Will government intervention and regulation kill cryptocurrency?

Bitcoin claims that “It is the first decentralized peer-to-peer payment network that is powered by its users with no central authority or middlemen.” That lack of central authority is the primary reason governments are afraid of the cryptocurrency. To understand this fear, it is important to know a little bit about governments and conventional currencies.

In What Do We Trust?

Fiat is a term used to describe the conventional currencies that are issued by governments. Fiat currencies have value because governments say that they do. To an increasing number of people, that promise means nothing. After all, fiat currencies are not backed by any tangible assets. You can’t return the currency to the government in exchange for a bar of gold or silver, a can of beans, a pack of cigarettes, or any other items that might have value to you. Fiat currencies are backed by the full faith and credit of the government that issued them and nothing more. If you want gold, silver, beans, or smokes you need to exchange your fiat currency with a person or entity that possesses the item that you want.

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Why Control Matters

Governments control fiat currencies. They use central banks to issue or destroy money out of thin air, using what is known as monetary policy to exert economic influence. They also dictate how fiat currencies can be transferred, enabling them to track currency movement, dictate who profits from that movement, collect taxes on it, and trace criminal activity. All of this control is lost when non-government bodies create their own currencies.

Control over currency has many downstream impacts, perhaps most notably to a nation’s fiscal policy, business environment, and efforts to control crime. While each of these topics is broad and deep enough to fill volumes, a brief overview is enough to provide insight into the general concept.

Fiscal Policy

While the potential for crime captures the public’s attention, the role currency plays in a nation’s monetary policy has the potential to have a far greater impact. Since governments intentionally increase or restrict the amount of money circulating in an economy in an effort to stimulate investment and spending, generate jobs, or avoid out-of-control inflation and recession, control over currency is an enormous concern. It’s also an extraordinarily complex topic.

The Business of Bitcoin

Bitcoin users don’t need the existing banking system. The currency is created in cyberspace when so-called "miners" use the power of their computers to solve complex algorithms that serve as verification for Bitcoin transactions. Their reward is payment with cyber currency, which is stored digitally and passed between buyers and sellers without the need for an intermediary. On a smaller scale, airlines reward miles function in a similar way, enabling travelers to purchase plane tickets, hotel rooms, and other items using airline miles as virtual currency.

If bitcoin or another cryptocurrency become widely adopted, the entire banking system could become irrelevant. While this may sound like a wonderful concept in light of the recent behavior of the banking industry, there are two sides to every story. Without banks, who will you call when your mortgage payment gets hacked? How will you earn interest on your savings? Who will provide assistance when a transfer of assets fails or a technical glitch occurs?

While the financial crisis gave bankers an even worse reputation than they already had, there is something to be said for institutions that oversee timely, effective, and trustworthy asset transfers and their associated record keeping. There’s also the issue of the fees banks earn for the services they provide. Those fees generate a lot of revenue and a lot of jobs across the global banking industry. Without banks, those jobs disappear, as does the tax revenue those banks and their employees’ paychecks generate. Money transfer business would also disappear in a virtual world. Nobody needs a Western Union or its competitors if everybody is using bitcoin.

Crime Concerns

So much has been written about virtual currency and crime, that it is enough to recap the issue by stating that untraceable financial transactions facilitate crime. Drug trafficking, prostitution, terrorism, money laundering, tax evasion, and other illegal and subversive activity all benefit from the ability to move money in untraceable ways. The now-defunct Silk Road online drug market is a case in point. Its founder credits Bitcoin for its success.