- Personal Savings
- Personal Spending
- Business Spending
- Full Departure
PERSONAL SAVINGS
The first phase of the crypto takeover is characterised by people entrusting their savings to the cryptosphere. That is, people ``invest'' their savings in crypto because they believe it to be a (1) safe place to store their money and (2) profitable way to use their savings to create more savings. Note that historically this function has been fulfilled by banks, however also note that your money is not really safe and not really profitably stored in a bank. First of all, the interest rate offered by banks on standard savings accounts rarely yields a profit, leaving people who'se savings are too little to invest but too much to keep in cash in an unfortunate position. Second, your money is ``safe'' only as long as the bank remains in business. Many banks have gone down in the past, and so the safety of your money depends on how much you trust your bank. Not only that, but do anything the state dissaproves of and your assets are possibly forfeit. The state reserves the right to seize your assets if you break the law, and the law is decided by the state, so you are entirely at the mercy of the state in this regard. That is, the safety does not only depend on your trust in the bank but also on your trust in the state. It may seem like the last note is not a problem for the law abiding citizen, but laws can and do change. Increasingly authoritarian free speech laws have already led to raids in the EU and the jailing of a man the UK over statements that were perfectly legal only years before. It is also worth noting that most people do not live in the West and suffer from authoritarian regimes that outlaw things that we generally do not such as homosexuality or women walking outside without men. The law is not necessarily just just because it is the law, or in the words of Bastiat: "Slavery, protection and monopoly find defenders not only in those who profit by them but inthose who suffer by them. If you suggest a doubt as to the morality of these institutions, it is said directly --You are a dangerous experimenter, (...), a despiser of laws; you would shake the basis upon which society rests." [note]the Law, Frédéric Bastiat, 1850[/note]Clearly when it comes to matters of safety, the level of trust should be maximized but the amount of trust should be kept to a minimum. When keeping a secret, you want the people you entrust the secret to to be trustworthy but the amount of people as close to zero as possible. Any trustee is a liability and it is desirable to have as little liabilities as possible. Cryptocurrencies therefore provide an out for people who want to reduce the minimal amount of trustees from two to zero. With cryptocurrencies you are the only person who can access your savings. There is no feasible way to access your funds without your private key, and it is up to you to keep your private key safe. With some cleverness it is possible to store your private key in such a way that it cannot be lost but still be nearly 100% safe. For example, changing the character in the position that is your favorite number, or doing some permutation of the characters in a way that you can remember makes your private key even when found by a malicious agent unusable. This means the key to accessing your funds is entirely in your brain, and the funds are locked in cryptospace forever. Even if you do something the state disagrees with it cannot touch your crypto funds. The state can come knocking on your door and demand you hand over your funds, but it will have to resort to some form of torture to get the key out of you. Only the most authoritarian and desperate of states will resort to torturing its own citizens, especially if a large part of its citizenry is guilty of the same ``crime''.
Because of all this cryptocurrencies will become an attractive place to store wealth. First for those in disagreement with the state in one way or another but later also for others who simply want a place to store their wealth in a profitable way. As more people start using cryptocurrencies big swings in prices will decrease and price indexes will stabilize. However, as long as, for example, Bitcoin's popularity rises, its price will rise due to its inherint deflationary properties. There will only ever be twenty one million bitcoins in existence and that maximum only drops due to funds being lost constantly. This is why this phase is dubbed the Personal Savings phase, as people will start adopting new methods of storing their personal savings and leave the old methods. Also note that this phase has already started. Millions of people around the world have heard of Bitcoin and have converted their savings to crypto in order to put their savings to work. However, this phase has only just started, as billions of people more have not.
