Cryptocurrencies like Bitcoin are meant to circumvent the traditional banking system. That may have more impact on the basic functioning of a nation's economy than one might realize.
In December 2017, Bitcoin’s value rose by nearly 50 percent, with one of its biggest spikes coinciding with CME Group announcing it had United States regulatory approval (CFTC) to launch a Bitcoin futures exchange. One month later, Bitcoin’s value fell by nearly 50 percent, with one of its biggest dips coinciding with South Korean regulators’ announcement of a ban on its citizens using anonymous bank accounts to trade Bitcoin. Those who sought and were able to time the market for short-term gain did well. But how did those thinking longer-term evaluate Bitcoin in terms of fundamental value and then apply regulatory risk premium?
For many, circumventing traditional financial markets and regulation is the chief appeal of cryptocurrencies. However, as their champions seek to access retail investors around the world, the link between government approval and price may reveal the key to realizing the theoretical benefits that cryptocurrencies claim to offer over fiat currencies (those a government has declared have value, but are not backed by a physical commodity). That validation may be critical in establishing confidence that cryptocurrencies could eventually fulfill their promise to dramatically cut both cost and speed of payments.
Broadly, governments around the world have banned cryptocurrencies, given them some leeway to gain experience, or proactively explored frameworks to permit private crypto-finance at some stage with a few governments actually developing their own forms of cryptocurrency. Such state sponsored development is encouraging. When regulators are more involved there tends to be more progress; therefore, more regulatory engagement and innovation of those kinds may well be where we see a more widely acceptable crypto currency model emerge, gain acceptance and then scale. Direct or indirect involvement of state actors may not be the only way cryptocurrencies will truly establish themselves within the mainstream, but the chances are certainly higher. Equally, it may be the only way for regulators to control this technology and redirect the underlying activity out of the shadow economy.
Governments use their control over the supply of currency to manage their domestic economies and their ability to trade with and control their relationship with other governments. They determine how much currency there is and how easily it can change hands; together with interest-rate control, how much debt can be created and ultimately how much growth is possible. This economic control is important for achieving social and political goals.
Governments can directly determine who can create more wealth and indirectly who can gain power over the economy. Indeed, when a government loses control of its currency, it loses a large part of its independence. Greece, as part of the Euro, famously lost much of the ability to determine key parts of its internal affairs, including its social welfare system (which has significant electoral implications).
Loss of sovereignty is critical to understanding why governments are (at a very deep level) inherently wary of alternatives to fiat currencies.
Full faith and credit
We are able to trust the complete strangers we deal with when we trade both everyday items and fairly significant materials. This is, of course, because they offer us physical notes or transfers of digital versions of the same to our bank accounts or apps in a way we believe is reliable.
That perception of reliability is actually an assumption that our banks will hold those notes or transfers safe and our government will ultimately redeem them for other forms of value. This is rational, but not actually true. The government will not redeem notes for other physical goods or services. Governments may, in some cases, guarantee savings held at certain institutions, but only up to a threshold. They can only do so because they control the amount in circulation and can simply print more.
If no one can truly control the creation and deletion of a cryptocurrency, how can a government model and assume that risk and protect investors?
Fitness and propriety
Banks perform a vital function for any economy, reinforcing the macro strategy and following the micro rules set by governments. When they don’t, they are invariably punished. In economic and regulatory terms, banks and governments usually agree very well with each other. (It is not a coincidence that banks and regulators hire often staff from each other.) This broad consensus in economic and regulatory approach ensures a level of certainty and stability – and therefore predictability – which is considered desirable by many economists.
However, cryptocurrencies don’t need the current banking system at all. Many welcome this, seeing it as enabling the greater democratization of banking. However, upending the system to simply weaken the power (and wealth) of bankers would also have many unintended consequences. Banks manage transfers of money across the entire economy, which enables governments to count, track and tax them.
Jumping in with something we can’t fully understand managed by entities we may never know creates an uncomfortable regulatee vacuum.
Governments target the proceeds of crime in part to try to deter the underlying crime. With cryptocurrencies, it’s impossible to trace transfers. There is little doubt that criminal elements have provided much of the demand for cryptocurrency innovation. Bad actors will find many benefits from being able conduct their financial business without money laundering controls. The government can assure all participants that it has established a sound framework and are supervising institutions and payment intermediaries can be relied on. They can only do so because they authorize entry and can send people to jail.
If it exists entirely in a digital form, what is to stop a cryptocurrency disappearing altogether? Who would one look to blame let alone sue?
In theory, centralized monetary and fiscal policy and market interventions support stable growth and prevent market collapse. While some have argued that may be an illusion: volatility, recessions and financial crime and banking failures have and will always remain a constant threat; however, they can be partially redirected and its worse effects mitigated.
Indeed, while human greed can’t be regulated away entirely, at least its criminal manifestations can be punished and changes can be made from the lessons.
If Mt. Gox, one of the largest trading exchanges in the world, was compromised and hundreds of millions of dollars’ worth of Bitcoin were stolen, what is stopping attacks happening over and over and over? Given this, how could one even attempt to hedge or insure against a cryptocurrency position?
Just moving ahead with risks we can’t predict or likely be able to do anything about probably should make a responsible government wary.
Governments are understandably cautious (and inherently resistant) toward to any challenges to fiat currencies. However, a clear message from their varying responses to date to cryptocurrency innovators is that understanding and then consciously addressing the key policy concerns that governments have will help enormously in developing a cryptocurrency toward acceptance.Equally, governments actively embracing the underlying technologies may be the only way to fully understand and effectively counteract threats to their sovereignty and enable them to supervise their economy and develop tools and capabilities to prevent systemic risks.
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