Rickards: Bitcoin meets the taxman

Bitcoin is much in the news. Whether it’s the supposed unveiling of the mysterious creator of bitcoin, the tragic death of a prominent bitcoin executive, or the bankruptcy of the best-known bitcoin bank, the topic of bitcoin is hard to avoid. But, this raises the question — what is bitcoin?

Bitcoin is a digital currency backed by nothing. If that sounds strange, it shouldn’t. The dollar is also a digital currency backed by nothing. It’s true we have a few paper dollars in our purse or wallet, but these are mere tokens of dollarness. The overwhelming majority of dollar transactions, from credit cards to the government bond market are digital. Dollars emerge from and vanish into thin air — just like bitcoins.

Dollars come from computers at the Federal Reserve. Bitcoins come from computers all over the world not controlled by any central bank or government. This is also not as strange as it seems. In 1999, a decade before bitcoin was invented, Milton Friedman said, “The internet is going to one of the major forces reducing the role of government. The one thing that’s missing, but will soon be developed, is a reliable e-cash, a method whereby … you can transfer funds from A to B without A knowing B.” That is exactly what bitcoin is.

Bitcoin skeptics are quick to point to the recent failure of bitcoin bank, Mt. Gox, as evidence that the phenomena will be short-lived. But regulated brokers doing business in dollars fail all the time. Look no further than Lehman Brothers, whose failure marked the death of that firm, but not the dollar’s demise. Currencies exist independent of the entities that use them. The Mt. Gox failure is a speed bump, not the end of the road.

Skeptics also point to the use of bitcoin for criminal transactions and the arrests of prominent bitcoin promoters as cause for concern. But dollars have been used for crime from Al Capone to Bernie Madoff. Again, the critics are confusing the currency with the uses to which it is put.

If bitcoin has so much in common with the dollar, does this mean that bitcoin may soon rival the dollar as a store of value? This is unlikely because the dollar has set a trap for bitcoin in the form of taxes. If you acquire a bitcoin for $100 and use it later to purchase $200 of goods, the IRS says you have a $100 gain on the sale of bitcoin that must be reported on your tax return. It’s no different than buying and selling a share of stock. It seems likely that many of the technophiles so ardent about Bitcoin are not bothering to report those gains. They may be hearing from the IRS soon.

And don’t even think about trying to pay your taxes with bitcoin. The dollar has a monopoly as legal tender for the payment of U.S. taxes. According to John Maynard Keynes and many other economists, it is the ability of state power to coerce tax payments in a specified currency that gives a currency its intrinsic value. This theory of money boils down to saying we value dollars only because we must use them to pay our taxes — otherwise we go to jail.

Bitcoin is extremely volatile. In recent years, the value of bitcoin has fluctuated widely from $1 to $1,000. It’s true that dollars fluctuate in value relative to other currencies such as the euro. But those changes are typically measured in fractions of pennies, not jumps of $100 per day.

Bitcoin does not have a lengthy track record in bull and bear markets. Everyday Americans have no reason to own bitcoins for now. They’re too volatile and there are too many unanswered questions about liquidity and how bitcoin will perform in a financial panic such as 2008.

One solution to the bitcoin volatility problem is to link bitcoin to gold at a fixed rate. This would require consensus in the bitcoin community and a sponsor willing to make a market in physical gold at the agreed value in bitcoin. This kind of gold-backed bitcoin might even give the dollar a run for its money as a reserve currency, especially if it were supported by gold powers such as Russia and China who are looking for ways out of the current system of dollar hegemony.

Bitcoin is not just a currency, it is also an open-source technology that can facilitate cheap, secure, distributed processing for all kinds of property transfers including stocks, bonds and land titles. It is this technology potential that has attracted interest from investors such as Marc Andreessen and the Winklevoss twins. Bitcoin technology may survive even if the bitcoin currency dies out, much as human DNA survived even as Neanderthals went extinct.

Bitcoin’s future may lie in its role as a technology platform for inexpensive verifiable transfers rather than its role as a currency. To the extent it remains a currency, bitcoin is an interesting, if risky, experiment. Just don’t try paying your taxes with it.

James Rickards is the author of “The Death of Money” from Portfolio/Penguin and a portfolio manager for the West Shore Group

 

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  • Guest

    Bitcoin is an exciting technology, I want to see it put to use in the voting system. Real open transparency voting for political candidates. We could see exactly how many votes they would receive and it would all be absolutely infallible. Its cool as a new currency but it can be used for many things..