PERSONAL SPENDING
Cashing out crypto is an expensive and laborious process. It usually goes something like this: Alice has put $100 of her savings into Bitcoin, and that Bitcoin is now worth $10,000 (Alice was early). Alice is not very wealthy. After all, she only had $100 in savings. Now she has $10,000 however, many times her monthly wage, and she would like to use this money to improve her life. Barely any store accepts Bitcoin, so she will have to convert her bitcoin to cash before she can use it in the real world. Alice sends her Bitcoin to Coinbase, and pays a transfer fee of about $30. She then sells her Bitcoin on Coinbase and pays a 1.5% fee, or $149.55. Next, she can expect to pay between 10 and 30 percent capital gains tax, leaving her with between $6,874.32 and $8,838.41 of her $10,000. It would be beneficial for Alice if she did not have to spend all that time and money simply to make a purchase. She stands to gain much from being able to do transactions in cryptocurrency. Hence the name of this phase: Personal Spending.
As illustrated above, everyone in the cryptosphere stands to gain from being able to transact in cryptocurrencies. Not only would it save everyone time, it would save them at least the cost of the conversion service, and at most their taxes if they decide not to report the transaction. This is likely as long as the transactions are small and maskable, for example, if you pay for your groceries in a privacy oriented cryptocurrency that masks transactions. If you have any doubts about the likeliness of this scenario, it is always helpful to think of the real life example of off-the-books work. It is very common for odd jobs to be paid out off the books, and very little people object to this phenomenon. Usually people agree that going through the process of declaring these gains would be too laborious to justify. If there were a 100% chance of getting caught in the act no doubt people would think otherwise, but since the state has limited resources and since people recognize that it is unlikely to be caught let alone prosecuted over fraud worth only a couple dollars, they take the risk. It is therefore likely that people will think the same way when it comes to occasional purchases, where declaration will be laborious and the chance of getting caught will be low.
Because it would be beneficial for cryptocurrency users for shops to accept cryptocurrency transactions and because we are by this time well into Phase 1, meaning a large part of people have a large part of their savings stored in crypto, there will be an incentive for stores to start accepting cryptocurrencies. If one grocery store starts accepting crypto payments for groceries and everything else stays the same people will flock to this shop for the simple reason that they stand to gain both time and money by shopping there. Think for a second about what an impact sales have on shopping behaviour, and now imagine a shop opens that has a permanent sale between 1.5% (the cost of conversion of BTC to USD) and 30% (the cost of capital gains taxes that can be circumvented). It is not outside the realm of imagination to imagine many people will choose to shop here. Shops gain an edge over their competition by accepting cryptocurrency payments, and in a capitalist society business owners are always looking for that edge.
Another angle to this argument is to use simple game theory. Consider for example how advertising currently works. To start with, consider a world where there are two soft drink manufacturers, and they both do not advertise. The popularity of each drink will be dependent on personal taste, availability and word of mouth only. Now soft drink manufacturer A decides to dabble in the world of advertising. Because of his advertising, soft drink A becomes much more well known than soft drink B, and people default more often to soft drink A relative to soft drink B. Manufacturer B is not having it and starts an advertising campaign as well. His campaign is more aggressive and he reaches a wider public, and soft drink B becomes more popular than A. An advertising war starts, and each company is forced to spend as much as it can on advertising. We can pose the question however, "Do A and B benefit from this situation?". They are forced to spend money on advertising to return to the status quo, and one can wonder if they wouldn't be better off not advertising at all. If this is true, we are stuck in a situation where we are in a collective optimum, but one player's selfish move means great gains for him and losses for his opponent. However, if both players act in their own self interest and against the other we move to a worse situation for both. We can compare the situation with crypto transactions in the following way: If one store accepts cryptocurrencies he forces his competitors to also accept them or suffer the wrath of the market.
