Bitcoin: A Global Virtual Currency?

Project Sources:

Satoshi Nakamoto’s now famous article that represents the foundations of the Bitcoin cryptocurrency begins by explaining the shortcomings of modern, state and bank backed currency. He argues that having a trusted third-party allows for a) the increase of transaction costs because of the need to compensate a mediator b) reversible transactions because the mediator is given too much power and c) mismanagement and even exploitation because too much power is given to a mediator. The solution, he says, is to create “an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.”

The concept of an electronic coin in Bitcoin is defined as “a chain of digital signatures.” This essentially implies that each transaction is interlocked with previous transactions because the parties in a previous transaction have to computationally (as in the computer automatically does it) sign off on the next transaction and so on. This creates a system of users that verify the following transaction on the network, which leads to a transaction history imbedded in the network where “new transactions are broadcast to all nodes.”

The public network would be almost impossible to be compromised because it interprets the longest string of transaction accounts as the true log. Therefore, the number of attacker nodes in the network would have to outnumber the number of honest nodes to corrupt the system.

The genius of Bitcoin is that it cuts out the middleman, the bank, which is controlled by the state, which is why libertarians like the idea so much. But they aren’t the only ones. Bitcoin through thoughtful use of computational devices and practices creates a safer, more reliable option for money transfer across the globe. Your money is now officially your money.

  • 2. Bitcoin: Questions, Answers, and Analysis of Legal Issues by Congressional Research Service (Policy Paper)

Written by a federally tied body, one important section of this long article seeks to answer the question, “What effect could Bitcoin have on the Fed if it grows in size as a global currency?” They begin by saying that Bitcoin is not big enough now to have any real effect of the Fed and Congress’s economic policy. But if it grew in size, the author suggests that Bitcoin would have a major effect on policy. “Conceptually, Bitcoin could have an impact on the conduct of monetary policy to the extent that it would (1) substantially affect the quantity of money or (2) influence the velocity (rate of circulation) of money through the economy by reducing the demand for dollars.”

Aside from the lower transactions costs that I’ve discussed in the previous source, the article lists two other arguments for wider use of Bitcoin. The first is increased privacy. There is less risk of identity theft. However, it’s not as anonymous as a cash transaction because there is a long log of Bitcoin transactions. I personally don’t agree with this one, because even though it’s anonymous, if you could find out the timestamp for one purchase you could look through the log and find a history of all that person’s purchases. The second new argument for Bitcoin is that there is no “erosion of purchasing power by inflation.” Because the possibility of creating new currency, through the process of mining*, is dependent of the demand of the currency, it’s not possible for the supply of the currency to outpace the demand of the currency. The introduction of new currency is controlled by demand.

*I should explain what mining is. It has nothing to do with this article. Bitcoin mining is the process through which Bitcoins are introduced into the networks. These new Bitcoins are earned as a reward for the computation power required to support the Bitcoin network. A person lends their computer’s computational power and in return gets compensated by receiving a Bitcoin. As the network traffic and usage of Bitcoin increases, it takes more computational power to run the network and therefore it becomes harder to introduce more Bitcoins into the market.

Countries “implementing” the Bitcoin would be antithetical to its original purpose because it would mean taking a peer-to-peer money transfer system with no central authority and letting the states be a central authority. The Euro is a currency that was adopted by many countries in the 1990s. I looked to it as a reference for multilateral implementation of a currency. Does it make commerce easier?

Implementing monetary policy normally means controlling a currency through central bank operations. The Euro was developed in the 1990s as a way to create a common currency for European countries in the EU. It had several immediate effects: “Travel was made easier by removing the need for exchanging money”, “labor and goods can flow more easily across boards to where they are needed”. These factors increase globalization. It allows goods to flow across Europe unimpeded.

Some smaller countries have cited that the Euro is slanted in favor of the larger European countries. This is likely not an issue with Bitcoin because large countries would not be able to regulate Bitcoin. However, if large countries found that they could easily control the global Bitcoin market, smaller countries would not be in control of their country’s economic policy, something they enjoy by having their own currencies.

This paper focuses on the possibility of Bitcoin becoming a much larger currency. The main deterrent to that, the authors argue, is “inelastic supply in the face of volatile demand” making it unstable relative to established currencies. They say that because Bitcoin owners hold Bitcoin on the speculation that it will become widely used, it has no real worth. Only if speculations about wide spread use come true will it have marketplace value. With that being said, if the Bitcoin takes over the dollar’s market value ($1.28 trillion) then the value of one Bitcoin could be as high as $98,000.

There are a few innovations that attempt to make Bitcoin easier to use and less volatile. These are market exchange pricing facilities and instantaneous exchange facilities:

Market exchange facilities allow consumers to see the price of an item in a store (it’s much easier for an online store). Getting the exposure will increase the demand for the currency and therefore increase its value. The more options there are to pay for it, the more people will be willing to use it.

Instantaneous exchange facilities, on the other hand, are helping businesses let consumers use Bitcoin without the business being disadvantaged. Many businesses don’t want to deal with the volatility of Bitcoin and so getting paid in Bitcoin is not ideal for them. But instantaneous exchange facilities allow those companies to receive Bitcoin payments, but then immediately transfer the payment to a different currency. This makes using Bitcoin a safer option for companies that don’t want to carry risk.

The IRS, as the United States taxing body, has a responsibility to monitor the transactions in the United States. The IRS needed to clarify its guidelines on the taxation of virtual currency.

They say that, “the sale or exchange of convertible virtual currency, or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction, has tax consequences that may result in a tax liability” (1). The IRS sees Bitcoin as property and therefore can be taxed like any other property in the United States. However, the IRS doesn’t see virtual currency as “that could generate foreign currency gain or loss.” They also say that Bitcoin miners are subject to income taxes.

The significance of this government document is that the IRS (one of the most notoriously bureaucratic divisions of the US government) is attempting to control the Bitcoin. Bitcoin was developed to keep the government out of the economy (although its mostly meant to keep the Fed and Congress out of the monetary system). But it makes sense: if Bitcoin got large and the IRS had no ability to tax Bitcoin, would the US lose tax dollars? But at the same time, does the US government have the ability to tax currency that is not its legal tender?

Comment Stream

a year ago

Excellent, comprehensive sources analyzed here. Actually, reading these summaries bookended your presentation nicely in that I understood the complexities of Bitcoin and B-coin policies better. Appreciated the endnote explanation about mining. The sources looked quite technical and I applaud your distillation of the technical info into accessible text. Your enthusiasm for this topic came through nicely in your presentation and in the summaries. Cheers!👏