Bitcoin is getting hammered today. The Caixin website says it has seen the draft of a Chinese central bank ruling that would require banks and payment service providers to stop dealing in Bitcoin as of April 15. The implications:
This means people will only be able to use cash to buy bitcoins, an analyst who has been following the matter said, and will force all trading websites in the country to close…
The requirement, which Caixin saw in a document the central bank’s headquarters recently sent to regional offices, says money can be taken from the accounts before the deadline, but no deposits can be made. Banks that fail to close the accounts will be punished, the PBOC said, but it did not elaborate on what those punishments would be.
And notice how the thinking of the Chinese authorities is similar to that of their counterparts in Japan and the US, albeit even more forceful:
The circular said bitcoins are a commodity, not a currency. It added that investors are free to trade in bitcoins at their own risk, but should know they cannot be used as legal tender.
This would be a serious blow, since roughly 60% of global Bitcoin trading occurs in China. Bitcoin prices fell by almost 10% today.
Separately, Bitcoin enthusiasts seem not to have grasped the implications of the IRS notice in the US on the status of Bitcoin. As we predicted, the IRS has deemed it to be property, which means that Bitcoin mining will be subject to income taxes. While Bitcoin may be viable as a speculative vehicle, this ruling will make it impractical to use it in commerce. I spoke about the record-keeping and reporting burdens, since any end user who holds Bitcoin will be subject to short or long-term capital gains treatment when he cashes in his Bitcoin for stuff or services. I may have done readers a disservice by not spelling out in more detail what that means in practical terms. Georgetown law professor, at the Credit Slips blog, filled in that gap:
For a payments geek, the real lesson from the IRS Bitcoin ruling is that for a currency–or any payment system–to work, its units must be completely fungible. One reason dollars work really well as a currency is that one $20 bill is entirely fungible with another $20 bill. This means that when I pay, I don’t have to make a decision about which $20 bill to use (unless I have some idiosyncratic attachment to the crisp ones or the like). It means that when I accept a payment, I don’t care which $20 bill I am given, in part because I know that my ability to spend that $20 bill will not depend on which $20 bill it is. If payment were in, say, camels, then it would probably matter a great deal which camel were tendered. Camels aren’t fungible. And we know that’s not going to make for a very good payment system.
So what does this have to do with Bitcoin?
The IRS ruled that Bitcoin and other virtual currencies are property, not currency. This means that they are subject to capital gains taxation. And that means that Bitcoins are not fungible. The price at which a particular Bitcoin was acquired (and this is traceable) determines the capital gains on that particular Bitcoin when spent. If I spend Bitcoin A, which I bought at $10, but is now worth $400, I’ve got a very different tax treatment than if I spend Bitcoin B, which I bought at $390. (Poor Satoshi–he’s got a lot more capital gains than most…) This means Bitcoins are not fungible, and that makes it unworkable as a currency. If I have to figure out which particular Bitcoin in my wallet I want to spend and what the tax treatment will be, Bitcoin just doesn’t work as a commercial medium of exchange. Bitcoin still works as a speculative medium, but Bitcoin’s claim has always been to being more than the latest iteration of the trading sardines–it aspired to be a commercial medium. I don’t see that happening now.
And despite the confidence of Bitcoin enthusiasts in the technology, the Mt Gox bankruptcy revealed a significant flaw, that of “transaction malleability” and cloning. In simple terms, a peer-to-peer network supposedly tracks a public ledger of Bitcoin transactions. But the bugs apparently have not been worked out (I have this from a writer working on a story. Intuitively, you can see how this would be easily done on via a central ledger; a distributed ledger adds complexity and hence the potential for mischief). Transactions can be both cloned and hidden from the network. While the core developers have been working on a fix, one can see that this could easily become an arms race, not just in terms of technology but conceivably speed. If so, the continuing effort to keep ahead of fraudsters will not just add to perceived risks (for mere mortal users) but also to the costs of active market participants like exchange operators.
So I remain baffled as to the hooplah about Bitcoin. It is not a replacement for currency. Building out the infrastructure for it to be a grown-up payments system would involve all sorts of investment by parties expecting to make a profit (did you miss how Silicon Valley is salivating about the potential of Bitcoin-related services). Its cost advantage over current payment mechanisms rests solely on the fact that it is now begin done on a hobbyist basis. Add all the overhead, and a profit motive, and any fee reductions to merchants were likely to be thin even before the IRS designation made Bitcoin use in commerce extremely cumbersome. Sure, it may be an interesting speculative medium, but if you want to gamble, Vegas is a lot more fun.
This piece is cross-posted from Naked Capitalism with permission.