Lentis/Cryptocurrency

< Lentis

Overview

Cryptocurrencies are electronic currencies that operate in a cryptographically-secure network. Their distributed, peer-to-peer model and and low transaction fees allow individuals to transfer funds directly between each other, reducing the need for central third-party institutions in the financial system (e.g., the Federal Reserve). Their novel operating model has attracted attention from individuals, governments, academics, and industry. However, cryptocurrencies have created friction with regulatory institutions because user's anonymity is secure on the network, making it easy for criminals to conduct operations or launder money. Like any currency, adoption depends on people's acceptance of them as payment.

Bitcoin

There are hundreds of cryptocurrencies in existence today, a handful of which are valuable[1]. Bitcoin is the first, most valuable, and most popular cryptocurrency. A single Bitcoin has ranged in price from as little as a nickel to peaking over $1100[2].

Created in 2008 by Satoshi Nakamoto on the P2P Foundation's forums, it was initially used by a niche group of cyber-security and computer-network enthusiasts[3][4]. Satoshi Nakamoto is a pseudonym, and the real Satoshi may be a male, female, or group of software developers. Regardless, building the Bitcoin system required expert knowledge in peer-to-peer networks, economics, and software development. Various attempts by journalists to unveil Satoshi's true identity have failed[5][6].

At a high-level, Bitcoin can be thought of as a large accounting ledger that volunteers monitor for accuracy. The ledger is encrypted, to prevent altering transaction logs. For more information on the technical details, see Satoshi's paper[3].

Bitcoin can be acquired either through a currency exchange or through mining. Mining is the process where a person volunteers their computing resources to verify previous transactions and encrypt new ones. The first computer to encrypt a new block of transactions is rewarded with newly minted Bitcoins.

Bitcoin will be the focus of this article, as there is a plethora of information on it and its discussion relates to all cryptocurrencies.

Interested Parties

IMF

Though the IMF currently takes no action to directly regulate cryptocurrencies, they have publicized their thoughts on them. In a 2014 draft on monetary and financial statistics, the IMF did not recognize Bitcoin as a currency, stating, "Bitcoin also does not meet the definition of a currency."[7] Similarly, when asked about the disruptive potential of cryptocurrencies in a 2014 interview, Christine Lagarde (Managing Director) said "To have alternative monetary systems in place is only acceptable provided that there is enough scrutiny, enough transparency, enough governance, so that those key obstacles are avoided."[8]. As cryptocurrency adoption grows, the IMF may employ more regulations to counter their concerns.

IRS

According to tax guidelines released in early 2014, the IRS treats virtual currencies as property and subjects it to capital gains taxes[9][10]. In doing so, the IRS has laid the groundwork to regulate virtual currencies. As one of the key agencies involved against tax evasion and money laundering techniques, the IRS supports regulation as a tool to protect against criminal activity.

Banks

Banks are largely skeptical of supporting cryptocurrencies because of the risks they must take on. Cryptocurrencies are lightly regulated by governments, so the cost of doing the regulation falls on banks as they must meet their own regulatory standards. Given the use of cryptocurrencies for criminal activities (e.g., money laundering), the risks and costs for performing such regulation are high[11]. Moreover, Bitcoin's low transaction fees contrast to the higher fees charged by banks, increasing competition between the two[3].

Rabobank

Some international banks such as the Dutch Rabobank have taken more extreme measures to fight back against Bitcoin users. Experts monitoring exchanges were able to cancel customer transactions involving bitcoins before they were able to be completed.[12] Customers were not explicitly told that the reason that their transactions were failing because of the involvement with cryptocurrencies; rather they were given messages involving incorrect errors that they were unable to fix, even after calling to ensure that the transactions they were making were legitimate[13] Rabobank has not released a statement on these actions, but the ethical and legal repercussions are still a major source of contention for all involved parties. More legislation will likely be needed for Bitcoin in order to set standards for modern banking systems to deal with cryptocurrency.

Bitcoin Foundation

One major example of a reputable company in favor of a growing cryptocurrency market is the Bitcoin Foundation, whose main goals are to standardize, protect, and promote Bitcoins[14] They openly state in their mission statements that Bitcoins are only as valuable as the code behind them, and they recognize the need to keep an emphasis on cryptography in order to make this cryptocurrency more accessible and safe for customers. They are in favor of less regulation because they wish to shift control from banks to consumers, and they organize lobbying efforts to reach this goal.[15]. The Bitcoin Foundation does not want Bitcoin spending to be completely uncontrolled, but they advocate more research and understanding by legislators before any major laws are passed concerning regulation.

