The Opportunity of Cryptocurrencies

Governments could benefit from crypto, but likely won't embrace the new technology
May 11, 2018 Updated: August 9, 2018

Last year, cryptocurrencies like bitcoin and other crypto products based on ethereum burst onto the financial scene for good with spectacular price increases. In 2018, there have been a mini-crash and some sideways movement. Will this volatility keep cryptocurrencies from playing a larger and possibly significant role for payments and investment in the future?

Cryptocurrencies have three basic features. First, they are similar to fiat money, like dollars, euros, or pounds, in as much as they are not backed by anything real like gold and only have value because individuals believe somebody else will accept them as a means of payment in the future.

Thus, confidence, as well as legal incentives, are an essential component of any successful fiat or cryptocurrency in circulation. A possible exception is Venezuelan President Nicolás Maduro’s project of a gold-backed cryptocurrency, ambiguously called the Petro Oro. However, it is not at all obvious that he will keep his word and deliver gold ingots to anybody who shows up at the exchange window.

Second, cryptocurrencies are created by algorithms. While the programmer of the algorithm can alter a cryptocurrency’s supply rule (this is what one suspects Maduro will do), such intervention is unlikely to occur at whim, at least for the big ones. The loss of credibility would destroy a cryptocurrency overnight.

Third, the way many of the big and tested cryptocurrencies are created allows virtually anonymous, safe transactions, with minimal risk of fraud, but this is not the case for all of the 1,000-plus variations around. Since controls are exercised by so-called miners (a network of cryptocurrency controllers), even Maduro would find it hard to sell the same monetary unit more than once.

Natural Enemies

That makes cryptocurrencies appealing to those who appreciate security and do not want outside parties—including governments or banks—to snoop around and violate their privacy. By contrast, the authorities do not like cryptocurrencies because they make tracking transactions difficult and cannot be confiscated by default through the government-regulated banking system.

For example, Singapore and South Korea recently proposed measures allegedly aimed at protecting cryptocurrency investors and avoiding money laundering. In fact, these are attempts to crack the wall of anonymity shielding the world of bitcoin and other virtual currencies. The goal is to prevent cryptocurrencies from becoming a preferred instrument of tax evasion and guarantee that they do not interfere with traditional monetary policymaking.

We can therefore expect governments will move to kill an instrument that could seriously undermine their powers of taxation and monetary policy. As a matter of fact, much of the present volatility on crypto markets reflects how operators perceive attempts by the authorities to regulate and restrict them.

Technology will play a major role in this context. For example, there is little governments can do to identify a transaction while it is being processed, but they can probably track the machine (computer or server) from which the transaction originates. Monitoring capabilities will certainly become more sophisticated in the future, but so will the barriers to keep intruders at bay.

Freedom to Choose

All governments do not necessarily have the same priorities, however. Those differences can lead to various scenarios. Most governments do not want to lose their taxation power, which today relies heavily on the possibility of tracking money transfers. Others, however, are eager to attract foreign investment and create a favorable environment for economic growth.

Freedom to choose the means of payment is an important way for governments to encourage business activity and relocations from abroad. Of course, these governments must be ready to revamp their tax systems (heavier taxation on consumption and very light or zero taxation on income and wealth) and to apply lower taxes in general. If some governments prefer to go that route, they will attract crypto innovators and investors alike.

If and when the supply and demand for virtual currencies steadies, these currencies would also provide monetary stability. For example, quantitative easing and manipulated interest rates would be all but impossible in a bitcoin standard.

Countries that welcome bitcoin and the other virtual currencies would signal a strong commitment to fiscal and regulatory restraint, monetary rigor, and confidence in a free-market economy. This is precisely what most governments abhor, which would make the impact of those that think differently even greater.

A Gold-Backed Cryptocurrency?

As mentioned earlier, the biggest drawback of cryptocurrencies at present is their volatility and price uncertainty. These are the same things that make them attractive to risk-loving investors, as well as people who hold lots of cash and wish to avoid government scrutiny–or even common criminals. Yet this same volatility and uncertainty are enough to scare away ordinary individuals who are looking for a safe place to park their savings.

Now, a real cryptocurrency backed by something tangible would minimize these difficulties and open new possibilities in monetary policy and global finance. A real cryptocurrency could be backed by commodities such as gold or oil, or even by shares in blue-chip companies.

The collateral would be priced at a fixed parity—for example, one cryptoruble for a gram of gold, or a barrel of oil, or 1,000 shares of Gazprom. Having both a fiat currency (e.g., the Russian ruble) and a real cryptocurrency (e.g., the Russian real cryptoruble) would lead to a system of competing currencies, since anybody in Russia could issue cryptorubles.

In this context, the government would play two roles: It could continue to print the paper currency, but also issue its own cryptocurrency backed by real assets (e.g., oil). Furthermore, it could periodically certify that other domestic issuers have the collateral necessary to redeem cryptocurrencies in circulation.

What Are the Odds?

The outcome would be an end to the government and bank monopoly on legal tender. It would introduce alternative and credible means to store wealth, as well as a new source of international financing. Terms of credit would no longer be dependent on the discretionary decisions of monetary policymakers associated with the currency in which the transaction is denominated.

Who would benefit? Large corporations, which would gain access to a new source of rather cheap credit; states that can claim ownership of abundant natural resources; and other countries with the courage to overhaul their tax systems and downsize public expenditure.

But is it realistic to expect governments to seize this opportunity? Not very. Politicians are always reluctant to give up monetary sovereignty, reduce spending, or cut back the fiscal burden. They are much more likely to punish monetary innovators, especially the big ones.

China has already cracked down on crypto; the United States is neutral, Japan more positive. Only tiny countries like Liechtenstein and Switzerland have fully embraced crypto within their banking systems.

For the time being, there is no need to outlaw them. The market capitalization of all cryptos is relatively small compared to other assets and only a fraction of this amount is used to buy goods, services, and financial assets. Their impact on monetary policies is minimal.

However, should virtual money cease to be a plaything of financial speculators, the authorities will step in to regulate the cryptocurrency market in the name of global governance. This will limit its appeal to aficionados. Bitcoin and its competitors will not disappear. Yet an important opportunity to make money markets more competitive will have been missed.

Enrico Colombatto is a professor of economics at the University of Turin, Italy, and a senior fellow at Geopolitical Intelligence Services. This article was first published by GIS Reports Online.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.