Can Bitcoins remain unregulated?
Akash Karmarkar 08 August 2014

While Bitcoin investors have been quick to revolt against regulations, the system reeks of a lack of transparency and Bitcoins have exhibited a characteristic typical of a highly speculative market

 

Bitcoin is a highly speculative and unregulated virtual instrument, which has been the subject of a global controversy since its genesis. Bitcoin was created by an anonymous hacker to facilitate decentralised online transactions using Bitcoins as a quasi currency.

 

Transactions in this system are made with no intermediaries, banks or regulatory agencies. Bitcoins are a completely decentralised form of money, which is not regulated or issued by any government. To classify Bitcoins as a virtual currency is wrong. It is an undefined virtual exchange without any economically or empirically sound price discovery mechanism or rationalised process for generation.


Bitcoin has been created by cryptographic software running on a network of volunteers’ computers, making the system both hard to track, and decentralised to operate on exchange platforms set up in various jurisdictions, which results in regulatory issue in regulating of such a currency. Clearly, Bitcoins do not fit the legal definition of “money” that is a medium of exchange authorised or adopted by a domestic or foreign government, whereas there exists no such central authority to govern Bitcoins. The promoters of Bitcoins have naively argued that the decentralised system ensures that there is no control dependence on a particular centre of control. This also ensures that inter-jurisdictional regulation of Bitcoins is impossible.


Bitcoins have a striking and rather ominous similarity to the derivatives, which were designed to challenge the most financially literate investors. Since Bitcoins are neither stable in terms of price, nor underwritten by any government, they fail to serve as a virtual currency. Potential investors in Bitcoins are lured into ‘investing’ in Bitcoins merely by the promise of riding the speculative wave, which has incentivised by the skyrocketing price of Bitcoins.


Although the Bitcoin has been tremendously successful, it has been wildly volatile as the its value is pegged to the whim of investors and can only be assessed by speculation. The market value of the Bitcoin has exhibited a characteristic typical of a highly speculative market, starting with a rapid, parabolic jump to the top, followed by an inevitable crash. Bitcoins have continued to operate solely on the naïve trust of online purchasers who continue to purchase Bitcoins from Bitcoin miners, who generate Bitcoins.


In a press release, the Reserve Bank of India (RBI) has pointed out glaring issues with the virtual currencies, including Bitcoin and has raised concerns about the potential hazards of trading on an anonymous peer-to-peer basis without an authorised central agency, which regulates such payments.


Market manipulators could potentially inflate prices of the Bitcoin, and then offload their entire holdings, leading to a cataclysmic meltdown. Using a modus operandi similar to that of a Ponzi scheme, market manipulators could allow the Bitcoin bubble to grow till there is a critical mass of investors who have earned from the speculative trade and lure more investors into the scheme. What remains to be seen if the entire system collapses after a massive disposal of Bitcoins.


This concern has been underscored by the bankruptcy of Mt.Gox, the world’s largest Bitcoin exchange in 2013. The implosion was triggered when half a billion dollars worth of Bitcoins ‘disappeared’ triggering a mass withdrawal and raising allegations that the collapse was an orchestrated scheme. The price of Bitcoins on Mt.Gox eventually became completely disengaged from the wider Bitcoin market, and in the days leading to its collapse, the exchange’s total Bitcoin holdings were just at 2,000, while customer deposits totaled 6,24,408.


This highlights the fact that there is no established framework for Bitcoin users and investors to recover their investment in Bitcoins in the event of market manipulation or any economic offense for that matter. In the absence of regulators, the possibility of market rigging and price manipulation is a very real possibility.
This dilution of control has become a critical concern as the decentralisation could lead to serious jurisdictional issues when there is an attempt to regulate the currency is a serious regulatory challenge. The amorphous classification of the Bitcoin also raises concerns as to the actual value of the Bitcoin, which neither has any inherent value nor is it pegged to the value of any underlying asset or commodity.


Regulators around the world, including the US Securities and Exchange Commission (SEC) and Federal Bureau of Investigation (FBI) have been grappling with the jurisdictional issues due to the ambiguity of Bitcoins being a currency, a derivative and an investment contract. While Bitcoin investors have been quick to revolt against regulations, the system reeks of a lack of transparency in the asset structure, and any rationalised, empirical basis for the generation or appreciation in the value of the Bitcoin.


A critical issue that continues to plague regulators is this classification of Bitcoins. Since its value is not pegged to any underlying asset, it cannot be classified as a derivative. The incredible part about Bitcoins is that it does not qualify as a fiat currency since there is no central authority that issues Bitcoins. This raises concerns about the sustainability of Bitcoin, but since it is the first decentralised digital currency, perhaps a new regulatory framework needs to be set up to retrospectively regulate such instruments and prevent their misuse.


With the current rhetoric surrounding the legitimacy and classification of Bitcoins it may be prudent to desist from investing in an instrument which has the dubious distinction of being beyond regulatory purview in most countries.

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