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2017 saw a meteroic rise in the value of cryptocurrencies — followed by a disappointing start to 2018. But who among us can explain why? Here to discuss the mechanisms and purpose behind these commonly-used but little-understood words like Bitcoin and blockchain is Jerry Brito.
Jerry Brito is the executive director of Coin Center, a research and advocacy organization that focuses on the public policy implications of cryptocurrencies. He was also a senior research fellow at the Mercatus Center and an adjunct professor of law at George Mason University, and he is the co-author of the book Bitcoin: A Primer for Policymakers.
PETHOKOUKIS: I was not planning on beginning our chat by asking you to define terms, but the Twitter-verse was demanding it. People sometimes use the terms “Bitcoin” and “blockchain” interchangeably. What are their differences?
BRITO: Right. So let’s start with Bitcoin, which I think is kind of the main way to get into it. Bitcoin is the world’s first completely decentralized digital currency. We have had digital currencies for decades, so whether you think of Facebook credits or Microsoft points or World of Warcraft gold or even the dollars in your PayPal account, these are all digital currencies.
So what is it about Bitcoin that makes it unique, that makes it worth having a podcast about? It is that it’s the world’s first completely decentralized digital currency. It is the decentralized piece that makes it unique.
Before the invention of Bitcoin, for two parties to transact electronically always required a third-party intermediary to be between them. And why is this? Well, you can think about what a transaction is like without a third-party intermediary, and that’s cash.
So if I have $100 bill and I hand it to you, now you have it and now I don’t. And we can verify this transaction by looking at our hands, so there’s physical scarcity. I don’t have it anymore and now you do. And we don’t need anybody else between us, just peer to peer, person to person.
If we try to replicate that electronically, online, before the invention of Bitcoin, what would that look like? Well, I would have to have some kind of digital representation of that $100 bill. So, you know, call it $100 file, some kind of digital file. And I would send this to you, the same way that I might send a photo or a Word document to you.
But think about a photo or a Word document. If I send you a photo, you now have it, but what about me? Do I no longer have it? No. I retain a perfect digital copy of that thing I just sent you. And if that was money, it doesn’t work. And this is what computer scientists very imaginatively refer to as the double spending problem. And the way we solved the double-spending problem before the invention of Bitcoin is that we employ a third party, something like a Bank of America or a Visa or a PayPal.
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And what I do in order to send you money electronically is I wouldn’t send you a message. I would send a message to PayPal, of which we are both customers, and it doesn’t work if we’re not both customers of PayPal. And I would say, hey, PayPal, please deduct $100 from my account and add it to James’ account. And PayPal would dutifully do this, minus $100 from Jerry, plus $100 to James, that reconciles to zero, and across all transactions, across all — you know, everybody — that comes out to zero. And that’s essentially what PayPal is, a ledger keeper. They do two things. They basically verify that you have authority to make a transaction and they keep a ledger.
So what Bitcoin does is that for the first time it allows for true peer-to-peer, person-to-person transactions online without the need of a third-party intermediary, with nobody between us.
That is the breakthrough. And I would put it this way. This is getting a little technical, but I think it’s worth noting. What Bitcoin created was digital scarcity. Before scarcity, where I hand you a $100 bill and now you have it and now I don’t only existed in the physical world. Scarcity only existed physically.
What Bitcoin invented was digital scarcity. So for the first time, I could hand you something or a representation of something and now you have it and now I don’t and the whole world can verify this by looking at this ledger of transactions called the blockchain.
So we talk about it as a currency. But what is it good for other than speculation right now?
So I think in the developed world, at least in my lifetime I don’t think we’re going to see Bitcoin used for day-to-day payments. And part of the reason for that is we don’t need it. In the developed world, we have a very good financial system where if you want to go to Starbucks, you can pay for your $1.50 cup of coffee with a credit card and it’s frictionless already. It’s very difficult to improve on that.
In the developing world, it might be a different story because in the developing world, you have many places where there are no electronic transactions. If you are a handy-craft maker in Afghanistan or Pakistan and you want to sell online, you can’t take credit cards because you don’t have a bank account. And even if you had a bank account, Visa does not serve your country. And so this technology allows folks in the developing world to sort of skip — it’s kind of like how cell phones skipped landlines.
What is the regulatory risk in the US, and what should government be doing to promote beneficial applications?
There’s this myth that Bitcoin and cryptocurrencies are this unregulated space. And the fact is that this space is one of the most regulated in technology. At least since 2013 we’ve had the government issuing all kinds of different pronouncements of guidance or any regulation that affect this technology. And so the areas are basically consumer protection, tax, anti-money laundering, securities and then commodities of regulations. And in each of these, there is a regulatory regime that applies to this technology.
We probably don’t have time, but if you’re in a Bitcoin exchange, you are subject to the same anti-money laundering requirements that banks are. And, indeed, all of the US exchanges comply with these. If you are an exchange or wallet service, you need a license in every state in which you do business. And so what the government can do to help along adoption here is get rid of that arcane 50-state licensing regime and have either a more unified federal regime. If we have a Commerce Clause for a reason, it’s to get rid of barriers to interstate commerce.
What are the tax implications?
The tax implications are pretty straightforward. So in 2014, the IRS issued guidance basically saying that they interpret something like cryptocurrencies to be property, that they’re not currencies under the law. Currencies are the coins and paper notes of a state. This is not that so this is property. So it’s more like a car or a house or gold. And so, in that respect, it’s pretty simple. If you bought Bitcoin at $100 and then you sold it for $1,000, and you held it for over a year, you owe capital gains on that $900 gain. That’s pretty straightforward.
I think where there are still questions is, well, what’s your basis? Let’s say you bought a Bitcoin every month for five years and then you sold some. Did you sell the first ones you bought or did you sell the last ones you bought? So I think today you can kind of choose which ones you sold, but we could use some more guidance there.
What is the attitude on Capitol Hill toward Bitcoin?
It runs the gamut, and I think it depends where these legislators sit. In the vast number of cases where we’ve talked to folks, we explain what is the technology and how it works, and the reaction is very positive. It’s, what can we do? How do we encourage this? How do we make sure its use is responsible in a vast number of cases?
In other cases, you have perfectly reasonable responses, so, for example, there is the Terrorism and Illicit Finance Subcommittee of the House Commerce Committee. So they’re interested in it for very particular things, and we’ve helped them with an investigation. They have held a hearing on this topic and they’ve been satisfied that law enforcement has tools to deal with it.
And then you have some folks who are just allergic to it. And I think those folks often times come around. But, typically, I think once you show folks, look, the law enforcement is on the case. All of these service providers are subject to anti-money laundering rules. Rogue exchanges are routinely taken down. And look at all this innovation that’s happening not just in Silicon Valley with startups, but at Microsoft.
And, finally, your 12-month end-of-year Bitcoin forecast.
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