Their advantage is security and anonymity, attributes that facilitate the sale of narcotics and other contraband on the Dark Net.
The downside of cryptocurrencies is that they have no official status anywhere in the world and are therefore not legal tender. No one is required to accept them in payment. Most importantly, no government will accept them in payment of taxes, fees, or fines. Money owed to the government must be paid in the coin of the realm. This is a serious drawback to widespread use and puts cryptocurrencies in the category of artificial currencies, like time dollars, Ithica hours, green dollars, and even frequent flyer miles.
Moreover, whereas these currencies have virtually none of the characteristics of the official currency, transactions in many of them are taxable by the Federal Government as income. I have no doubt that at some point in the near future, the IRS will issue an opinion letter (if it has not already done so) finding that Bitcoin transactions can be a taxible event, the same as though the transaction was made in the official currency.
Since Bitcoin transactions are anonymous, an IRS audit would be unable to determine the value of a transaction in cryptocurrency, nor would it reveal exactly what was being sold or purchased. This would protect small, casual transfers, since the investigative cost would vastly exceed the amount to be recovered.
If the sums transferred were large, however, the IRS would have at its disposal the extensive array of techniques that it has always possessed for catching tax evaders. The first method that comes to mind is a net worth analysis, in which they compare your declared income against changes in your net worth. Suppose you declare an income of, say $50,000. Then an IRS agent, noting that your zip code is located in a posh neighborhood, drives by your house and sees a five million-dollar mansion with two Rolls-Royces parked on the side. This will cause him to inquire as to how you manage to live in a five million dollar mansion and own two very expensive autos on a $50,000 annual income. [1]
If you have no reasonable explanation for the disparity between your income and the increase in your net worth, the agent will dig further to see where the money is coming from. He may not be able to lay his hand on the actual Bitcoin, but he can ultimately discover what you have spent and the source of your legitimate income. A large gap would be strong evidence that you concealed part of your income. In fact, the only way to truly conceal your Bitcoins is to never convert them to cash or property.
But I digress. My interest is in the economic factors that are driving people to use Bitcoin and why it should be now. Part of the reason is that the computing power to make the technology work has only recently become available, and the mathematics of the blockchain is relatively new. Also, dealers in contraband needed a reliable, anonymized and secure system of payment that concealed it from law enforcement agencies.
But another factor also was present: governments and central banks have been imposing austerity for approximately seven years. What that means is that governments have been cutting taxes on the wealthy and corporations while making cuts to the safety net and other expenditures that benefit the public. Corporations and wealthy people spend less than ordinary folks, simply because they already have what they need and can buy whatever they want out of their current earnings, as well as the income from their investments. Corporations have not been inclined to make capital investments anywhere close to the scale they have done in the past, preferring to either retain the profits, distribute them to shareholders, or purchase their own stock.
When the economy tanks, as it did in 2008, the proper governmental response is to lower interest rates and increase the deficit by spending more money than it takes in. The deficit will not cause inflation so long as production remains substantially below capacity. In the case of the 2008 crash, however, interest rates were close to zero, so the usual monetary remedies were to no avail. It’s called the zero bound, for obvious reasons. Briefly, governments engaged in deficit spending, and it stimulated their economies, as textbook economics would predict. But then, there arose in the U.S. and the EU an austerity fever that put pressure on politicans to cut spending and raise taxes. Paul Krugmen wrote a good article in the Guardian on this subject.
When a sovereign government (note that the members of the EU have no control over their currency) spends more money that it collects, it increases the amount of money in circulation, and conversely. Austerity lowers the money supply and reduces demand.
Businesses and banks have learned how to avoid the effects of austerity by creating new forms of money. In the 1960s, it was unquestionably the credit card, essentially a device to facilitate borrowing, and therefore increasing currency in circulation. Banks create money by lending it, which is a subject for another day[2].
In 1932, President Franklin Roosevelt took the U.S. off the gold standard. Without the constraint of gold (governments were expected to back their currency in gold) the U.S. could create as much money as it needed to stimulate the economy, and things started becoming better almost immediately.
In 1970, President Nixon took the dollar off the Bretton Woods agreement and allowed its value to float. This move helped to staunch a serious balance of payments problem.
Is it possible that these new forms of currency are another response to austerity? History has shown that when there is insufficient currency to handle ordinary business transactions, the system will find new forms of liquidity. The process can be disruptive. The same goes for inflation: people will find a way to avoid the losses incident upon an increasing supply and a declining value of money. Artificial currencies, however, are fragile so long as they do not have official status under federal law.
Keep in mind that governments perform their function by spending money and then taxing it. Without taxes, we would be faced with inflation that can only be stopped by not creating any more money. Cryptocurrencies break that oscillation of spend-tax-spend-etc[3] that all governments engage in. That is why I believe that Bitcoin and the other cryptocurrencies will ultimately go out of use. Governments simply cannot tolerate another issuer of money that it cannot tax.
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You might have a legitimate reason. You could be living in the servants’ quarters and performing maintenance work. ↩
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See How Bank Lending Really Creates Money, And Why The Magic Money Tree Is Not Cost Free ↩
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The government must spend money before it can tax it. ↩
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