    • Capital-R

      Who would distribute the bitcoin votes, and check that they werent being given to people not entitled to vote (more than once, because they have died, because they coerced their neighbours into it in a back room i.e. not a supervised polling booth, etc). Why not allocate one vote per Social Security Number and allow people to vote after paying their taxes electronically… isn’t that easier? It doesnt require “500 supercomputers” churning away 24/7 for the electorial commission to protect that data? Bitcoin just isn’t efficient enough to be stable or of use.

  • TerminalSanity

    The Dollar is not backed by nothing this a patently misunderstood about fiat currencies in general point upon which will doom unbacked crypto currencies to perpetual instability.

    The author needs to read a Dollar bill and realize that the full faith credit of the US federal Government is not an empty abstraction. The Government retains its credit in much the same fashion a person does by holding sizable assets of value: from vast tracks of land, buildings, vehicles both military and mundane, not to mention the taxable portion of the goods and services its citizens produce the US federal government holds a massive store of value upon which it can lend against to establish credit. There is a massive diverse concrete store of value being divided up by proxy behind the dollar including what gold the federal government still holds there is no such backing behind Bitcoin and all the false/misplace equivocations in the world will not alter that in the slightest nor will it mitigate the considerable significance in that distinction.

    As for tying Bitcion to gold its a near impossible option, never mind that the complete lack of centralization makes establishing the consensus to do so near impossible but acquiring the gold to back and establishing an means to store and transfer it to implement such a change likewise without a centralized authority that is a decidedly tall order.

    Frankly I’ll just state the obvious cyrpto currencies are frankly by and large redundant in a world already full of electronic cash transactions. All they really do is replicate the current cash banking system with potentially lower transfer costs involved but much higher risks and seeing as the vast majority of cash transfers for most people are already costless Bitcoin offers decidedly little in actual practical benefits to most people and its hard to justify the risks to those it can meagerly benefit.

    • Michał Rudnicki

      Oh look, an internet troll here.

      1. James Rickards does not really need schooling on what fiat money is. He has an impressive track record as money manager, adviser to US govt on financial warfare, and author of phenomenal book Currency Wars.

      2. Bitcoin is so much more than just a substitute for “current cash banking system”. It is a digital asset registry, suitable not only for carrying money, but also deeds, legal titles, serving as dispute resolution platform, automatic contract execution mechanism, ownership transfer vehicle, an so many more. If you view cryptocurrency only as a measure to transfer money from one wallet to another, you are only looking at small fraction of what it’s capable of.

      • TerminalSanity

        Oh look a vapid overly defensive comment here

        1. Then he should know better than to make such ridiculous statements that patently ignore fundamental economic principles. When you open an article with a flat out falsehood/gross misunderstanding of the subject matter being discussed your credibility on it goes strait into the toilet regardless of your credentials.

        2. Bitcoin currently offers none of the additional applications you mentioned without 3rd party exchanges being involved which operate essentially as unregulated banks and the de-centralized manner in which Bitcoin was implemented pretty much ensures that it never will be able to do so. That’s not really a notable innovation at all if you actually stop and think about it for moment but by all means continue to take the word of people trying to sell you on something at face value what could they possible have to gain by you buying into what they’re selling?

        • Michał Rudnicki

          Oh look, an attempt to ignore evidence to the contrary.

          1. Going back to the original statement, can I have one unit of that thing which backs US dollar, please? I thought so.

          2. Yes, you actually can have digital asset registry/notarization service right now – http://www.proofofexistence.com/. Yes, you actually can have contract execution directly in the blockchain right now. Yes, you actually can have smart properties aka legal titles and deeds and even share issuance right now – colored coins. No regulated or unregulated entity is required for any of the above and surely an exchange is not a prerequisite either. Not exactly a 1:1 replica for “current cash banking system” as you initially claimed.

          • TerminalSanity

            Oh look another vapid overly defensive comment here.

            1. Do you not understand how credit works or are just being deliberately obtuse? Or does that fact that normally when you use an asset or assets to establish a line of credit you usually aren’t expected to produce the asset or assets on the spot at all times only if you default on your line of credit simply escape you?

            2. What you linked me to was digital document certification application that utilizes the Bitcoin blockchain that’s a far cry from you just described, also not exactly a new innovation Digital certification is nothing new. So far you’re just affirming what I previously stated.

