Curb the Cryptocurrency Enthusiasm
Many sources of information and analysis provide good reasons to believe that Bitcoin (“BTC”) and other cryptocurrencies (together “Coin”) may become valuable as a store of value and as a payment system
Significant risks, however, exist with Coin and CoinCurb outlines them in this discussion
We are not expressing any view or making any prediction
Blockchain is Something Very Different
Each Coin is an application built on the underlying Blockchain technology
Curbing one’s enthusiasm for Coin may in fact help people recognize why Blockchain is a big deal
Blockchain technology may revolutionize the recording of a wide-variety of transactions similar to Email technology revolutionizing communications and World Wide Web technology revolutionizing the access to information
The Blockchain is a technology revolution and there will be further revolutions – Coin has been announced that will use Direct acyclic graph (DAG) technology instead of a Blockchain to increase the speed at which transactions are disseminated and recorded by distributed ledger systems. DAG and the Tangle are two new technologies being used for IOTA, a backbone network for the Internet of Things
We discuss below only the risks in the asset value of Coin. This discussion does not relate to its current underlying Blockchain technology
Coin owners only have claims on the value of the Coin itself. They do not own a share of the entire Coin process, i.e. the Coin’s network.
Coin is similar to owning a product made by a company. It not like owning a share of the company itself.
Capital Gains Tax
Coin is not a currency. Currency is recognised and regulated by governments
Coin is an asset similar to how a company share is an asset
Every sale of Coin generates a capital loss or gain for tax purposes in the USA, Canada and many other countries. All capital gains must be declared and tax paid when due. Penalties include significant fines or imprisonment
Accountants will increasingly advise their clients of this tax reporting obligation. Even the purchase of a coffee with BTC results in a capital gain/loss
Some blame, in part, the January 2018 crash in the price of Bitcoin on such accountant advice
The USA IRS is an aggressive tax collector and it is likely that in the near future at least one person will be imprisoned for a major tax evasion due to Coin.
An imprisonment will wake up many who are still not taking the capital gains reporting requirements and paperwork seriously and raise doubts in peoples’ minds about the hassle and risk of using Coin.
Many Airbnb hosts and homeowners did not pay taxes on rental income earned “on the side” – until governments started cracking down
In Canada, many professional real estate re-sellers (“Flippers”) did not report their profit properly as income, preferring to pretend that the transactions were tax free due to Canada’s personal residence exemption – until the government started cracked down
Is Anonymity Actually Important?
Coin is not normally anonymous as every transaction is on public record and easily traceable. Take a look at Blockchain.info and enter a user's public-key address – such the example address: 1DpZHXi5bEjNn6SriUKjh6wE4HwPFBPvfx . Further, see the data available publicly on Blockchain.EXPOSED .
Coin is pseudo-anonymous – similar to using a pseudonym. Coin can, however, be made more anonymous using services such as a “mixer”. However, better criminal investigative tools continue to be developed such as CipherTrace and Chainalysis which are being used by police world-wide. These tools can identify illicit Coin, which Coin may then be treated as less valuable than other Coin destroying the requirement of fungibility of money. An example of fungibility is that one dollar is replaceable with another dollar.
All banking and credit card transactions, online and off, are currently recorded and traceable
Legitimate reasons for counter-party (i.e., seller or buyer) anonymity include: reducing risk of identify theft, avoiding the risk of a seller following buyers home and robbing them and avoiding directed advertising
It is third-party anonymity (i.e. anonymity even to a central authority such as a financial institution), not counter-party anonymity, that facilitates criminal activity such as tax evasion, terrorist financing or money laundering
At the same time, a legitimate reason for third-party anonymity is that knowledge by, for example, a credit card company of the payee, amount, and time of payment for every transaction made by an individual can reveal a great deal about the individual’s whereabouts, associations and lifestyle
Strict and strongly enforced privacy laws and adequate cyber-security at all financial institutions are critical to manage this legitimate reason for third-party anonymity
Almost all business and individuals based in Western liberal democracies have shown to date that they are happy to sacrifice their privacy in return for the convenience of credit cards
Association with Illegal Activity
Since Coin can be made anonymous, it can facilitate international crime. Ransomware payments and Dark Web purchases of illegal items use BTC.
Association with illegal activity is a major negative if there are suitable government-approved alternatives
Traditional cash, which is anonymous, is used for crime much more than Coin but must be transported – making practical anonymity difficult for large transactions
Anti-Money Laundering (AML) Laws
All organizations that transmit money or exchange currencies must comply with AML laws: registration with the government, complying with “Know your client” (KYC) rules and maintaining records. Some Coin-related companies such as exchanges have not complied and have been penalized.
Some Coin companies and users will violate the law. Some believe that governments are now obsolete due to the possibility to bypass government censors and regulators using secure VPNs.
