Bitcoin Really Is an Existential Threat to the Modern Liberal State - Bloomberg

So far, Bitcoin is not a big deal. Its total value in circulation was $1.4 billion as of this week. That's equivalent to the currency stock of a small nation -- somewhere between Iceland and Uruguay -- and just one-thousandth of the total value of U.S. dollars in circulation. The volume of transactions in Bitcoin is growing only slowly, relative to the massive increase in demand for the currency: This discrepancy is strong evidence that Bitcoin’s rise is a speculative bubble.

Nonetheless, Bitcoin raises some interesting questions. One is whether it might undermine the modern state -- which, for many of its libertarian-anarchist advocates, is the whole idea.

Technology enabled governments to grow more powerful and more centralized in the 19th and 20th centuries, as Tyler Cowen, an economist at George Mason University, has argued. The intriguing possibility is that technologies of the 21st century -- such as Bitcoin -- might push the other way.

Physical cash is used in a rapidly shrinking share of transactions: 27 percent in 2011, 23 percent by 2017, and so on, according to Javelin Strategy & Research, a financial-services research firm. The central banks of Sweden and Nigeria have both declared goals of a cashless economy. In Europe, the volume of non-cash transactions is forecasted to rise by 7 percent per year, despite economic stagnation.

What's going on? First, a global shift to mobile payments and credit and debit cards. Second, a rise in online retail -- one that could put 15 to 20 percent of all retail sales online in the U.S., U.K., China, and Europe, according to Bain & Company.

Electronic payments aren't new. Bitcoin's only innovations are its status as an independent currency and its decentralized network design. But those differences might make Bitcoin -- or rather, crypto-currency in general -- an existential threat to the modern liberal state. If widely adopted, crypto-currencies would cripple government in three central functions: taxation, police and macroeconomic stabilization. That is exactly what Bitcoin's biggest fans are hoping.

Taxation: How do governments collect taxes on transactions in Bitcoin? The answer is they don't, and they can't. Crypto-currency's strong protections on anonymity make it impossible for any state to know who is buying what, who is paying whom, who earns what, and who has what in savings. That poses a direct challenge to the power of states to levy taxes.The problem is that Bitcoin makes tax evasion easier. States could enforce reporting of Bitcoin income for individuals and businesses, as they try to do for cash, which is also hard to track. But encryption and the peer-to-peer network structure make Bitcoin even harder to follow than physical cash, and digital cash is much better than the physical kind for storage and transactions, so the scale of the challenge could end up being much bigger. Police:It would be almost impossible for states to detect certain crimes. One of the major alleged uses of Bitcoin -- though, of course, one can never truly know -- is buying illicit drugs. Bitcoin’s cryptography makes it uniquely able to facilitate money laundering, insider trading, fraud, and bribery. The transactions would be untraceable, and the money doesn’t ever have to return to the bank, where the financial crime might have been detected. Macroeconomic policy:A Bitcoin economy would undermine the power of real-world central banks to make monetary policy. Yes, governments can influence the demand for national currencies by requiring taxes to be paid in them. But the monetary lever on private transactions and lending would be gone if such commerce was denominated in Bitcoin. And by displacing governments as currency issuers, Bitcoin also threatens their ability to finance public debt. In a world where many transactions are anonymous, it’s unclear how governments could even compile accurate economic data, without which macroeconomic policy is impossible. Economic depression in a Bitcoin regime could be an insoluble problem.

If Bitcoin remains on the fringes, then the state is safe. The question is, if it shows signs of becoming a widely used currency, what could governments do to crush it?

The Financial Crimes Enforcement Network, the wing of the U.S. Treasury Department that investigates money laundering, said last month that it has the authority to regulate transactions involving both Bitcoin and U.S. dollars under the Bank Secrecy Act. These inter-currency exchanges appear to be the best foothold for regulation. Governments could require records of all purchases and sales of Bitcoin, for instance.

But this approach has severe limits. There are, by design, no direct avenues for government to interpose itself in Bitcoin-only transactions. Government does have some enforcement leverage over the individuals and businesses. Bitcoin transactions have a real-world side. The problem, though, is that the usual mechanisms for detection and enforcement are very weak against Bitcoin. Ask the Federal Bureau of Investigation. Bitcoin presents “distinct challenges for deterring illicit activity,” according to a leaked intelligence assessment that was prepared in April 2012. "Bitcoin is unique because it is the only decentralized, P2P network-based virtual currency,” the FBI’s Cyber Intelligence and Criminal Intelligence Sections wrote. “The way it creates, operates, and distributes bitcoins makes it distinctively susceptible to illicit money transfers.”

Bitcoin may be a bubble that will burst. If it does, other forms of digital cash will come along. The state was intimately involved in the development of money -- but that was before networked computers. In the next chapter of the history of currency, money might very well turn on its creator, and roll back government.

(Evan Soltas is a contributor to the Ticker. Follow him on Twitter.)