Table of Contents
Introduction
Since its introduction in a 2008 whitepaper, Bitcoin (BTCUSD) has generated controversy and news. Its enthusiasts herald the cryptocurrency’s launch as the advent of a new and equitable monetary system. Critics point to the cryptocurrency’s role in criminal activities and the absence of legal recognition as proof that it is “rat poison squared.” The reality probably lies somewhere in between.
Meanwhile, governments around the world are eyeing Bitcoin’s advance and taking action when they can. Some, like El Salvador, have adopted it as currency. Others refuse to recognize it as legal tender, treat it as a commodity or property, or even ban it completely. In 2023, the European Union adopted a framework for regulating cryptocurrency.
The Challenges of Bitcoin to Government Authority
Bitcoin enables the citizens of a country to undermine government authority by circumventing capital controls imposed by it. It also facilitates nefarious activities by helping criminals evade detection. Finally, by removing intermediaries, Bitcoin can potentially throw a wrench in the existing financial infrastructure system and destabilize it.
Governments and Trust
To understand why governments are cautious about Bitcoin, it is important to understand the role that fiat currencies play in a country’s economy. Fiat refers to conventional currencies issued by governments. Fiat money is backed by the full faith and credit of a government. This means that governments promise to make a currency borrower whole in case of a default.
The U.S. government relies on the Federal Reserve, a central bank on which Congress only has partial authority, to manage the supply of circulating money. The cycle of transactions in the U.S. economy—one that involves borrowers, lenders, and consumers—relies on a chain of trust between transacting parties. The Federal Reserve, the lender of the last resort, is the final leg of that chain, lending only to depository institutions.
Bitcoin advocates charge that the Fed creates money out of thin air (i.e., the currency is not backed by tangible assets). By manipulating the supply of money in the U.S. economy, they say, the central bank also manufactures asset bubbles and crises.
Governments facilitate the role of central banks in an economy. While central banks are involved in making policies related to money, they do not have the authority to regulate its use. That responsibility lies with the government. Through a series of intermediaries, such as banks and financial institutions, governments distribute and regulate the flow and use of money in an economy. Thus, they can dictate how it is transferred, sectors where it is distributed, and trace its utility. They also earn revenue from it by taxing the earnings of individuals and businesses.
Bitcoin Undermines the Cycle of Trust
Bitcoin’s decentralized system has the potential to dismantle the system described above. Its network does away with intermediaries and, by extension, the elements of a government’s system.
When cryptocurrency is used, a central bank is no longer required. That is because it can be produced by anyone running a full node. Peer-to-peer automated transfers between two parties on Bitcoin’s network mean intermediaries are no longer required to manage and distribute currency.
The chain of trust underpinning the current financial infrastructure becomes an algorithmic construct in Bitcoin’s network. A transaction is generally not included in the central ledger unless a specified majority of nodes approve it.
Theoretically, at least, the streamlining of operations between individuals and various actors on Bitcoin’s blockchain can rearrange the current system. The financial infrastructure is decentralized, and the power to increase or decrease currency supply is not appointed to a single or group of authorities. Thus, in the new setup, the role of governments in managing and regulating economic policy through intermediaries may become superfluous.
Reasons Governments Are Wary
Whether the state- and regulation-less future envisaged by Bitcoin evangelists comes to pass is still an open question. Meanwhile, governments around the world are trying to understand the effect that cryptocurrency might have on their economies in the near term. Specifically, they are grappling with the following three problems Bitcoin and cryptocurrency present in their current forms.
Bitcoin Can Circumvent Government-Imposed Capital Controls
Governments often institute capital controls to prevent currency outflows because exports could debase their currency’s value. For some, this is another form of control exerted by governments on economic and fiscal policy. In such instances, the state-less nature of Bitcoin comes in handy for circumventing capital controls and exporting wealth.
One of the more well-known instances of capital flight using Bitcoin has occurred in China. The country’s citizens have an annual limit of $50,000 to purchase foreign currency. A report by Chainalysis, a crypto forensics firm, found that more than $50 billion moved from East-Asia-based Bitcoin wallets to wallets in other countries in 2020, meaning Chinese citizens may have converted local currency to Bitcoin and transferred it across borders to sidestep government regulation. Not all $50 billion is thought to be from China or capital flight, but it shows an increase in capital movement in the form of cryptocurrency from previous years.
Bitcoin Ties to Illegal Activity
The ability to bypass existing financial infrastructure for a country is a blessing in disguise for criminals because it enables them to camouflage their involvement in such activities. Bitcoin’s network is pseudonymous, meaning users are identified only by their addresses on the network. It isn’t easy to trace the provenance of a transaction or the identity of an individual or organization behind the address. Besides this, the algorithmic trust engendered by Bitcoin’s network obviates the need for trusted contacts at either end of an illegal transaction.
Not surprisingly, Bitcoin is a favored conduit by criminals for financial transactions. The most famous example of a crime involving bitcoin was the Silk Road case. Briefly, Silk Road was a marketplace for guns and illegal drugs, among other things, on the Dark Web. It allowed users to pay in bitcoins. The cryptocurrency was held in escrow until the buyer confirmed the receipt of the goods. It was difficult for law enforcement to trace parties involved in the transaction because they only had blockchain addresses as identification. Eventually, however, the FBI was able to take down the marketplace and seize 174,000 BTC.
Recently, infecting popular applications with ransomware and demanding payment in bitcoin has also become popular with hackers. The 2021 Colonial Pipeline hack, which resulted in energy supply disruptions in various states, demonstrated the degree to which such attacks can become national security issues.
Bitcoin Is Not Regulated
More than a decade after Bitcoin was introduced, governments around the world are still trying to figure out ways to regulate the cryptocurrency. There are multiple strands to Bitcoin’s regulation problem.
Is Bitcoin a currency to be used in daily transactions or a store of value primarily used for investment purposes? Is Bitcoin a safe haven asset during times of global economic turmoil? Neither the so-called Bitcoin experts nor the average bitcoin investor agree—it’s possible that all are true.
It could be argued that the use of bitcoin in investing products like futures is proof of its attractiveness to traders. Government-approved marketplaces like the CME Group and the Cboe offer regulated cryptocurrency futures, and exchanges in more developed countries must register with the appropriate authority, like the Securities and Exchange Commission (SEC). But in other countries, it isn’t regulated as strictly, so concerns about investor and user safety arise because cryptocurrency has a global reach and possibly influence.
Cryptocurrencies Are Opaque Ecosystems
While Bitcoin has the potential to upend established dynamics of the existing financial ecosystem, it is still plagued by several problems. Government wariness about the cryptocurrency can be partly attributed to fear and partly to the lack of transparency about its ecosystem. The latter concern is not misplaced.
Little is known about the cause-and-effect relationship between Bitcoin’s influence and global developments—it hasn’t yet reached a scale equal to that of the dollar. That is a crucial sticking point in light of the cryptocurrency’s volatile price swings; if it were to gain the influence of the dollar, it could have serious repercussions globally.
Conclusion
Bitcoin has become a touchstone for controversy since it was introduced to the world in the aftermath of the financial crisis. Governments have become wary of Bitcoin and have alternated between criticizing cryptocurrency and investigating its use for their ends.
While it has the potential to decentralize and change the workings of the existing financial infrastructure, the cryptocurrency’s ecosystem is still rife with misuse, scandals, and criminals. Bitcoin will likely continue to provoke distrust and criticism from established authorities. With that in mind, government-backed cryptocurrencies called central bank digital currencies (CBDCs) based on blockchain technology are more likely to be accepted by governments than decentralized ones.
