Bitcoin risks and regulatory recommendations

The evolution of currency is in line with economic development. The Internet economy has created a new economic model, which is bound to give rise to a new form of currency. Bitcoin is a variation of currency under the Internet. At present, Internet currency is still in its early stages of development. The maturity of Bitcoin faces many risks, among which regulatory uncertainty is the biggest risk. Corresponding policy measures must be taken to strengthen supervision and continue to track and study.

With the continuous and enthusiastic attention of the media, the dollar price of Bitcoin has been soaring from less than $10 at the beginning of last year, and once exceeded $1,100; then, affected by the strengthening of supervision and technical problems of the trading platform, its price quickly fell back and continued to fluctuate, as shown in Figure 1.

Figure 1: Bitcoin price fluctuations (from February 2013 to present)

The "strange" Bitcoin has caused a lot of controversy, many of which are related to currency and continue the main issues about monetary theory since the end of the last century, including the exploration of the nature of currency, the issuance of non-sovereign currency, and the challenge of new technologies to the theory of money supply, etc. Yin Long once made a brilliant explanation of these controversies in his article "Internet Banking and Electronic Currency".

At the same time, Bitcoin also brings some new thoughts to people. For example, what is the innovation of Bitcoin compared with existing currencies? Is Bitcoin a complete currency solution? What lessons can we learn from it in designing new currencies, or even new world currencies? What risks does the development of Bitcoin face, and how should we formulate our policies?

Bitcoin is not yet a complete monetary solution

We believe that Bitcoin can be considered a variation of currency under Internet conditions, and it provides some useful references for us to design new currency schemes.

First, Bitcoin is the world's first digital cryptocurrency. It is generated by computer programs, issued and circulated on the Internet. The biggest innovation of Bitcoin is the construction of a distributed electronic payment system that does not rely on the existing banking system, as shown in Figure 2. Users can complete transactions point-to-point, and payment activities are relatively convenient and timely. It can save traditional banks from paying high transaction fees. This feature coincides with the Internet financial model mentioned in our article "Three Essentials of Internet Finance".

At the same time, because Bitcoin is an Internet-based currency, it can easily flow across borders and is suitable for cross-border payments. Digital cryptocurrencies like Bitcoin may have a place in the many forms of currency in the future. JP Morgan has also recently applied for a patent for a similar digital currency.

Figure 2: Schematic diagram of a distributed payment system

Secondly, Bitcoin provides us with new ideas on how to regulate the discipline of currency issuance. Since the transition from gold to national credit currency, the discipline of currency issuance has been criticized by people. Severe inflation has devoured people's wealth. One solution is to strengthen the independence of the central bank and enhance the transparency of monetary policy. Hayek's solution is to support the issuance of private currency and constrain currency issuance through competition. Bitcoin is a new idea. There is no central bank, and a transparent currency issuance mechanism is established through computer programs; in addition, the currency issuance and payment intermediation are separated through distributed payment features, further strengthening the discipline of currency issuance. Some studies have also suggested that the issuance of Bitcoin can be reset by modifying the computer code, or it can be made to comply with certain growth rules to overcome the tightening problem of the gold currency scheme.

Bitcoin is not yet a complete currency solution. The biggest problem is that it lacks stable purchasing power. Since there is no specific issuing entity, it does not have the intrinsic value of commodities like precious metals such as gold. There are great doubts about the price stability of Bitcoin, which seriously restricts the circulation and development of Bitcoin. Under the condition of unstable prices, it is difficult to carry out cross-period transactions of Bitcoin, and it is also difficult for financial products and transactions based on it to appear. Therefore, Bitcoin still needs new mechanism design. At present, the establishment of a Bitcoin fund can be regarded as an attempt to stabilize the price of Bitcoin. In addition, the transaction and savings characteristics of Bitcoin are also worthy of attention. According to the analysis of Israeli researchers, the distribution of Bitcoin is highly concentrated, and 97% of accounts hold less than 10 Bitcoins; since the birth of Bitcoin, most Bitcoins have not participated in circulation. After they were transferred to specific accounts, they disappeared from circulation. The stability of prices and the transaction and savings behavior of holders will have a significant impact on the future development of Bitcoin.

