Bitcoin’s road to legitimacy
3 Apr 2017|

Image courtesy of Pixabay user MichaelWuensch.

Bitcoin is often mentioned in the media in the same breath as the now defunct ‘silk road’ dark-web trading site, and usually accompanied by a nonsensical stock photo of a laptop user wearing a balaclava. The perception generated by such reporting is that bitcoin and other cryptocurrencies are purely for shady dealings. While this may once have had some truth to it, cryptocurrencies, and particularly bitcoin, are now on a trajectory towards legitimisation and widespread acceptance. This is because of the real benefits that a decentralised cryptocurrency has for legitimate users, particularly in developing countries and countries with hyperinflation.

Bitcoin is the oldest and best known cryptocurrency; cryptocurrencies being a subcategory of virtual (or digital) currencies. Unlike virtual currencies designed for virtual economies, such as those on which online games rely, cryptocurrencies are designed to be traded for real world goods and services. Bitcoin was devised in late 2008 by the mysterious and possibly pseudonymous Satoshi Nakamoto.

The subversive element of the cryptocurrency concept is the anonymity ‘baked into’ the protocol, with an obvious appeal to criminal enterprises. However, this anonymity applies to the ownership of the cryptocurrency, not to the transaction itself. Fundamental to the integrity of bitcoin is the public register of transactions—the block-chain. So while individuals may hide behind the cryptographic anonymity of their bitcoin address, transactions are in the public domain. If a bitcoin user’s private key is recovered from a seized computer, for example, their complete transaction history is then known. The protocol was also designed to inhibit the mapping of bitcoin addresses to Internet Protocol (IP) addresses, but this anonymising has subsequently been shown to be flawed and users can be traced over the network to some degree. There are technological solutions to the investigation of crime involving cryptocurrencies.

Significant trends in bitcoin adoption are occurring in the developing world where the benefits of a decentralised currency are much easier to see. Despite the volatility of bitcoin, it is less volatile than some government backed currencies. In Venezuela, people are increasingly turning to bitcoin to survive the world’s highest inflation rate. India’s demonetisation experiment is likely to drive the adoption of bitcoin in that country. Innovative uses of bitcoin micro-transactions are also appearing in Africa.

There are substantial user benefits to a currency that is not controlled by a central bank which can be transacted without a financial institution as an intermediary. This is particularly apparent in developing countries with hyperinflation or limited banking infrastructure. By December 2016, bitcoins in circulation topped USD 14 billion when bitcoins were valued at USD 850 each. Since then, the bitcoin exchange rate peaked at over USD 1000 but has most recently dropped back below these historic highs.

The reason that governments, law enforcement and intelligence agencies should care about the regulatory and technological challenges of cryptocurrencies, is that bitcoin is approaching a tipping point where governments may have little choice but to recognise it as a currency. Germany recognised bitcoin as a unit of account in 2013. The US Inland Revenue Service (IRS) treats bitcoin as property but recognises that it has some of the properties of a currency in certain situations.

At home the Australian Tax Office (ATO) treats bitcoin as a method of barter, which can cause the double taxation of some bitcoin transactions. The Federal Government has undertaken to reform the tax treatment of digital currencies in response to the Senate Economic References Committee’s report on digital currencies. As bitcoin continues to be treated less like a commodity and more like a currency, governments will find it harder to put the cryptocurrency genie back into the bottle. In a world first, the Pirate Party of Iceland, which may yet put together a coalition to govern the island nation, has a policy platform of making bitcoin legal tender.

The widespread adoption of cryptocurrencies like bitcoin will have a disruptive effect on the financial sector, reduce central bank control and, as with any new technology, create new opportunities for criminals. Governments will need to adapt to this disruptive new system of exchange, and this is occurring to some extent. The Australian Senate Economic References Committee’s report on digital currencies also recommended changes to the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 to better deal with digital currencies.

If the current rate of bitcoin adoption and capitalisation continues, governments must implement legislative, regulatory and technological controls as a matter of urgency; controls that retain the benefits of cryptocurrency and block-chain technology while minimising its utility for money laundering and terrorist financing.

The challenge for law enforcement and intelligence agencies will continue to be obtaining, developing and retaining relevant expertise, and the creation of institutional frameworks to support it. For better or worse, ‘magical internet money’ appears here to stay.