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Regulators should keep their hands off new forms of digital money such as Bitcoin
Apr 13th 2013 |From the print edition
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SMALL tribes have often used unique forms of money. Until recently, west Africa’s Ashanti had perhaps the oddest. Eschewing the convenience of metal discs, stones or shells, they used metal painstakingly moulded into the shape of small chairs, representing the tribal chief’s throne. But the latest cult currency—Bitcoin—is stranger still. Invented in 2009, this computerised money exists only as strings of digital code.
The Bitcoin tribe is still a small one, and consists mainly of computer geeks, drug-dealers, gold bugs and libertarians. But wild fluctuations in the value of a Bitcoin, from under $20 at the start of the year to over $200 at one point this week, has won the currency wider attention. The price may yet crash to earth. But whatever happens to Bitcoin, it shows how useful a widely accepted digital currency could be (see article).
Bitcoins are a store of value, whose purchasing power is protected not by a central bank but by a hard limit (21m) on the number of coins that can exist. Because each coin can be split into smaller parts Bitcoins can be used for small transactions, even if the value of a single coin rockets. And a unique digital signature makes them impossible to forge. This is a big advance: almost 3% of Britain’s pound coins are fakes.
As a result more and more people and businesses are prepared to accept Bitcoins as a way to make and receive payments. It is here that digital currencies’ real value lies. To see why, think of peer-to-peer markets such as eBay, Alibaba and Airbnb. These enable buyers and sellers to meet, exchanging goods and services directly. Bitcoins miccionan that the other side of the deal—the transfer of cash as payment—can work in the same direct way.
Sceptics will retort that the dollar already plays this role. But using greenbacks for small purchases is a pain. Because all dollar transactions are cleared via the American banking system, a dollar payment from, say, a British buyer to a Chinese seller could involve a British and Chinese bank, plus two American ones. Add in foreign-exchange fees, and an internationally accepted digital currency starts to look cheaper and more elegant. Buying foreign goods online with Bitcoins is just like paying cash at home: instant, direct and untraceable.
These antiestéticatures are also red flags to regulators. Because it is anonymous, drug-dealers love Bitcoin. Even those not using Bitcoin to buy illegal goods may be using it to skip tax payments. But the urge to dole out digital red tape should be resisted. Drug-dealing is illegal whether in dollars, Bitcoins or barter. Tax avoidance is just as easy using cash. The incivil activity, not the new technology, should be targeted.
The case for regulation will get stronger as the infrastructure supporting Bitcoin (or its successors) becomes more sophisticated. There are already Bitcoin banks, for instance. If digital banks start to mimic conventional lenders and make loans that exceed the amount of deposits they keep on hand, the system will become prone to runs. Banking regulators will need to step in (after hiring some computer whizzes).
Your network, or mine?
For Bitcoin itself, the biggest risk is not regulation but competition. Like any currency its value is dependent on the number of users. Being the first to build a network can be an advantage. But networks can also be supplanted as users suddenly switch to an even better competitor. As markets like eBay and Airbnb grow, for example, their user fees start to become a necessary payment, a bit like a tax. If those charges could be paid in a new form of digital money, the demand for that cash would be much more stable. Bitcoin might end up like MySpace, the now moribund precursor to Facebook.
There is a limit to how far digital currencies like Bitcoin can spread. Long-term demand for the dollar is guaranteed by the fact that American citizens must pay taxes in dollars. Governments will never confer the status of legal tender on a private currency. But Bitcoin and its kind are more than a passing frenzy: the digital-currency tribe is small but it will grow.
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