Bitcoin and other crypto-currencies (secret currencies) are getting a lot of airtime and being considered with seriousness, for example at HM Treasury, for inclusion in or coalescence with the traditional payments eco-system.
HM Treasury launched a Call for Information on Digital Currencies and is now digesting the results. The watchwords at HMT are echoed at the new UK Payment Systems Regulator:
• Access for new entrants
• Reduction of the market power of the vertically-integrated incumbents – the big banks
This has to be seen as part-and-parcel of the banking reforms based on Vickers Report and Changing Banking for Good. The UK government has encouraged the emergence of a London-based FinTech market, with all manner of incubators and venture funds trying to get a piece of the action on two distinct sides of the fence, in the EU at any rate:
• Start-ups that will register as Payment Institutions, or eMoney Institutions, or even as ‘Challenger’ banks if they are large and diverse enough
• Bitcoin and crypto-currency companies that appear to be intent on steering around the regulatory regime
Since the Call for Information was launched, however, the prices of bitcoin have fallen as have volumes traded, and there are fresh concerns over the fate of funds deposited with exchange operator Bitstamp, which has suspended services over a possible compromise of its ‘hot wallet’.
The company, which initially took over the mantle of the world’s biggest USD Bitcoin exchange following the scandal-ridden demise of Mt Gox, has ceased all withdrawals and warned customers not to make any fresh deposits while it investigates the problems.
These problems seem to underpin the position-takings of influential regulatory bodies in 2014, which have a direction of travel exactly opposing the apparent enthusiasm at HMT. This should be concerning for the market participants, regulators and supervisors on the traditional side. Financial Action Taskforce – in its June 2014 paper on definitions and AML risks – and the European Banking Authority – in its July 2014 ‘Opinion on virtual currencies’ – have made their positions clear: crypto-currencies have no validity and are a channel for money laundering, illicit financing, and tax evasion.
Crypto-currency cannot be ‘money’ in the accepted sense. It is not a fiat currency issued by a national government and backed by the full faith and credit of its taxpayers. It cannot be legal tender as the designation thereof is another power reserved to national governments or associations of national governments (in the case of the euro).
It is ‘mined’ (i.e. manufactured) via computer algorithms and the difficulty of mining is supposed to limit supply, and where there is limited supply and significant demand, the price should go up. FATF and EBA have a very clear picture of where the demand is coming from.
The US Department of Justice has designated it as ‘goods’: if that treatment is replicated in the UK and the rest of the EU, then all exchanges involving bitcoins are sales by the giver, and subject to the VAT regime, including – for businesses – adding VAT to a bitcoin payment you are making, if you are VAT-registered. Since bitcoin is secret, do you even know who you are trading with, what VAT should be added, what you should put in your EU Sales List?
As regards accounting, should payments made with bitcoin be added to ‘Cost of Goods Sold’, and payments received added to ‘Sales’? In other words payments for sales and costs are themselves costs and sales i.e. a payment with bitcoin is a barter.
What about the valuation of bitcoin owned if it rises or falls? Are such profits taxable and any losses tax-deductible? Here we need the Inland Revenue to make a statement.
And what does an ‘owner’ of bitcoin own actually – shares, an account balance, an investment?
Who is behind a crypto-currency and what claim does the owner have on the sponsor or any assets that were purchased with the real money that the owner parted company with? What about transparency of pricing, certainty of delivery, and recourse to a lifeboat fund if a bitcoin ‘deposit’ goes bad or disappears?
It would appear that all of these characteristics are absent.
An “investor” is meant to have confidence that, because it is very difficult to “mine” bitcoin, the supply will remain limited and so the price will be supported. It is correspondingly difficult to have confidence in this line of argumentation when:
• Moore’s law on the increase on computing power pertains
• There are 6 billion people on the earth and a large fraction have access to a computer and to the internet
• The recent hacking of SONY around the film “The Interview” demonstrates the degree of ingenuity that exists to bypass any supposed controls
• If the alternative for so many of the world’s population is to work for very long hours in unpleasant conditions and for very low wages, is it not credible that many will either switch full-time or else expend extra hours to manufacturing their own money?
There are further monetary policy ramifications for authorities. If there is any easy link between the bitcoin world and the fiat currency world, such that the creation of ‘money’ in the crypto-world creates money in the real world too, how does that affect any attempts by central banks to manage money supply? Is it a sort of private and uncontrolled Quantitative Easing? What could be the ramifications for prices of assets, pensions and investments and so on?
Secondly, if economic activity does start to be conducted using bitcoin out in the ether, and such inconveniences as Online Pay-As-You-Earn filings and EU Sales Lists can be circumvented, that can leave a hole in national revenue accounts, at a time when demand for public services is rising and tax revenues and living standards are under pressure. FATF and EBA certainly see bitcoin as a large home for the black economy.
By Robert Lyddon, General Secretary, IBOS Association
Read the full article on pg 26-27 of Finance Monthly’s February 2015 issue here.