The Empire Strikes Back At Bitcoin

One of the uncertainties with cryptocurrencies has always been how governments would react once bitcoin and its kin got big enough to actually threaten the monopolies of national fiat currencies.

That day seemed to be approaching as cryptocurrencies’ aggregate market cap blew through $100 billion and the pipeline of new bitcoin wannabes (initial coin offerings, or ICOs) swelled into the hundreds. Even – in a classic sign of a bubble top — Paris Hilton got involved:

Hotel Heiress Paris Hilton Is the Latest Celebrity to Promote an ICO

(Coin Desk) – Celebrity heiress and reality TV star Paris Hilton has taken to Twitter to announce her participation in a token sale, or ICO.

Called Lydian, the venture claims the project is developing “blockchain driven technologies to reduce ad fraud and to maximize the effectiveness of ad marketing expenditures.” The idea has been floated by a number of projects of late, including efforts backed by advertising industry participants.

In the tweet, Hilton wrote:

Looking forward to participating in the new @LydianCoinLtd Token! #ThisIsNotAnAd #CryptoCurrency #BitCoin #ETH #BlockChain pic.twitter.com/a8kT9eHEko

— Paris Hilton (@ParisHilton) September 3, 2017

And lately governments have indeed begun to defend their turf. The US Internal Revenue Service decided that since cryptocurrencies were clearly not money (only the dollar is money!) they must be commodities, which means every transaction creates a taxable gain or loss. In August the IRS drove the point home by unveiling software that can track supposedly anonymous crypto transactions:

The IRS Has Special Software to Find Bitcoin Tax Cheats

(Fortune) – One benefit of using bitcoin is the digital currency can be anonymous—its owners can move money around the world without revealing who they are. Well, in theory at least. In reality, bitcoin is less secret than people think.

The latest reminder of this comes via a report that the Internal Revenue Service is using software to unmask bitcoin users who have failed to report profits. According to a contract unearthed by the Daily Beast, the IRS is paying a company called Chainalysis to help identify the owners of digital “wallets” that users employ to store their bitcoins.

In a letter to the IRS, the co-founder of Chainalysis says the company has information on 25 percent of all bitcoin addresses and that it deploys millions of tags to help track and identify transactions.

The decision by the IRS to license the software of Chainalysis, which is based in Switzerland with an office in New York, appears to be part of the agency’s larger campaign to target digital currency users who have failed to pay tax.

As Fortune reported earlier this year, the IRS claims only 802 people declared a capital gain or loss related to bitcoin in 2015. This is significant since the price of bitcoin soared from around $13 to over $1100 between 2013 and 2015, and hundreds of thousands (like millions) of Americans bought and sold digital currency during this time—in other words, there are many people who face bitcoin-related tax trouble, and the IRS is tracking some of them down.

Then China decided it had had enough of the dot-com-like tsunami of new digital currencies pouring into its economy, and banned future releases, crashing the price of most extant cryptocurrencies.

China Halts Initial Coin Offerings

(Bloomberg) – Bitcoin tumbled the most since July after China’s central bank said initial coin offerings are illegal and asked all related fundraising activity to be halted immediately, issuing the strongest regulatory challenge so far to the burgeoning market for digital token sales.

The People’s Bank of China said on its website Monday that it had completed investigations into ICOs, and will strictly punish offerings in the future while penalizing legal violations in ones already completed. The regulator said that those who have already raised money must provide refunds, though it didn’t specify how the money would be paid back to investors.

It also said digital token financing and trading platforms are prohibited from doing conversions of coins with fiat currencies. Digital tokens can’t be used as currency on the market and banks are forbidden from offering services to initial coin offerings.

“This is somewhat in step with, maybe not to the same extent, what we’re starting to see in other jurisdictions — the short story is we all know regulations are coming,” said Jehan Chu, managing partner at Kenetic Capital Ltd. in Hong Kong, which invests in and advises on token sales. “China, due to its size and as one of the most speculative IPO markets, needed to take a firmer action.”

Bitcoin tumbled as much as 11.4 percent, the most since July, to $4,326.75. The ethereum cryptocurrency was down more than 16 percent Monday, according to data from Coindesk.

And apparently there’s more coming:

ICO crackdown may just be the start: China is reportedly planning tighter cryptocurrency rules

(CNBC) – China is poised to further tighten rules on virtual currencies after regulators on Monday banned virtual coin fundraising schemes, Chinese financial news outlet Yicai reported, citing sources.

China banned and deemed illegal the practice of raising funds through launches of token-based digital currencies, targeting so-called initial coin offerings (ICO) in a market that has exploded since the start of the year.

Yicai’s report late Monday cited a source close to decision-makers as saying the announcement on the ban was just the start of further follow-up regulations of virtual currencies.

The above raises two big questions. First, how will cryptocurrencies fare in a world of increasingly strict and complex regulations? Second, what kinds of assets stand to benefit if cryptocurrencies cease to function as “digital gold”?

The first question is a tough one, because it involves the interplay of governments, revolutionary tech and free markets, which means pretty much anything is possible. The second, though, is easier: If digital gold falters, real gold wins:

Mobius Foresees Cryptocurrency Crackdown Sparking a Rush to Gold

(Bloomberg) – Mark Mobius is sensing danger in the explosive growth of cryptocurrencies.

Governments will begin clamping down on digital currencies because of their use in illicit financing, with terrorist groups to drug dealers contributing to their rise, Mobius, executive chairman at Templeton Emerging Markets Group, said in an interview in Hong Kong Monday.

“Cryptocurrencies are beginning to get out of control and it’s going to attract the attention of governments around the world,” Mobius said. “You’re going to get a reversion back to gold because people are going to wonder, can I really trust these currencies?”

Mobius isn’t the only one voicing concern. Bank of America Merrill Lynch was cautious around bitcoin in July, saying there were a lot of obstacles, such as theft and hacking risks, that make it unlikely it will gain the status of pledgeable collateral.

“People need a means of exchange and they need to trust that,” said Mobius, who was interviewed before China’s announcement. “Right now the trust is good — with bitcoin people are buying and selling it, they think it’s a reasonable market — but there will come a day when government crackdowns come in and you begin to see the currency come down.”

********