This week, a ruling by a federal judge in Texas was cause for optimism among a small group of technologically minded investors.
The case involved a man who had lured unwitting Bitcoin enthusiasts into what the Securities and Exchange Commission alleges was a rudimentary Ponzi scheme. The defendant (who referred to himself, inauspiciously, as a "pirate" in his online profile) argued that the SEC couldn't sue him because the Bitcoin investments he was offering didn't amount to actual, real-life securities.
The judge thought otherwise. The suit will proceed. And Bitcoin fans have concluded that Bitcoin is now a step closer to being respected as actual, real-life money. (My colleague Kirsten Salyer explains their reasoning here.)
But instead of affirming Bitcoin's legitimacy as a new and revolutionary currency system, the case actually demonstrates its insoluble contradictions: The closer Bitcoin gets to being an accepted currency, the less useful it will be as a method of exchange. And the less useful it is as a method of exchange, the harder it is to see why it has any value at all.
Almost all the advantages Bitcoin has -- it's cheap, somewhat convenient, anonymous, free from centralized authority -- derive from the fact that governments haven't taken it very seriously. As the Texas case shows, that's changing. The SEC has issued a pointed warning about investment schemes using virtual currencies; its crackdown is unlikely to stop with the wayward Texan. The Treasury Department's Financial Crimes Enforcement Network has issued rules defining virtual currency exchanges and administrators as "money service businesses," with all the attendant regulation that implies.
The Federal Bureau of Investigation has expressed its interest. So has the Homeland Security Department. And the Internal Revenue Service has surely noticed Bitcoin's appeal for some other users -- say, citizens with a lot of money and not much civic enthusiasm. I bet the percentage of users who pay taxes on the gains they realize after selling bitcoins approaches zero. That means guidance from the IRS is on the way. And Bitcoin users won't like it one bit.
See, the thing about transferring money -- the thing that makes it expensive and cumbersome and oh-so-20th-century -- is that it comes with these annoying rules. Companies that move money have to register themselves and apply for licenses. They have to comply with money-transmitter laws. And the Patriot Act. And the Bank Secrecy Act. And international anti-money-laundering norms. And, if they're overseas, the profoundly complicated and meddlesome Foreign Account Tax Compliance Act. And then there's the taxes.
All of which is to say that doing anything legally with bitcoins -- and especially converting them into fiat currencies -- is going to get harder and more expensive as governments involve themselves. So hard and so expensive, I'd argue, that any advantages the crypto-currency may have over normal means of exchange, like credit cards, will soon disappear.
And if Bitcoin isn't an improvement as a method of exchange, what's it good for? Unlike gold or silver, bitcoins have no intrinsic uses; they can't be turned into dental fillings or jewelry. Their price is unstable, meaning they're unlikely to overcome network effects and implausible as a store of value. They can't be used to pay your taxes. They are algorithmically in finite supply -- 21 million will eventually be created -- so either users will willingly submit to a further deflationary spiral or, more likely, they'll clamor to expand the stock. Or do so by fiat. Either would negate Bitcoin's putative advantages over normal central banking. And should the system get hacked? You've got no bitcoins, no deposit insurance and no one to complain to.
The only people likely to still be interested, then, will be those who want to purchase things anonymously. And they should have some doubts about just how anonymous they're going to remain.
The group of developers who came up with Bitcoin did not produce a viable replacement currency, a revolution or even a particularly wise investment opportunity. They invented a very clever peer-to-peer payment system that also happens to enable fraud, tax avoidance, drug dealing and other sordid pursuits that governments won't abide for much longer.
(Timothy Lavin is an editorial writer for Bloomberg View. Follow him on Twitter.)