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Bitcoins: A Triumph or Disaster of the Modern Age?

About The Author

Chris Bridges (Executive Editor)

Chris is an IT and Data Protection solicitor at a top 20 full service firm and the founder of Keep Calm Talk Law. He also contributes to Computers and Law and other sector specific publications.

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The Bitcoin, a digital currency that is quickly growing in popularity, reached an all-time high value against the US Dollar at the end of last month, hitting a maximum price of $1,250, when a year before one Bitcoin was worth a mere $10.

However, the Bitcoin has attracted a great deal of criticism from around the globe, creating deep divides in opinion. There are great concerns about not only its volatility, but also the problems it creates for criminal law enforcement and the collection of tax.

What are Bitcoins and how do they work?

For readers that are unaware of what a Bitcoin is, or for those with a limited understanding of the Bitcoin, I shall attempt to give a brief description of this hugely complicated digital currency, how it was created, how it continues to exist, and how it is secure. If you have no interest in how they work, skip to the next section ‘The Problems’ and take it as a given that: the Bitcoin is run by no one, involve direct transactions, transactions are free and secure, the currency is impenetrable and virtually impossible to counterfeit.

Bitcoins are in essence encrypted files that can be verified as a unique Bitcoin. Furthermore, they can be transferred anonymously and directly to anyone with a ‘Bitcoin wallet’, which can be created free. Wallets can be thought of like bank accounts, but these ‘bank accounts’ are entirely anonymous – there is no easy way to determine the identity of the owner. However, unlike money held in a bank account, nobody holds a cash equivalent.

I must stress that it is not simply ‘online credit’ as you might have at Paypal, or even in the form of ‘digital pounds’ that show up I your online bank account. The Bitcoin is much closer to a currency in its own right than these. It is traded, like a traditional currency, on numerous broking websites that act like a traditional currency exchange. However, unlike a typical currency, the Bitcoin is not controlled by any government or financial institution, in fact, somewhat surprisingly; the Bitcoin is controlled by nobody.

The Bitcoin was developed by a Japanese man under the alias ‘Satoshi Nakomoto’, who has never revealed his identity, and has completely withdrawn his involvement in the Bitcoin network. He pressed the start button, and disappeared.

You may wonder how this is possible, who exactly is running it if not him? Bitcoins can in theory be created by anyone with a computer, by a process that has come to be known as ‘mining’. The Bitcoin is able to exist by means of a vast peer-to-peer network (a computer-to-computer network, with no server in between, much like torrents and other file sharing protocols). To create Bitcoins, a computer must make thousands of complex mathematical calculations, in a race to find the next ‘piece to the jigsaw’. The first computer to do so is rewarded with a certain amount of Bitcoins (originally 50, now 25 – the amount automatically halves every 4 years, an inbuilt protection against over saturation). For a more in depth visualisation of the Bitcoin process, please visit this flowchart, although even this is hard to follow if you are not technically minded!

However, this is not as easy a $1,000 as you make think. With each successful piece to the puzzle added, the puzzle becomes more complicated, requiring more computer power. The puzzle has become so complex now, that it would likely take a standard home computer more than 10 years to solve, and vastly more than the value of the Bitcoins in electricity bills. Energy efficient and extremely powerfully specially designed processors worth tens of thousands of dollars are now required to have any chance at making a profit. Sorry to let you down!

Without going into technical details, it is virtually impossible for Bitcoins to be duplicated or counterfeited, as every transaction is encrypted into the puzzle each time the puzzle is solved. To work backwards would essentially be impossible, requiring infinitely more computer power than the process to solve the puzzle. Due to the puzzle becomes more complicated as more pieces are added, at a much faster rate than computers are ever likely to develop, it will likely be forever impossible to unravel the puzzle.

The Problem

This currency may seem somewhat ideal, run by no one (therefore no bank to mistrust), direct transactions (again, no one to mistrust), free and instant transactions, impenetrable and impossible to counterfeit. So what is everyone’s problem with this seemingly perfect currency? The problems can be boiled down to two categories – the volatility of the currency and it being virtually impossible to trace, making it perfect for tax evasion, money laundering and other criminal activities.

Volatility

Whilst not a legal problem, it is nonetheless a problem for individuals and businesses alike. Towards the end of November, the Bitcoin reached a value of $1,250. On Wednesday, just three weeks later, the Bitcoin was worth a fraction of this, at only $421. While this may still be by far the most valuable unit of currency in the world, this volatility makes the currency almost worthless in terms of utility.

Admittedly, the Bitcoin is going through a particularly turbulent time, where speculation is rife. On Wednesday the price plummeted due to indications that the Chinese government were making moves to restrict the currency’s use. The price spike in late November was caused by a US Senate Committee hearing with a more positive outlook of the currency, with the justice department dubbing virtual currencies as “legitimate financial services” which “have the potential to promote more efficient global commerce”.

Whether a particularly turbulent time or not, this demonstrates just how volatile a currency it can be. Whilst some major companies such as Virgin Galactic (Virgin’s space travel arm) have announced they will accept Bitcoins to pay for space flights, it seems doubtful many will follow suit. With such drastic changes in value, retailers could make huge loses on even the smallest of goods. The currency simply lacks the certainty required to make it a feasible option. In doing so, retailers would be speculating themselves, which when trying to make accounts balance, does not do any favours.

As for individuals, would you spend your Bitcoins knowing that in a few weeks time they would be worth nearly three times as much? On the other hand, would you hold onto your Bitcoins for long if you knew in three weeks they would be worth three times less?

Until this volatility diminishes, it is hard to see Bitcoins replacing hard currency, and without a financial institution controlling the currency, it seems unlikely this will ever be the case.

