July 20, 2019

Bitcoin: Regulation & The Domino Theory

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With Bitcoin – a currency, a commodity, digital gold, or all of the above – set to be regulated by the highest levels of monetary authority, the question is whether there will be a Domino effect among nation-states trying to regulate a stateless, decentralized asset?

For the first time in history, we have seen Bitcoin propelled into the mainstream Finance media thanks to Trump Tweets, Libra testimony, and some cheeky commentary about #shitcoins.

While there is clearly a need for regulatory clarity, a crackdown on fraud and money laundering and better cross-border governance, one thing is clear – the genie is out of the bottle, Bitcoin will be very difficult to stop.

Many emerging markets have already tried to outright ban Bitcoin. While it appears that some Western nations may try and outlaw the world’s first decentralized digital currency, there is little evidence that a ban or extreme censorship would actually work. As @PatrickMcHenry points out, even authoritarian countries that have tried to outright ban Bitcoin have been unable to actually ‘kill Bitcoin’ within their respective borders.

However, if Bitcoin does become mainstream and reach ‘escape velocity,’ will some nations attempt to outlaw it, or even worse, seize it the way the US did with Gold in 1933? via Executive Order 6102

Before getting into a series of scenarios around heavy-handed regulations and asset seizure, let’s first understand what Bitcoin is and why it works.

Why Does Bitcoin Work and Who Is Using It?

Bitcoin is a decentralized, stateless digital currency with a fixed supply of 21 million Bitcoin, released algorithmically over time (99% will be mined by 2032). There is no central party that can control who owns Bitcoin or how much they own; miners are incentivized (via Block Rewards) to secure the network and validate ‘blocks,’ a series of timestamped, immutable transactions that are published on the blockchain permanently. Bitcoin is pseudonymous, not anonymous, meaning that sophisticated tracking tools can be used to find out who bought, sold or transferred Bitcoin.

As we wrote in our analysis of the Bitcoin Standard, Bitcoin is essentially a “modern experiment in Austrian economics:”

“A large part of Bitcoin’s value, at least for Maximalists, is attributed to the cryptocurrency’s scarcity and the embedded philosophical principles of Austrian economics.  Many attribute a currency’s value mainly to its backing by the State, and the acceptance of it by all entities within the State as legal tender; yet we have seen in the history laid out above that this doesn’t always correlate to a strong currency that holds its value over time.”

Cryptocurrency – The Bitcoin Standard

It’s the last part that is relevant to why Bitcoin works. Its usage and popularity are NOT (yet) seen in Western countries like the US and Europe because on a relative basis their respective fiat currencies do not experience rapid inflation or politically-motivated seizures.

But recent events in countries like Venezuela et al, where their fiat-backed currencies have gone through massive devaluations due to hyper-inflation, demonstrate a need for an anti-inflationary currency like Bitcoin. Most recently, Argentina has seen an uptick in Bitcoin usage due to the rampant inflation of the Peso:

Therefore, the idea that Bitcoin will compete with the US Dollar and other Western Government currencies is far-fetched. But in nations dealing with unpayable debt loads, hyper-inflating currencies, and/or excessive taxation, Bitcoin becomes an asset with utility.

Much has been made about Bitcoin’s usage for nefarious purposes and fraud; however, the devil is always in the details. With US Fed Chair Jerome Powell admitting Bitcoin is a ‘speculative Store of Value‘ comparable to Gold, it’s easy to see how individuals on both sides of the coin – both honest citizens and criminals – would be able to use Bitcoin.

While it’s clearly unlikely that we will return to a Gold Standard in the short-term, there exists a ‘Paradigm Shift‘ where both investors and individuals in nations around the world are starting to question the future in nations where Central Banks continue to print money and citizens continue to increase debt loads. Given a consensus view that Bitcoin is a stateless Store of Value (SoV), it appears that the key is to regulate fraudsters out of Bitcoin rather than regulate Bitcoin out of the market.

What If, Regulatory Regimes and the Domino Theory of Bitcoin?

What if, however, a Western nation does decide they want to ‘shut it down’ and try to kill Bitcoin in their local market?

Given that Bitcoin is an asset with a market cap of ~$200bn USD, it’s easy to see how ‘one man’s trash is another man’s treasure.‘ Both Bitcoin talent and those with significant holdings will move to jurisdictions that have a clear regulatory framework for digital currencies. Heavy-handed regulations in another major nation would immediately create economic and social incentives to move any other developed nation with regulatory clarity.

As Bitcoin is technically a politically-neutral asset – there is no central authority with the ability to seize wallets or censor transactions – it would be extremely difficult to ‘kill Bitcoin,’ even if the cross-border political will is there.

Then there is the Central Bank question. In an era where Central Banks are slashing interest rates and printing money with no end in sight, what happens if any major nation’s Central Bank decides to buy a large quantity of ‘Digital Gold?’

At this point, the asset has ‘value’ in the global marketplace, since the buyer would become a fiat-based counterparty with an incentive to see Bitcoin succeed. Without getting into complex economic or game theories, it’s easy to see how even one Central Bank buying Bitcoin creates a ‘Put’ under the market and effectively underwrites its value as a global SoV.

This is the Domino Theory in action. If one nation bans it, another will accept it. If one Central Bank calls it a fraud with no value, another will buy it and give it value. The decentralized, stateless nature of the asset makes it difficult to shut down for purely political reasons, as there is no CEO to subpoena or Corporation to press charges against.

All combined, it looks like we are in for a regulatory crackdown across the Bitcoin world in the short-term, but in the long-term, it looks like Bitcoin will be here to stay and create entirely new business models and economic possibilities for individuals and nation-states alike.

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