Price Discovery in the Absence of Bitcoin Exchanges

By Jon Matonis
CoinDesk
Tuesday, December 31, 2013

http://www.coindesk.com/price-discovery-absence-bitcoin-exchanges/

Recently, authorities in India, China, Korea, Denmark, France, and Norway have issued stern warnings regarding the use and trade of bitcoin and other digital currencies.

As a consequence, important exchange outlets for price discovery have been slowed or shuttered following the government advisories. Furthermore, India and China represent nearly half of the globe’s total population.

The world has mostly underestimated the latent demand for a free and nonpolitical currency unit. In the face of this percolating demand, the arrogance of our monetary overlords is startling.

Imagine if we were forced to use a particular brand of toothpaste in the same way that we are coerced into using the prevailing unit of legal tender. The response might not be so submissive. Contrary to the misinformation in this article, bitcoin is not illegal in any country in the world.

In two separate incidents following the Reserve Bank of India advisory warning, trading operators’ premises were raided by the Enforcement Directorate (ED) citing a clear violation of Foreign Exchange Management Act (FEMA) rules. A top ED official said:

“We have found that through the website 400 persons have recorded 1,000 transactions that amount to a few crores of rupees. We are gathering the data of the transactions, name of the people who have transacted in the virtual currency from Gupta’s server that is hired in the US. At present, we believe that this is a violation of foreign exchange regulations of the country. If we are able to establish money laundering aspect then he can be arrested.”

In the days ahead, the ED will be challenged either to define bitcoin as a currency or to clarify the nature of bitcoin as an asset under Indian law.

Also, the South China Morning Post reported that China’s central bank met with payment processors on 16th December, ordering them to “stop giving clearing services to bitcoin, litecoin, and other cryptocurrency exchanges”.  The payment processors were ordered to sever their relationships with bitcoin exchanges by the end of January.

This action had a significant impact on bitcoin exchanges in China, such as BTC China.

In Korea, financial authorities announced that “the virtual currency does not have ‘intrinsic value’ due to its lack of stability while there is concern at the absence of structure and indicators to measure it.” Participating government agencies discussing the impact of bitcoin included the Ministry of Strategy and Finance, the Bank of Korea, the Financial Services Commission, and the Financial Supervisory Service.

In Denmark, Michael Landberg, chief legal adviser at the Financial Supervisory Authority in Denmark, said the most likely outcome for bitcoin exchangers would be an “amendment to existing financial legislation so that we have regulation covering it.”
Landberg added:

“It is also important to have this included in money laundering acts. We’ll seek to follow the mainstream. Bitcoins are not forbidden in the US and the UK It is out there and will continue to be out there. It just needs to be regulated. The challenge for us is how to do that.”

Currently, Denmark’s FSA doesn’t have the legal authority to prevent trade in bitcoin rendering it unable to stop a company that exchanges real currencies for bitcoin.

A report from the Bank of France said: “Even if bitcoin does not today meet the conditions to become a credible means for investment that could therefore threaten financial stability, it represents a clear financial risk for those that hold it.”

Warning that the use of bitcoins as an investment tool is limited because there is no underlying asset and the virtual currency is subject to high volatility, the central bank said speculators are at risk, as they would have no legal recourse if there is a loss of confidence in the cryptocurrency or if they are victims of theft from hackers.
According to the Bank of France report:

“The system can collapse at any moment if investors want to unwind their positions but find themselves holding portfolios that have become illiquid.”

In Norway, the director general of taxation, Hans Christian Holte, said the currency “doesn’t fall under the usual definition of money.” Instead, the Norwegian government decreed bitcoin to be an asset upon which capital gains tax can be charged.

Even the European Banking Authority (EBA) weighed in with its own report on virtual currencies warning consumers that they are not protected through regulation when using virtual currencies as a means of payment and may be at risk of losing their money.

These various warnings from around the world have not yet affected the larger price discovery mechanism for bitcoin which still occurs in certain jurisdictions. But, what if exchange-based price discovery for bitcoin was impeded in the future. What would be the price setting mechanism for conversion in and out of national currencies?

Just as with other restricted or ‘banned’ goods around the world, bitcoin trade would react by going local and going to a person-to-person model, such as LocalBitcoins.com. Additionally, small exchanges in certain countries would still cater to a local population in jurisdictions where crackdowns were not prevalent.

It might not be easy to chart aggregated price quotes from hundreds of small operators, but price discovery finds a way like water finds a way to flow downhill.

These global authorities are genuinely afraid of something like bitcoin with its limited issuance model and distributed trust architecture not requiring intermediaries.

However, they don’t fear it because of the potential for money laundering, terrorist financing, or harm to unsuspecting consumers. Authorities fear bitcoin because it threatens the adherence to their fabricated monetary illusion.

The genie is out of the bottle and centralized banking institutions are no longer seen as necessary for the provision of an exchangeable monetary unit. This cuts to the core of government’s power and prerogative of issuance, making bitcoin primarily a central bank concern – not a money laundering concern.

Some may attempt to harness the genie in the name of innovation and consumer protection, however the power of bitcoin will prove too difficult to contain. The best solution from authorities will be to accept the changes and to modify political behavior around a forthcoming model of decentralized currencies.