Criminal Activity & Tax Evasion

Whilst the anonymity of Bitcoins may be an advantage in some ways, it also opens an array of legal problems, causing a headache for both law enforcers and tax collectors. Back in October, the American website ‘Silk Road’ was shutdown, having succeeded to operate for several years. If you have not heard of the website, it was essentially an Amazon Marketplace for controlled substances. Users could buy and sell drugs, using Bitcoins as tender.

If the users had been using debit or credit cards to pay for drugs, law enforcement could easily have traced the transactions and arrested the suspects. With Bitcoins, this was impossible. Whilst in theory it would be possible to trace the source of payments by following the IP address trail of the Bitcoins used, these would often change hands so many times it would be incredibly difficult to conclusively proof anything, and besides, for anyone knowing what they are doing, IP addresses are not very hard to spoof.

To make this even more aggravating for law enforcement, every single Bitcoin transaction is in plain sight. The lack of identifying information means every single transaction can safely be published for the world to see, and some websites do just this, such as blockchain.info. Illegal transactions are right before their eyes, and yet they are powerless to do anything about it.

This anonymous payment method could be used, and probably has been used in numerous other criminal ways, from money laundering to payment for assassinations. This is clearly undesirable, and allows criminality to thrive.

The same principal applies to tax evasion. As a Bitcoin cannot be identified to a person as a bank account could, it would be all too easy for a person to conceal vast quantities of wealth from HMRC, the IRS, or any other national tax agency. The tax policing of the Bitcoin therefore relies on self-reporting. Whilst the non-payment of tax would still be illegal and punishable, it would be almost impossible to trace such assets, greatly decreasing the chances of a successful prosecution.

This is of course not to say all businesses using Bitcoins are using them for illegitimate purposes. Many, if not most, Bitcoins are likely used for perfectly legitimate purposes by legitimate individuals and businesses. In fact, one UK based Bitcoin start-up has decided to operate within money laundering compliance regulations, such as the ‘know your customer’ procedures, despite being un-obliged to do so.

You may ask, so why not just regulate the usage of Bitcoins, and shutdown website using the payment method for illicit purposes, as the FBI did Silk Road?

As there is no financial institution operating the currency, and there is no way to manipulate it once it has started, there is no way for governments to regulate it at the source. Nor can the currency simply be blocked as China has blocked many websites due the peer-to-peer nature of the Bitcoin network. Yes, they could illegalise the usage of Bitcoins, but as they are anonymous, would this really prevent their usage? Moreover, while government agencies can take down websites that use the currency for illegal activities, Bitcoins can be used offline for direct payments. Payments can be made by phone simply by scanning a barcode associated with somebody else’s wallet.

Therefore, the only way to control the usage of Bitcoins would be to pinch it so hard via other means that it is no longer a useful form of barter. This could include the blocking of Bitcoin exchange websites that allow users to sell their Bitcoins for hard currency, or it could include regulating businesses that accept Bitcoins by requiring them to take identification details, which would aid law enforcers in finding illicit users (but by no means would this make it easy). None of these things would however eradicate usage. There will always likely be countries that leave usage unregulated. Bitcoins could be anonymously siphoned off to these countries and exchanged for hard currency or goods.

Is this a desirable outcome?

I would suggest not. I am a great enthusiast for innovation, and wholeheartedly support new technologies such as the Bitcoin. However, I also understand that in its current form, it has the potential to be incredibly damaging due to its utility to criminals and tax evaders, and is of little commercial use due to its volatility. In this sense, the Bitcoin is a disaster of the modern age.

I find it a great shame that the illusive creator of Bitcoin, whoever he is, decided to adopt the principles he did. Whilst an anonymous form of currency is a nice thought, it was always going to have issues down the line. If he had built in a way of allowing enforcement agencies to trace transactions, it would not be subject to half the criticism it is under, and it really could be a widely used currency of the future. This however undermined his ethos. Other virtual currencies do exist but experience similar drawbacks and have not been as widely adopted as the Bitcoin.

Therefore, I hope another virtual currency that is perhaps more ‘responsible’ in its design comes to prominence shortly. Virtual currency has the potential to drive business forward. If a virtual currency were to take off in an easily regulated form, I believe it would be looked back on as an innovation of the century. It allows borderless transactions at a very low cost, is extremely accessible and does not require us to invest our trust in anybody else.

I believe the biggest impact it would have, at least to begin with, would be on start-up businesses that cannot afford credit and debit card fees. In an increasingly modern age, cash is becoming outdated, and many shops may be prevented from operating due the expense of card transactions. You may have heard stories of many start-ups using Bitcoins for exactly this purpose.

If virtual currencies are not permitted to become a private enterprise, I believe the Bitcoin demonstrates that virtual currency can be secure, and may very well have laid the building blocks for the future of country-backed currency. Most things are becoming paperless, so why should currency be left behind?

Whilst this may damage the banking industry (reducing the need for a current account), other financial services would still be required. People would still need savings accounts, and people would still need credit (whether in the form of a mortgage or credit card). This may be just what the banking industry needs. Many argue the banking industry is dusty and lacks innovation. This is perhaps somewhat unsurprising when Metro Bank was the first new bank to be granted a full banking licence in over 100 years back in 2010.

Even if the Bitcoin does have a bleak future, it has opened doors and helped pave the way to a currency revolution. This revolution may not come in the immediate future, but I believe it is surely coming within my lifetime. In this respect, the Bitcoin is a triumph of the modern age, even if it may be forgotten in the wake of what it creates.

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Tagged: Commercial Law, Criminal Law, Tax Law, Technology

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