However, there are hundreds of years of history of criminals who believe that they can get away with violating the law. Governments catch criminals through various methods including the old-fashioned informant, an aggrieved spouse or a business partner.
Governments regularly enforce strict laws with heavy penalties for the criminals who are caught. Such action is sufficient for general deterrence of others who may be tempted to violate the law.
Further Regulation and Many Global Jurisdictions
Government can enact further regulation should they see the need
Government may, for example, impose heavy taxes, ban anonymizing services, or require the identities of all Coin holders to be registered with Government. The art market’s traditional anonymity has facilitated significant money-laundering. The IMF estimated that art available for money-laundering represented 2.7% of global GDP in 2009. Governments are beginning to consider removing this anonymity and Luxembourg and Switzerland have already passed such laws.
As Coin is an international service, all Coin participants must be sure to comply with the laws of all jurisdictions that include the location of any party to a transaction, any of the services providers or network operators involved
It may be difficult to comply with all the myriad of different laws in different countries and even within the same country at the State jurisdiction level
Competition from Banks on Cost and Speed
What if Banks had the same transaction costs and convenience?
Credit cards and related payment systems generally charge 0.2 - 5.0% transaction fees depending on the merchant size and location
Financial intermediaries (all referred to as “Banks”) charge fees >$10 to each send or receive a wire transfer which may take days to arrive
Each conversion between currencies for wire and credit card costs is approximately 2%
Credit cards companies generally charge an additional 2% fee for international transactions
Many banks now charge no fees for instant transfers between domestic banks of approximately $3,000 or less
In a competitive marketplace, prices will, over time, move close to the marginal cost of providing the service. Decades ago, a simple broker stock trade would cost approximately $200. The trade cost is now $5 online or even virtually no cost with minimum volume. An international phone call that used to cost several dollars a minute in the 1990s now costs 1 cent a minute and Internet calls and video conferencing are free.
Given the growing options for payments, global electronic payment transaction costs will be driven down significantly to a very low amount
BTC Capacity to Scale in Speed and Cost
BTC transactions are currently verified in minutes
Credit card transactions are verified almost instantly. Credit card transactions are reversible, whereas BTC are not. Reversibility can be both good and bad
BTC transaction verification fee was $2.40 per transaction in early 2017 and $10 at the end of 2017
In addition to fees, miners are rewarded with BTC for their mining verification of transactions (which reward is a general cost to the entire BTC system)
Bitcoin mining is inefficient and is not “green-friendly”
Mining algorithm verification has been designed to be computer processing intensive so as to secure the transactions
As miners are competing with each other to win the verification reward, there is significant duplication of computer processing. A BTC transaction’s electricity consumption is > 40X that of a credit card transaction. Difficult to compare. Some estimate > 1,000X. BTC mining consumes >0.1% of the world’s electricity.
The BTC system can change its rules in the future to move to a less processing intensive, yet still reliable, system
Even today, for many transactions, Banks are cheaper and faster
Is There an Effective Cap on BTC Issuance Given Competition Between Coin?
A good argument for BTC is that there will be a limited number issued. Only 21 million will ever be issued.
The limited nature of it may be an illusion. It is similar to saying that there are a limited number of 3 letter .com domain names. What about 4 letter, 5 letter etc. .com domain names? What about 3 letter domains in the vast number of new non “.com” domains such as “.ltd” and “.corp”? Such short .com domains are, in fact, also used as a store of value. Unlike BTC, there is inherent value in such domains themselves as they can be and are used for short company websites.
There are various and growing types of Coins and BTC spinoffs (“forks”)
BTC code may be changed pursuant to BTC’s rules to allow the limit to be raised
Peter Schiff: “There’s nothing special about bitcoin that another cryptocurrency can’t replicate and improve on. Right now, bitcoin is just the most popular because it was first.”
See below section, "Is Coin More Like Diamonds or Gold"
New Coins have new features including energy-efficiency, faster transaction confirmation algorithms, and an integrated network privacy
Competition From Government
Coin has no government backing
The Bank for International Settlements (BIS) suggested that the central banks of countries may wish to consider launching their own wholesale (accessible only to financial institutions) or retail (accessible to all) central bank crypto currency (a “Retail CBCC”)
Russia has announced the “Crypto-Ruble” which will be fixed in value to the Russian Ruble
Fedcoin is being designed for possible use by USA Federal Reserve Banks. An alternative form of sovereign currency always convertible at par with the USD issued similar to cash and forming a third component of the monetary base in addition to cash and reserves
A Retail CBCC could have similar features to Coin including pseudo-anonymity. However, customer information, i.e. the true identity behind the public address, may be made a requirement. If anonymity is not important, then – instead of a Retail CBCC – permitting public access to Direct Central bank Accounts (“DCA”) would accomplish the same goal as a Retail CBCC. DCAs have been technically feasible for a long time but Central Banks have largely decided not to adopt them. Retail CCBC and DCAs might be competitive with commercial banks and have consequences to both the business models of and essential economic functions (i.e. monitoring borrowers) traditionally provided by commercial banks. Cash, CBCCs and DCAs are all liabilities of the Central Bank. If cash is deposited at a commercial bank, it becomes the liability of that bank and the depositor assumes the risk of that bank failing.
