The Jamaican bobsledding team qualified for the 2014 Sochi Olympic Games, but did not have the resources for training, equipment or travel expenses. It relied on crowd funding.
Many people donated in the form a digital currency called Dogecoin. The demand for Dogecoin lifted the price by nearly 50% against the more widely known Bitcoin. The Dogecoin contributions were converted into Bitcoins and the Bitcoins were then converted into US dollar and voila, the Jamaican bobsledding team will be at the Olympics.
When the digital currencies were valued at $15-$20 mln a year ago, officials and the media rightfully took little notice. Now Bitcoins in circulation are worth around $10 bln and there is a multi-billion dollar ecosystem of small companies who facilitate Bitcoin (and other digital currencies) transactions. The trading volume of several other digital currencies may exceed the Bitcoin on any given day.
None of this demonstrates that Bitcoins and the myriad of other digital currencies are really money. The proponents argue that an increasing number of brick-and-mortar businesses accept it. Reports suggest Finland may roll out the first Bitcoin ATM, though Taiwan blocked a similar effort earlier this month. The networking effect remains elusive. One economist estimated that businesses that accept the Bitcoin payments are less than 1/100 of 1% of US GDP.
Some analysts have celebrated their libertarian instincts by warning that digital currencies would be seized upon by central banks as reserve assets, or that the Bitcoin could supplant the dollar. Others sought to estimate fair value of the Bitcoin which has no income stream or intrinsic value, without taking into account production costs.
Our initial critique of Bitcoins (November 21, 2013), took the controversial stance that there was a contradiction in the Bitcoin between its function as a store of value and as a means of exchange. The more it was hoarded by those fearing the debasement of conventional money, the less it would be used as a means of exchange. We now see that insight has been picked up in research by other banks and by Jean-Pierre Landau’s in his critical essay in the Financial Times.
The money-ness of the digital currencies is not simply decided by the users. A network of critical mass is necessary but insufficient. It is clearer that government officials have to recognize it as such. And therein lies another hurdle for digital currencies. This is becoming a more salient issue as one considers the tax liabilities. In the UK, for example, is the Bitcoin is ruled money, users would likely be exempt from a 20% VAT that would otherwise apply.
In Finland, laws already specify the definition of an official currency. Digital currencies do not make the cut. Moreover, Finnish officials have requirements for an electronic payment system, and without an issuer responsible for its operation, Bitcoins and many other digital currencies simply do not qualify.
Official opposition seems more adamant in Asia, China has banned its banks from transacting in Bitcoins. South Korea has ruled that Bitcoins are not legal tender. Taiwan has discourage their use by banks and individuals. India has also discourage the use of Bitcoins.
The US Internal Revenue Service has yet to provide guidance, leaving many digital coin participants in a bit of no man’s land.
As the market for digital currencies has grown, officials have a greater interest in protecting consumers and businesses as well as countering efforts to avoid taxes. Officials also have an interest in blocking the attempts to circumvent money laundering laws, the engagement in contraband trade,and/or the undermining national security.
We have suggested that payment companies, including credit card businesses, may feel competitive pressures from the digital currencies. We warned that they will likely respond to the challenge. In this note we warn that the power of the sovereigns should not be under estimated when it comes to projecting the future of digital currencies.