    • The dollar is backed by nothing. “Full faith credit of the US federal Government” is an intangible concept and is just as worthless as the mythical “social contract.” I cannot take my dollars to the bank and redeem them for “full faith credit.” There is nothing that prevents the government from printing dollars into extinction. In fact, in the last 100 years, the dollar has been devalued by 96%.

      • TerminalSanity

        The Federally held lands, Buildings, commodity reserves, vehicles, equipment to say nothing of the taxable portion of the goods and services of US citizen are all quite tangible and have sufficient market value to establish the credit upon which the dollar is backed. The social contract has nothing to do with it the global market made that determination and the dollar rises and falls accordingly upon that determination. This not an opinion or interpenetration on my part just a statement of fact whether or not you choose to recognize it or not.

        The Government intentional strives to inflate the dollar by 2% to 3% annually, they even did so when we were still on the gold standard. If you understood macro economics you’d understand why: I’ll explain in brief but essentially deflation is economically bad actually serves to undermine the entirely point of money which to serve as a facilitator/medium of trade you want people to either spend their money in the purchase of goods and service or invest in their production. If the value of a currency continuously increases in value then people tend not to invest and that’s a bad thing if you want your economy to grow which if you’re running a nation is something you generally want to do. So essentially functional modern governments tend to make their currencies sightly inflationary by design not so much that people will dump the second they get their hands on it just enough to discourage people from just sitting on large quantities of for years at a time.

        • TannrBeau

          Two periods, during the 1800’s prior to the civil war and post civil war, the dollar experienced steady deflation. That was real deflation and was an healthy aspect of the economy which lead to huge technological advancements and the building of America’s middle class. After the creation of the Federal Reserve, the dollar started being backed by debt instead of gold, which set the need for continual inflation. Deflation during the Great Depression was only harmful because it was due to debt deleveraging and wages declining faster than deflation.

          Today, ANY U.S. dollar in existence, exists solely because someone is in debt – be it some consumer or the U.S. treasury. Without all this debt, there’d be no U.S. dollar… therefore, it cannot be backed by anything other than debt.

          • TerminalSanity

            Completely different economy in those days economic in the nation growth was primarily being generating tapping into the land resources acquired in the Louisiana purchase and Mexican session with steady flow of immigrants to provide the labor to do so relatively little capital investment was necessary to process it. Since we won’t being acquiring vast racks of minimally processed resource rich land I don’t think we’ll being a repeat of those economic conditions ever again.

            Saying the USD is unbacked isn’t going make the assets the Federal government hold which in turn establishes the credit that lends its value go away or lose their value. The USD is backed period whether you acknowledge it or not.

          • TannrBeau

            Exactly, it IS completely different economies. One where the money is based on a commodity, the other where the money is created through debt.

            Zimbabwe’s currency became valueless… yet their government still owns all the assets it owned prior to experiencing hyperinflation. Obviously, their assets had no tie to their currency… nor does the assets held by the U.S. government. Federal assets have absolutely no tie to the value of a currency, therefore do not back it.

            Theoretically, the money we use has nothing to do with the government. It is issued by the Federal Reserve, which is independent of the government. What assets does the Federal Reserve own other than bonds (IOUs) and very little gold?

  • gerry d welder

    Crypto is now nothing like it started out to be (rather, naively perceived to be, like AGW, Obama, the Nobel Peace prize winner and Obamacare).

    If hackers don’t get you, governments will slaughter this cash cow.

    Governments won’t allow their tax revenue and regulatory structure to be by-passed… think tax evasion and money laundering just for starters, every transaction is recorded forever, so there is no rush, the government will slaughter this cash cow.

    Think your getting away with stuff in a system you don’t even understand or who really is at the controls or what predator is burrowing it’s way toward you?

    There will always be a generous supply of muppets for the world’s predators.

    Anybody doing any transactions in crypto better get all your IRS forms ready for submittal. Think your overseas transactions are final?

    Now suppose the ‘other party’ did a submittal and you didn’t?

  • John Prescott

    It appears that the IRS is going after a very few people who bought bitcoin a long time ago at a low price (disclosure: I am NOT one of them). It also is trying to cool down people from investing in it, by effectively reducing future gains.

    In so doing, the IRS has painted itself into a corner: If bitcoin goes down in price, then IRS has to give money back as capital losses.

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