BUSINESS SPENDING
The next phase is dubbed Business Spending, and is a very important and tricky step. In this businesses make a transition from conducting business amongst eachother in state currency to using cryptocurrencies. The reason for this transition is similar to the one that went before, where businesses started accepting cryptocurrency transactions from customers because these customers had cryptocurrency to spare and were actively looking for a place to spend it. Once we are well into the personal spending phase, businesses will find themselves in a position where they have large incomes in various cryptocurrencies, and because of the benefits of keeping their money in cryptocurrencies and because of the hassle and costs involved in having to convert these cryptocurrencies back to fiat, they will tend to keep at least part of their earnings in cryptocurrencies. More over, this part will tend to increase as income from cryptocurrency payments increases and income from fiat payments decreases. As business cryptocurrency stores increase they will be looking to spend these funds without having to convert them first to fiat. Especially in business to business transactions there is always an interest in fast and optimized transacting. When faced with two options, namely (1) converting crypto to fiat and then exchanging goods for fiat or (2) exchanging goods for crypto directly, it is very likely that businesses will start going for the latter option over the former as cryptocurrencies become more and more accepted. For one, the former option includes a third party, namely a bank, which brings with it a liability. Moreover there are costs and labor involved with converting crypto to fiat, and costs are always undesirable. We find ourselves in the same position as in the previous phase, where there is the opportunity for a profit minded actor to exploit the gap in the market created by businesses wanting to purchase supplies with crypto but having no one who will trade them for crypto, and these kinds of gaps usually do not exist for long in a free market situation.
Of course businesses also employ many people and these people want to get paid. However, since we are past phase two and these people have a large part of their savings in cryptocurrencies, and since businesses now accept cryptocurrency transactions it becomes a hassle for these people having to convert their salaries to crypto each month. For the business the situation is quite the same. As the business is accepting cryptocurrency payments and as we are past phase two and many people are now transacting in crypto, it will be cumbersome for the business to have to convert their cryptocurrency earnings to fiat in order to pay their employees, who will convert those wages back to crypto anyway. Crypto salaries will be greatly beneficial to both parties and will be welcomed with open arms.
There is another reason for businesses to start transacting in crypto amongst eachother. As in the previous phase cryptocurrencies create a blind spot for state control. In my last article the concept of an end point was defined as that point in the market mechanism where crypto needs to turn into fiat. Right now there are many end points. For example, if a person wants to buy groceries with cryptocurrencies he first needs to convert his crypto to fiat, and then make the transaction at the store. The end point in this example lies on the customer's side. However, as cryptocurrency transactions become the norm in the personal spending phase, the end point will move to the business' side. The consumer will trade his cryptocurrencies for goods and the business will have to convert those cryptocurrencies to fiat to be able to transact with other businesses. The state, noticing the threat cryptocurrencies pose to its power over the monetary system, will want to keep very close watch over these end points. Therefore it is in your interest, if you want to keep your business private, to move this end point away from you. Businesses that do this will find that it becomes a lot easier to be able to commit fraud, even if it is only a small amount, and will therefore be more profitable. We have already discussed why it is likely that many people will not object to `light' fraud, such as working off the books or buying some goods under the table. These things already happen, and many people condone these goings on or if not, turn a blind eye. When punishability plummets and therefore profitability peaks it is likely that this kind of behaviour will turn more common.
We hereby have a threefold of reasons for businesses to adopt cryptocurrencies for mutual transactions. The first being lower costs for both parties, the second being the exploitability of a position as a crypto accepting business and the final reason being the incentive for (light) fraud. The end of this phase, full normalization of cryptocurrency transactions between all businesses brings us to the final phase.
FULL DEPARTURE
After phase one, most of people's savings will be in cryptocurrency. After phase two, most of personal transactions will occur in cryptocurrency. After phase three, most of business transactions will occur in cryptocurrency. One can wonder, then, what do we still need fiat money for? In stage four, the Full Departure from fiat, more and more people will find the answer to this question: nothing. There simply is no function that the common person needs fiat to fulfill that crypto cannot. The average person needs money for two things, trading and saving, and both functions have now been taken over by cryptocurrencies. People will steadily depart from fiat entirely.
