Bitcoins: The Evolution of Money and the Enforcement of the Law

The purpose of this note is to raise questions regarding the movement towards electronic money, and its possible impact on the enforcement of the law. The answer is yet unclear, but the questions are worth considering now.

Ancient money was used for a number of purposes. It was used as currency, in addition to its use as ornament, and sacrifices to God. Centuries ago, humans began to exchange foods and other assets. That was a wise evolution that enriched both parties, each of whom had too much of one thing but not of another. Exchange may have been hard to measure with precision. Therefore, humans developed ways to measure more accurately different products not only by amounts and weights, but also by the value and public demand.

To compare the values of different assets, humans found another type of asset that was fairly abundant and whose value and form were more stable. Such assets included “amber, beads cowries, drums, eggs, feathers, gongs, hoes, ivory, jade, kettles, leather, mats, nails, oxen, pigs, quartz, rice, salt,” tobacco in the south of the United States, gold in England, and sheep in ancient Israel (note that the word “kessef” in Hebrew means money, silver as well as a garbled word for sheep, “keves”). The value of these “measuring assets” was more or less fixed. Later, humans developed easier to carry assets, such as gold coins and paper, backed by the real assets. In fact, until 1971, the United States dollar was backed by gold at Fort Knox. Later, the value of money was determined not by assets but by government issuance of obligations, and its exclusive power to issue money was backed by law.

Money and banking evolved early. However, the source of the money (the mints) could have more power (in Rome). Early on governments began to play a role in regulating money.

The role of government in regulating money and the money supply has been subject to disagreements. Money could be viewed not only as a “thing” but as “social technology.” The effect of money on the well-being of the population is demonstrated by Germany’s plight at the end of the First World War, when the Allies imposed money-reparation on Germany and devastated the nation’s financial system.

Arguably, money is controlled by the government to maintain stability, or to guide, as well as manipulate, the economy. In the United States, money may not be copied or mutilated. In addition, banks must report to the government suspected legal violations. These suspicions may be raised by the amounts, frequency, the source, or the destination of payments. The transfer abroad of more than a certain amount of money must be reported as well. Because most countries have their own types of money, the International Monetary Fund was established to maintain a measure of predictability in the exchange of different countries’ money.

The search for ways to avoid government supervision over holding and transferring money has grown throughout the years. The reasons for the search include avoiding taxes, hiding the illegal sources of the money, or the desire to support countries that United States law prohibited from supporting. These incentives may have driven the creation of electronic money. After all, electronic money is harder to detect because it need not pass through a regulated banking system, provided this electronic money is acceptable to the recipients.

Thus, electronic money offers freedom from complying with some rules of law, or can undermine the enforcement of taxation and government supervision and controls. This type of money is different from money issued by other countries because the exchange of that money for the United States money is governed by law, while electronic money is not.

What we see is the emergence of an electronic “asset” (information) that is used to measure the value of dissimilar assets, that is: another kind of money. This electronic “asset” may be named coins or bitcoin or any other name for money.

There are three features that distinguish [bit]coins from other forms of money: (1) Bitcoins can be expressed in an electronic form; (2) They are, and can be, traded in the markets, so their value can change, sometimes significantly; and (3) they are not regulated by the government as money, and therefore can be used to hide the transfer of wealth outside government regulation, at least currently. To be sure, governments could develop electronic supervision and substitute for bank supervision. But most governments have not done so, at least not yet, although some have acted to control electronic money, as noted later.

Recently, the Securities and Exchange Commission cautioned one company and similar companies that they might be offering securities. The consequences of this classification would be to legally require these electronic signals to be described and disclosed not only to the users but to the government as well.

What should be described? (1) Who issues this money? (2) Who is the underwriter of this money? (3) Perhaps, the pricing and market price, and (4) the trading cost. The next stage in this development might be pooling different electronic coins into basks and trading each type of coin in the basket. The cost of trading and the market value of these money-securities may have to be disclosed. But the users may find it difficult to determine the value at any particular time in which this money will be used. Perhaps, the function of the banks may change. Who would need banks in that environment? However, it is not surprising that some banks have accepted bitcoins or similar electronic money.

