Part 5: The state’s blessing
I was well aware that we were in the final phase of a mania and the crash was near. Still, in December 2017, I made the bet that bitcoin would outperform gold on a five-year horizon. A few days after the bet, the price touched $20,000 and then it collapsed. A year later it was struggling close to $3,000.
I am continuing the article series after a lengthy hiatus. The topic is relevant again because bitcoin is above $16,500 again — the level where I made my bet three years ago. Even with that, I am still standing to lose badly at the time of writing, as the price of gold rose 50% since then. At that level, I would be winning only above a $25,000 bitcoin price. But I still have two years to get there.
In Part 1, I presented the background of my bet. As I already mentioned, I based my bet on the following assumptions:
- There is a need for digital gold, a role which is yet unfulfilled. I elaborated on this in Part 2.
- Bitcoin has a good chance of soon becoming the globally accepted digital gold, which I argued for in Part 3 and Part 4.
- State authorities cannot or do not want to prevent this from happening. This is what I will write about next.
Weaknesses as strength
Several famous investors, like Ray Dalio or Jim Rogers, think that bitcoin cannot be a long-term profitable investment, not least because governments will ban it. I am convinced that they are wrong. Bitcoin is protected by a very important feature that makes it unlikely to be the subject of prohibition: it works poorly.
There are many aspects to the poor functioning. It makes a terrible transactional currency because it is vastly volatile and has high transaction fees. It is not really used for that purpose anyway, since a general transactional currency would obviously have to be stable in value and have negligible transaction fees. Beyond that, the bitcoin blockchain can only settle a few transactions per second. This is very far from serving the world’s transaction volume, or even just that of large payment card networks. Bitcoin in itself will not uproot the financial system, and this considerably reduces regulatory anxieties about it. Regulators are more bothered by projects that aim to create the truly general and global transactional currency. One of these is Diem (previously called Libra), which had been in a regulatory crossfire after its announcement in 2019.
Volatility, high transaction fees and low transaction capacity are no issue, however, if we look at bitcoin as digital gold. The price is naturally volatile, since it is the financial system or the fear of inflationary risks that shape momentary demand, and those are continuously fluctuating. And a few dollars in fees are staggeringly high for paying for a coffee, but terribly cheap if compared to the cost of cross-continental transportation of gold bars. Also, you move (digital) gold bars much less frequently than making payments, so the low transaction capacity is sufficient. It is not a coincidence that bitcoin’s use as digital gold saw a boost in the recent years. It fits that purpose very well.
Those who expect bitcoin to be banned usually answer that President Roosevelt forbade the ownership of gold in the US during the Great Depression. People had to surrender it to the state. One might ask: what if the same happens to bitcoin? But this reasoning and comparison is flawed on multiple levels. First of all, the financial system at that time was based on the gold standard. Practically, money was gold. The dollar’s value was pegged to gold. It was partially this artificial monetary scarcity that caused and, for a long time, worsened the depression. The executive order’s point was to alleviate this systemic monetary scarcity and the depression. Today, however, forbidding the ownership of gold or bitcoin during an economic crisis would solve nothing, since the monetary system is not based on these assets. It is much more likely that they would impose heavy taxes on the rich, but there is no point in confiscating their gold or bitcoin.
Still, if they banned bitcoin on the brink of the collapse of the financial system, history shows us that the price would have to go up. Just like it happened with gold in 1933. And it is just logical: at that point, the monetary system would be in huge trouble, cracking and creaking. Money would lose value at an extraordinary pace. A ban would be a central acknowledgment of all this. Everyone would be in a mad rush to buy alternative assets such as bitcoin, despite the ban. Bitcoin could be only acquired in the black market, but at an increasing price.
Those for the ban also argue that even if bitcoin is weak as a transactional currency, it can still be used for moving value instantaneously and permissionlessly all across the world. That means it can even aid terrorism financing or circumventing a country’s capital controls. And states will sooner or later have enough of that.
However, nothing would change even if they banned bitcoin. The price would probably plummet because the law-abiding would try to get rid of it (unlike earlier, I am talking about a scenario where there is otherwise no particular problem with the financial system). But bitcoin is operated by a decentralized network that is incredibly resilient and is unaffected by prohibition. It is like BitTorrent: you can prohibit its use, but if someone wants to, they can download anything through it. The network carries on. Bitcoin would live happily ever after and permissionless value transfer would remain possible, while prohibition would not bother terrorists and criminals. That is just the way they are.
Meanwhile the trading volume would move from regulated bitcoin exchanges to shady offshore ones that would not mess around with customer identification. The identity of bitcoin owners would become a black box to authorities in an instant. Currently, practically every crypto exchange identifies customers, so authorities get a clear picture of those who enter the world of bitcoin through these points. With prohibition, all this knowledge would be lost. Banning bitcoin is completely pointless, it would mostly have disadvantages. It is not a coincidence that it has still not happened.
An open book
To top it all, bitcoin has a weakness that authorities are particularly fond of. The whole blockchain is public, one can pinpoint when and how much was transacted from where to where. Even though theoretically it cannot be known which wallet corresponds to whom, authorities have plenty of information available to identify the owners if they really want to. Blockchain analysis helps tracking the flow of funds if they suspect that certain transactions are associated with crime. For example, by following the money they can find the financiers of terrorism. They stand no chance in doing so if the financing happens as it usually does — in cash.
On another note, this is why criminals and terrorists do not really like bitcoin. It is yet another reason why the prohibition that focuses on them is pointless. Those who are up to no good rather use privacy coins such as monero or zcash. These have their public blockchains as well, but they are smartly built such that the details of transactions cannot be seen. If states really want to do something, they would rather ban these. Though this would also achieve little good, since the networks and the encrypted transactions would continue to work unaffected after the ban.
Regulation in sight
Finally, let me mention that I am most certainly not the only one who went through the above thought process. In September, the European Commission announced that it is preparing a comprehensive crypto asset regulation. Awaiting discussion, the detailed 168-page bill is available as “Markets in Crypto-assets” (MiCA) among the EU’s law making proposals. It formulates four main goals: ending the legal uncertainty around crypto assets, assisting innovation, protecting investors and promoting financial stability. MiCA will do for the cryptocurrency markets what the current MiFID II directive does for regulating the markets of traditional assets.
At the slow pace of the EU’s legislative process, approval and finalization of the bill is expected to take a few years. But even with that, the importance of these news is hard to overestimate. The proposed directive is sound proof of the legislative intent that authorities want to regulate bitcoin, not ban it.