Why bitcoin's success could be its downfall

Digital currencies have been front-page news as the value of bitcoin, the most popular of the cryptocurrencies, continues to surge, albeit with wild fluctuations. Bitcoin backers argue that once digital currencies become widely used, governments will be unable to destroy them — users simply won’t allow it.

This view falls short on two points. First, digital currencies, even in their current form, are a bigger threat to national governments than most people currently understand.

Second, bitcoin’s success would also be its downfall. As bitcoin gains popularity, and especially if it stabilizes in value, it becomes a viable substitute for government-backed currencies. But national governments have little incentive to allow this type of direct competition.

The hidden cost of digital currency

National governments tolerate bitcoin and other forms of cryptocurrency because these currencies are still bit players in the global economy. Bangladesh, Bolivia and Kyrgyzstan are among the handful of countries to have banned bitcoin transactions. The United States, Japan, the European Union and other governments have discussed stricter controls, but most seem to be taking a wait-and-see approach to regulation.

Most countries allow citizens to buy and spend digital currencies. In the United States, some stores and restaurants accept bitcoin as payment, and there are even some bitcoin ATMs. Increasingly, however, people are buying into bitcoin less to use as currency and more as an investment, hoping that bitcoin will continue to increase (bubble?) in value. Many fewer trades involve the actual purchase of goods or services, and converting large amounts of bitcoin in dollars can still be tricky.

For now, currencies like bitcoin are too volatile to be used for long-term saving or lending — this means they won’t readily replace dollars or euros. But governments cannot control the movement of digital currencies across borders — and that’s why these currencies already pose a threat. Digital currencies can provide a means to evade government restrictions on currency exchange and capital outflows.

Our research shows that countries frequently impose currency restrictions for political and economic benefit. By restricting the conversion of their national currency into dollars, for instance, national governments can prevent investors from fleeing their economy too quickly.

Or governments can move to stabilize the national currency in times of crisis. The United Kingdom may well tinker with its currency exchanges to “manage” Brexit better domestically, for example. If citizens hold large bitcoin reserves, their holdings are effectively free from these types of traditional government restrictions on currency flows.

Bitcoin backers may believe governments couldn’t kill off bitcoin or other digital currencies — but this is a mistaken assumption. Governments can make the possession, use and exchange of bitcoin illegal. While a democratic government might be hesitant to ban bitcoin if citizens strongly oppose doing so, such a ban is clearly within its power. Governments regulate, and even ban, currencies all the time.