THE STATE
A case has been made for each phase and under fully free market conditions these phases will surely happen in quick succession. However in the real world the market is far from free. Until now we have ignored the role of the state in this story completely, but it is foolish to think that the state will just stand idly as each phase happens before its eyes. Much more likely is that the state will realize very early on what is happening to its power over the monetary system and will spring into action. We can expect the state to try and stop each phase before or as it happens, or even after it has happened. Let us discuss now what we can expect from the state in terms of regulation and legislation in each phase.
PERSONAL SAVINGS
At this time in the game the state will not be very interested in intervening. Intervention in the form of regulation will probably more costly to the state than the little amount the state gains in revenue from capital gains tax on the average subject's couple thousand in savings. However, even though the state will not be acting, savvy states will become aware of the problem that cryptocurrencies will pose in the future. In this phase, states will be preparing and introducing the legislative framework for measures to be taken in the future. Since we are already in this phase we should be seeing the first signs of these moves, and we are. For example, Labour MP John Mann made the following statement: “These new forms of exchange are expanding rapidly and we’ve got to make sure we don’t get left behind – that’s particularly important in terms of money laundering, terrorism or pure theft." We can expect states to start classifying cryptocurrency assets as their own special category of property so that they, for example, can be distinguished from other property when it comes to tax law. For example, the Court of Justice of the EU has ruled that Bitcoin should be classified as a currency as opposed to a commodity. This means that the purchase of cryptocurrencies is exempt from VAT. On first look this may seem like an especially consumer friendly move, but classifying cryptocurrencies as currency means that VAT must be paid over any transaction done with crypto. The state therefore foregoes the small amount it would have gained from the initial conversion of fiat to crypto, and instead takes a cut every time crypto changes hands.
Any regulation at this point will be framed in way such that it may seem good for the consumer. A state may say “Virtual currencies may have potential benefits, but consumers need to be cautious and they need to be asking the right questions. Virtual currencies are not backed by any government or central bank, and at this point consumers are stepping into the Wild West when they engage in the market.”[note]CFPB Director Richard Cordray - https://www.consumerfinance.gov/about-us/newsroom/cfpb-warns-consumers-about-bitcoin/[/note]
PERSONAL SPENDING
As mentioned in the last paragraph by this time most countries will have some classification for cryptocurrencies in place, meaning the legal framework is there for the state to tax its subjects for cryptocurrency transactions. However, as cryptocurrency transactions by their nature are very hard to track and as this will make fraudulent behaviour all the more attractive, states will have an interest in very closely monitoring spending behaviour. End points are moving from consumer to business by this phase, and thus the state's eye will be on businesses. It is not unlikely that we will see regulations introduced on the hardware used to make cryptocurrency transactions. State regulated payment terminals with invasive software requiring some proof of ID so the state can track every payment may be an option. However, systems like this will be very expensive and maintaining a database for payments may become unwieldy. Also worth noting is that more and more of consumers are doing their shopping online and rarely even touch physical products before they are bought, and this kind of system is useless for online shopping, especially when purchases are made across borders. More likely would be that the state require citizens to provide it with details of their cryptocurrency payment addresses so that it can automate tracking of spending behaviour. For this to work cryptocurrency addresses must be public, but there are currencies that are privacy oriented and keep transactions and balances hidden. It is likely that a state will discourage the use of these kinds of privacy oriented cryptocurrencies, maybe by informing the public that these kind of currencies are too dangerous as they could be used for money laundering, for the funding of terrorism etc. We can safely make this prediction as the same worries are already present with respect to non-privacy oriented cryptocurrencies.