And yet: “If you own bitcoin, congratulations. Its explosive rise this year has earned you the right to gloat. Unfortunately, if you also thought bitcoin, or any cryptocurrency, would one day displace regular money, those prospects have never looked worse.”

Thus, the ultimate issue posed by electronic currency is government control rather than disclosure to future investors. Can the market control the price of our money? If we need a stable money-value, the answer is: No, at least in the current environment in the United States.

A related issue concerning control of money may be: “who should manage the economy?” Is it the government or is it the market-makers and broker-dealers? Will the price of bread, among other things, be linked to the market price of electronic money as well? If the government will not control the value of the money, then those who issue electronic money might influence, if not control, the economy: Money, as well as taxes, might fly to other parts of the world with electronic wings.

Bloomberg columnist Matt Levine noted: “Look, on the one hand: Sure, yes, when everyone can buy bitcoins over the phone from their banks, the price will go a lot higher. On the other hand, soon you’ll be able to buy bitcoins, the disruptive alternative currency that was meant to rebuild the financial system on the basis of computer-science principles, by picking up the phone and calling your bank! Because that’s what people want! It does seem simultaneously bullish for bitcoin — more buyers! — and yet somehow deeply bearish: People will be buying bitcoin while rejecting its premise.”

Some of the current securities markets have spawned a casino environment. Small investors may indirectly invest in hedge funds—less regulated mutual funds. Now the tendency to take risks is growing. The largest such a fund is about $6 billion, spawned by a former Goldman Sachs executive. Concentrated investments may carry more gain and more risk. Where will the electronic evolution of money lead?

In 1997 Jack Weatherford wrote: “As money grows in importance, a new struggle is beginning for the control of it in the coming century. We are likely to see a prolonged era of competition during which many kinds of money will appear, prolifierate, and disappear as rapidly crashing waves. In the quest to control the new money, many contenders are struggling to become the primary money institution of the new era.” Ten years ago this author suggested a cooperative attitude between government and the market. Whether it is wishful thinking or close to reality remains to be seen. What is crucial, however, is to clearly recognize that the market alone cannot and should not control the value and perhaps the amount of available money and that bitcoins and other electronic money devices are not exclusively investments.

Different countries have expressed different degree of concerns relating to electronic money have been expressed in various countries.

1. A number of countries viewed electronic money as money that competes or otherwise affects the monetary system. These countries include:

• China, whose central bank has taken full control over this electronic currency-seemingly treating it as currency;
• Morocco and India, which do not allow the introduction of electronic money;
• Russia, which denounced the types of electronic money as “Pyramid Schemes”;
• Australia, which viewed it as speculative mania.

2. A number of countries expressed concern:

• New Zealand describes bitcoins as too unstable to be classified as money;
• France views the developments with ‘great caution’;
• The Netherlands described bitcoins as a “most daring” type of money;
• The United Kingdom views electronic money as a potential revolution;
• Germany has expressed concern about bitcoins’ effect on money, although perhaps not to that extent;
• The United States is concerned about privacy rights.
• European Central Bank drew on history and expressed concerns about market instability but not instability of currency effects.

3. A number of countries have taken a “wait and see” attitude:

• Japan is in a “Study Mode”
• Canada accepts electronic money as assets;
• Scandinavia is exploring options;
• Turkey views the developments as important;
• The Bank for International Settlements is paying full attention to developments;

4. Brazil: Supports innovations.

You may say: “Who are you to analyze the economy and financial system? You are a lawyer; not an economist.” I hasten to admit that I do not have the credentials to speak about these related topics. However, this paper does not offer any solution. Its purpose is to open the door to plain English discussions about our future: The duality of money as asset and as money, the legal control of money transfers to prevent violations of the law, and the government’s control of money supply, which affects the economy and financial systems. These issues may be far more crucial in the near future. Currently it seems that we are not going to widely use electronic money because it is too volatile. But governments seem to have woken up to the implications of electronic money and so should the countries’ citizens.