Silk Road Users

Because Bitcoins are directly transferred from person to person without any regulation from a bank or trail indicating where the money was spent, they are ideal for criminals to use for buying illegal goods online. The Silk Road was an online black market part of the Deep Web, and customers could spend Bitcoins on whatever goods they found.[16] Once the Silk Road became more popular among customers, the Drug Enforcement Administration and Department of Justice were called upon to shut down the site. [17] This led to the eventual arrest of Ross William Ulbricht, the alleged owner of the site, and the website being seized by the FBI.[18][19] Since then, the Silk Road 2.0 has also sprung up and been shut down by the government, and any bitcoins seized on the sites were auctioned off by the United States government at extremely low prices relative to the average Bitcoin value at the time.[20][21]

Interesting Examples of Bitcoin Usage

Kristopher Koch's Massive Windfall

In 2009, Kristopher Koch purchased $26.60 worth of Bitcoins while studying cryptocurrency for his thesis paper. He stored the private keys for these coins on his local computer and forgot about them for years. In the media frenzy surrounding Bitcoins during April 2013, he checked the value of his Bitcoins just to see if they were still worth any money. To his surprise, Koch discovered that his purchase was now worth over $886,000. He waited until the price of Bitcoins on the ever-changing market went up a little more, then sold them all to purchase a new apartment.[22][23] This kind of gain is not typical for all Bitcoin investors; however it is an example of both how the market for Bitcoins is growing and how average people can stand to gain a great deal if they are willing to take the risk that Koch did.

James Howell's Huge Loss

When James Howell purchased 7,500 Bitcoins in 2009 he chose to store them on his local computer rather than storing them in an online wallet such as MultiBit[24] in order to keep his money safe from outside intruders such as hackers. Howell unfortunately then spilled lemonade on his laptop computer and mistakenly threw away the entire machine without removing the hard drive storing the BitCoins first. Once he realized his mistake, the hard drive was already deep in a landfill somewhere in Wales, and there was no chance of him recovering it without first investing more money into retrieval techniques. Howell has calculated the value of his Bitcoins since he lost them and estimates that he lost somewhere around $7.5 million due to one crucial error.[25][26] Despite this major loss, Howells has remained a very vocal supporter of Bitcoins and maintains his beliefs that cryptocurrency will soon be the funds that all business transactions occur will use in the future.

The Currency Market as a Zero-Sum Game

Zero-Sum Games

Banks and cryptocurrency supporters can be seen as competing for the same space in the financial market. In economics, game theory is used to define the “game” in which parties compete. Games are classified as either zero-sum or non-zero-sum games. In zero-sum games, the gains of one participant are balanced exactly by the total losses of other participants; the amount of whatever is being played for stays constant.[27] In non-zero-sum games, participants’ gains and losses do not have to be balanced by those of other participants. As such, there is a possibility that the actions of one participant can be for the mutual benefit of all participants (the “win-win” situation). Zero-sum games have been used to define many social systems. Professor John Mearsheimer views international power as a zero-sum game. Mearsheimer writes, “any country that improves its position in the global balance of power does so at the expense of other states, which lose relative power.”[28]

If participant groups view the currency sector of the financial market as a zero-sum game, then it will directly influence their actions. In fact, some of the actions and words from participants would indicate that they have adopted a zero-sum mentality. Clearly, the banks that are currently shutting down accounts of Bitcoin users such as Wells Fargo and Rabobank would indicate that banks are fearful of the growing influence of these virtual currencies. Yves Mersch, a member of the executive board of the European Central Bank stated “Euro banknotes and coins are a method of payment of stable value, acceptance of which is compulsory, and thus they are superior to alternative methods of payment. Of these, I would like to mention…virtual money.”[29] Rather than trying to incorporate virtual currencies, banking institutions are trying to undermine them while propping up traditional currencies.

The Role of Regulators

The examples of users losing large sums of money and assets being seized by banks illustrate that a lack of regulations creates an environment in which no legal recourse can be taken by those who have felt they have been wronged. Regulators, though, have yet to respond in full to the rise of virtual currencies as seen through the inaction of groups such as the IMF and Federal Reserve. If the currency market is truly a zero-sum game, this proposes a unique problem for regulators. By nature of the game, any action taken by regulators will either help or harm any parties involved. Thus, when crafting regulations, these organizations must consider the nature of the market and the impact of their actions on the parties involved.