Regulatory uncertainty is the biggest risk facing Bitcoin development

The maturity of Bitcoin faces many risks. For example, the development of Bitcoin faces technical risks. In February, Mt.Gox, the world's largest Bitcoin exchange, was attacked by hackers and suspended its withdrawal service. The price of Bitcoin plummeted by 50%. Mt.Gox suffered heavy losses due to the attack and may have gone bankrupt. In addition, virtual currencies similar to Bitcoin are emerging in an endless stream, including Litecoin, Peercoin, Primecoin, etc. These new currencies will compete with Bitcoin.

Regulatory uncertainty is the biggest risk facing the development of Bitcoin. Most countries have declared that they are highly vigilant against the use of Bitcoin for illegal activities such as money laundering and terrorist financing. In addition, there are still differences among countries. The German Ministry of Finance recognizes Bitcoin as a "unit of account" with settlement functions, but it cannot serve as a legal means of payment. Countries such as China and India do not recognize the legal status of Bitcoin currency, but basically believe that Bitcoin can be traded as a special virtual commodity. Russia and Thailand have adopted relatively strict regulations. The Russian government recently announced a ban on Bitcoin as a parallel currency to the ruble in domestic transactions. The attitude of the United States deserves attention. Former Federal Reserve Chairman Ben Bernanke claimed that although virtual currency will bring legal and regulatory problems, virtual currency may have long-term hope, especially if it can establish a faster, safer and more efficient payment system. In February, the California House of Representatives passed the AB129 bill, proposing that various forms of alternative currencies, such as electronic currency, points, coupons or other things with monetary value, are not illegal when used to purchase or pay for goods and services. If this bill comes into effect, it will pave the way for the legalization of Bitcoin in California.

Bitcoin and other virtual currencies still have a long way to go before they can mature. We recommend the following policy measures to strengthen Bitcoin regulation and continue to conduct follow-up research.

First, there is no need to recognize the legal status of Bitcoin currency for a long time. Currency is a trust relationship between general equivalents. According to a recent survey by the US government, no country has recognized the legal status of Bitcoin currency. For a new form of currency to mature, it needs to meet the minimum technical requirements, have a good mechanism design, and need market cultivation and development. The corresponding policy system, including the improvement of legal and tax policy systems, is also indispensable. For example, the taxation of virtual currencies such as Bitcoin is a very complicated issue, involving the legal positioning, tax types, tax rates, etc. of Bitcoin. Due to the anonymity of Bitcoin, it is easy to evade taxes, and tax collection and management is also a difficult problem. In short, as mentioned above, Bitcoin is not a complete currency solution, and it also faces many risks. It will take time for it to mature. It may be too early to judge the future of Bitcoin.

Second, strengthen the supervision of Bitcoin and consumer protection. The anonymity of Bitcoin makes it easy to be used for illegal activities. We can strengthen the supervision of Bitcoin exchanges and force them to implement anti-money laundering regulations. Bitcoin circulates on the Internet and is easy to trade across borders, so we need to strengthen regulatory cooperation among countries. At the same time, due to its highly concentrated distribution, the price of Bitcoin is easy to be hyped. We should speed up the research on relevant legal issues of Bitcoin as a special virtual commodity to safeguard the rights and interests of consumers.

Third, we should increase research on Internet currencies. Internet currencies represented by online community currencies and Bitcoin deserve attention. The evolution of currency is compatible with economic development. The Internet economy has created a new economic model, which will inevitably give rise to a new form of currency. We believe that Internet currencies will be widely used in online economic activities, and human society will return to a state where central bank legal tender and private currencies coexist.