going to allow mass, private, unchecked capital movements via digital assets.
Similarly, there is no way that the U.S. or other governments are going to allow mass, private, unchecked capital movements that go undeclared and untaxed.
The power of governments
China has the means to stamp out mass outflows (while probably keeping a window open for elites’ own affairs). Similarly, the U.S. has the power to begin regulating crypto as taxable assets.
FATCA, the Foreign Account Tax Compliance Act, came into effect in 2010. It gives the Internal Revenue Service coercive power over offshore licensed financial institutions to report any activity involving U.S. clients, or U.S. assets.
Moreover, many developed countries assign individuals and companies taxpayer identification numbers (TINs).
Core infrastructure is therefore in place there for enforcing people to declare digital transactions and pay capital gains or income tax on them, should developed countries make this a priority. As long as crypto-currencies still need to ultimately convert in and out of paper fiat money, governments will have a means of enforcing taxation.
Libertarians and crypto-utopians may chafe at this, but I think this is actually good news for the ultimate spread and conquest of digital assets.
Crypto currencies are not going to enjoy widespread consumer and merchant take-up until regulators and banks accept it. And that will happen when these things come under a proper regulatory and tax footing.
Helping crypto-currency gain traction
For ICOs, the U.S. Securities and Exchange Commission set the pace by outlining conditions in which they would be regulated as securities – conditions that Singapore and Hong Kong quickly emulated. This doesn’t eliminate scams in token sales, but it begins to define what is acceptable. It is a step towards driving the worst practices to the edges of the market, and attracting liquidity to the most reliable jurisdictions.
For broader use of Bitcoin for payments, Japan has been the pacesetter. Official blessing has given its banks the green light to accept, and encourage, consumer and merchant use of Bitcoin. The Financial Services Agency has begun to license crypto-currency fintechs. I expect Japan to see greater use of digital currencies for payments.
Better regulated markets will attract innovators. The future technologies that link markets seamlessly will be developed where usage is greatest. China is going to miss out on this, although it could reemerge as a crypto powerhouse if it establishes a viable digital renminbi; it also has a track record of using protectionism to develop unique conditions for other internet technologies.
I don’t know if Bitcoin per se is going to survive, or flourish as ‘digital gold’, no more than I can tell how other crypto-assets will fare. But Bitcoin is better than gold because of its ease of transfer and global access, and that is true whether or not it’s done in total secret. For crypto-currencies to thrive, though, there’s going to be a tradeoff: taxation for scale.
Jame DiBiasio is co-founder and editor of DigFin.
This article originally appeared on October 3, 2017