References

  1. ↑ "Cryptocoin World", com-http, Retrieved 7 December 2014.
  2. ↑ Bitcoin Price Index - Real-time Bitcoin Price Charts, Coindesk, Retrieved 7 December 2014
  3. 1 2 3 Nakamoto, Satoshi. Bitcoin: A Peer-to-Peer Electronic Cash System, bitcoin.org. October 2008. Retrieved 8 December 2014.
  4. ↑ Bitcoin open source implementation of P2P currency - P2P Foundation, P2P_Foundation. February 2009. Retrieved 7 December 2014.
  5. ↑ Goodman, Leah M. The Face Behind Bitcoin, Newsweek. 6 March 2014. Retrieved 7 December 2014.
  6. ↑ Penenberg, Adam L. The Bitcoin Crypto-Currency Mystery Reopened, Fast Company. 11 October 2011. Retrieved 7 December 2014.
  7. ↑ Classification of Financial Assets and Liabilities, International Monetary Fund. 26 June 2014. Retrieved 7 December 2014.
  8. ↑ Q&A - An Audience With Christine Lagarde, YouTube. 20 February 2014. Retrieved 7 December 2014.
  9. ↑ IRS Virtual Currency Guidance, Internal Revenue Service. 25 March 2014. Retrieved 7 December 2014.
  10. ↑ IRS Notice 2014-21, Internal Revenue Service. 25 March 2014. Retrieved December 7 2014.
  11. ↑ Dougherty, Carter. Bankers Balking at Bitcoin in U.S. as Real-World Obstacles Mount, Bloomberg. 5 December 2013. Retrieved 7 December 2014.
  12. ↑ [ http://www.nu.nl/internet/3634064/rabobank-klanten-kunnen-lange-tijd-geen-bitcoins-kopen.html Rabobank-klanten kunnen lange tijd geen bitcoins kopen], Sanoma Digital The Netherlands B.V. NU. 20 Nov 2013. Retrieved 8 Dec 2014.
  13. ↑ van der Chijs, Marc Dutch Bank Rabobank is Blocking Customers from Buying Bitcoins, CoinDesk. 21 Nov 2013. Retrieved 8 Dec 2014.
  14. ↑ Overview of Bitcoin Foundation Goals, Bitcoin Foundation. Retrieved 8 December 2014
  15. ↑ Sidel, Robin. Bitcoin Foundation to Ramp Up Lobbying Efforts, The Wall Street Journal. 11 March 2014. Retrieved 8 December 2014.
  16. ↑ Beal, Vangie Silk Road, Webopedia. 2014. Retrieved 8 Dec 2014.
  17. ↑ Schumer Pushes to Shut Down Online Drug Marketplace, NBC New York. 5 Jun 2011. Retrieved 8 Dec 2014.
  18. ↑ FBI Shuts Down Black Market Website ‘Silk Road’, US News & World Report. 6 Nov 2014. Retrieved 8 Dec 2014.
  19. ↑ Neuman, Scott FBI Arrests Alleged Owner Of 'Silk Road' Black Market Site, Natioal Public Radio. 2 Oct 2013. Retrieved 8 Dec 2014.
  20. ↑ Lawrence, Dune Silk Road 2.0 Shut Down by FBI, Just Like Its Black Market Predecessor, Business Week. 6 Nov 2014. Retrieved 8 Dec 2014.
  21. ↑ Lorenzetti, Laura Bitcoin seized from Silk Road on offer in a second auction, Fortune. 4 Dec 2014. Retrieved 8 Dec 2014.
  22. ↑ Gibbs, Samuel Man buys $27 of bitcoin, forgets about them, finds they're now worth $886k, The Guardian. 29 Oct 2013. Retrieved 8 Dec 2014.
  23. ↑ Loritzen, Fredrik Kjøpte leilighet for internettpenger, NRK. 25 Oct 2013. Retrieved 8 Dec 2014.
  24. ↑ https://multibit.org/
  25. ↑ Man Throws Away 7,500 Bitcoins, Now Worth $7.5 Million, CBS Local. 29 Nov 2013. Retrieved 8 Dec 2014.
  26. ↑ Hern, Alex Missing: hard drive containing Bitcoins worth £4m in Newport landfill site, The Guardian. 27 Nov 2013. Retrieved 8 Dec 2014.
  27. ↑ Ken Binmore (2007). Playing for real: a text on game theory. Oxford University Press US. ISBN 978-0-19-530057-4., chapters 1 & 7
  28. ↑ John J. Mearsheimer, "Structural Realism," in Tim Dunne, Milja Kurki, and Steve Smith, eds., International Relations Theories: Discipline and Diversity, 3rd Edition (Oxford: Oxford University Press, 2013), pp. 77-93.
  29. ↑ Mersch, Y. (2014, May 19). Euro banknotes – a means of payment recognised worldwide. Retrieved December 10, 2014
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