Sweden is considering both DCAs and a retail CBCC for its eKrona project.
Central Banks currently issue cash that is anonymous. An anonymous Retail CCBC would be similar to the issuance of cash. The big difference is that the issuance of an anonymous Retail CCBC would be a conscious decision of the Central Bank.
The anonymity of cash resulted from convenience and historical circumstances rather than the conscious decision of a Central Bank.
Blockchain Limitations to the Success of BTC
Code error or limitations may arise. Current mining energy inefficiency is a limitation of the code.
Hack or take over of > 50% of mining by a state actors with no interest in success of BTC. BTC Blockchain is governed by those performing >50% of the mining. Miners are incentivized financially by the success of the BTC system. However, state actors or others who may take control of mining operations may have a different incentive. Their goal may be to interfere with or wreak havoc on the BTC system
No well-defined governance process. >50% of mining computer power rules BTC. It is the law of the jungle: “Might is right.”
Service Provider Negligence or Malfeasance
Negligence or malfeasance by service providers
Hack of Mt. Gox exchange was one of the major hacks. 600,000 BTC stolen
“There’s certainly a lot of bullishness about bitcoin and cryptocurrency, and that’s the case with bubbles in general. The psychology of bubbles fuels it. You just become more convinced that it’s going to work. And the higher the price goes, the more convinced you become that you’re right. But it’s not going up because it’s going to work. It’s going up because of speculation.”
"Government-issued money works because there are other valuable things people can do with money…. you can pay taxes using fiat money; you can buy insurance denominated in dollars; you can buy bonds denominated in dollars, which will pay you interest in dollars."
"People have jumped to the conclusion: Since dollars have no intrinsic value, cryptocurrencies can work. Two wrongs don’t make a right."
"Libertarian-minded crypto fans saw this was a way to liberate people from the government. I think it will have the opposite effect. People are going to lose money. This could really backfire, giving libertarian ideals a bad name by making fiat look good. The downside can be spectacular."
See Bitcoin Bubble
A Coin Offering Can Be a Regulated Security
The USA law in this area has been clarified as set out by Goodwin, a USA law firm, in SEC Director Clears Path for Secondary Sales of Security Tokens as Non-Securities, Declares Bitcoin And Ether Non-Securities
However, selling a newly issued Coin asset may by still treated no differently than selling of a share in a Company. Jurisdictions in the USA and Canada have already made that determination in certain cases.
Strict securities laws may, therefore, apply to Initial Coin Offerings (ICOs). Securities laws ensure that investors are sold investments that include all the proper disclosures and are subject to regulatory scrutiny for investors’ protection.
July 25, 2017 S.E.C. Press Release: “Offers and sales of digital assets by “virtual” organizations are subject to the requirements of the federal securities laws. Such offers and sales, conducted by organizations using distributed ledger or Blockchain technology, have been referred to, among other things, as “Initial Coin Offerings” or “Token Sales.” Whether a particular investment transaction involves the offer or sale of a security – regardless of the terminology or technology used – will depend on the facts and circumstances, including the economic realities of the transaction.”
“The federal securities laws apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology. Virtual coins or tokens may be securities and subject to the federal securities laws.”
Is Coin More Like Diamonds or Gold?
Coin is currently considered by users to be more like gold than diamonds
Diamonds are not actually rare but are so perceived. Perceived retail value is maintained due to perceived rarity, marketing, a history of restricted supply management and the social and societal expectations thus created. Re-selling a diamond will yield a fraction of the retail price.
Gold is rare and has traditionally been used as a store of value for over 2,000 years. Gold can be easily resold for market value in a variety of ways.
Gold is universally accepted and has been for millennia. It is tangible, pretty and shiny, and has real use for jewelry and electronics. The Gold supply is limited by that which has been extracted and what can be extracted in future.
BTC is a brand of Coin and only 21 million will ever be issued. However, there are hundreds of other brands of similar Coin and an infinite theoretical number of Coin. BTC was the first popular Coin.
The South African Gold Krugerrand coin was the first popular modern gold coins. Other gold coins including the American Gold Eagle Coin and Canadian Maple Leaf later also became popular.
Like gold, Coin is currently perceived as rare and can be re-sold on exchanges for market value
However, what happens if, due to one or more of the above risks, the perception of Coin changes so that it is considered to be more like diamonds than like gold?