If states decide to outlaw the use of these cryptocurrencies or cryptocurrencies in general, we can expect fines for breaking the law to be exceptionally high. This is only logical as only a very high fine will deter potential criminals. Purely mathematically, if I am purely profit oriented and have no moral code, I will commit a crime if its expected return is positive. Let us take the crime of theft, and let us suppose that there is a fixed fee for theft of $1,000, and let us suppose that the chance of getting caught is very high: one of two thieves get caught. In this situation, I expect to make a profit if whatever I am trying to steal is worth more than $1,000. Namely, if I get caught I pay $1,000, but if I get away with the crime I earn more than $1,000. Now suppose the chance of getting caught decreases to 25%. I would now even commit the crime if whatever I am trying to steal is worth only over $333.34. As the chance of getting caught goes down, so does the value of the thing I am willing to attempt to steal. Even with a fine of ten thousand dollars, if the chance of me getting caught is only 1% I am willing to take the risk as long as whatever I am trying to steal is worth over ten dollars and one cent.
We have already discussed why any issue of morality tends to dissapear when people are dealing with the state, and the chance of getting caught for concealing cryptocurrency savings using privacy oriented cryptocurrencies is very very low. It therefore follows that in order to deter this behaviour the state will have to put in place very high fines, or even jail time. There will be a point where even the most naive of citizens will start to doubt his loyalty to the state. After all, why would the state punish a subject so harshly for a crime for which the consequences are so intangible. The threat of terrorism has never seriously worried anyone for very long, let alone the financing of terrorism. How silly then would it seem that someone would be harshly punished for posessing the means with which some party may or may not be financing terrorism. The same case can be made for money laundering. It will be a very risky move for the state to harshly punish anyone guilty of this 'crime', and the state will do its best to save face, using the media and anything else at its disposal.
BUSINESS SPENDING
Businesses especially stand to benefit from easy fraud. For you and me, avoiding taxes leaves us with more money in our pockets. For businesses the extra revenue gained by dodging taxes could mean the difference between staying in or going out of business. When one of your competitors is willing to commit tax fraud he effectively forces your hand. Either you do it too or you lose business to him, as he is able to provide the same product or service for a lower cost. In this way fraudulent behaviour becomes part of the business model. It is calculated in. Whenever there is the option to commit tax fraud you stand to gain (amount to be gained)×(chance of getting away with it) - (price of getting caught)×(chance of getting caught). For example, suppose your business is inspected once a year for illegal workers, and the fine for hiring an illegal worker is $1000 per worker. However, illegal workers work for much less, and therefore each illegal worker saves you $200 a month. The chance of getting caught in a particular month is one in twelve, so we expect to save $100 a month hiring illegal workers, even if we get caught! In fact over a year this practice saves us $2400 and only costs us $1000. In practice there may be other issues at stake. The business owner may be personally opposed to taking risks or there may be different consequences for repeat offences, etc. The point, however, remains valid. When there is the opportunity to commit tax fraud there is the opportunity to gain an edge over the competition, and many businesses, always looking for that edge, will be eager to take it.
If you have any objection to this, we have plenty of real world examples. Everyone is familiar with the practice of under-the-table work, where a business hires a person and pays him without the government knowing. But why does this practice exist? After all, the people hired are usually of equal or lower skill than people in the legal job market. Businesses hire these people in order to save money. But what are they saving money on? It cannot be the worker himself. If the worker got paid less than he would in the legal job market, then he would not take the risk. Both the employer and the employee stand to gain here, so we can only conclude that they both are saving on the taxes that they do not pay. The employer is able to pay the employee more since he does not have to pay taxes, and the employee is satisfied with less since he does not have to pay taxes.
The state is aware of all the above and will want to keep a close eye on business spending. We have already discussed why physical systems are likely too ineffective and expensive. More likely is that the state will want to monitor business spending closely, and will both forbid the business from owning any private cryptocurrency accounts and mandate that the business tell the state what its public cryptocurrency accounts are. In fact, this will make it easier than ever for the state to monitor business spending. If the state does decide to go this route we can again expect fines for owning and using private cryptocurrencies to be very high, especially since businesses are already in a position where they are used to making cost-benefit calculations, and so will be more inclined to take the risk of getting caught if the expected gain is positive.
A possible solution for businesses may be to design a system for payment that diverts some percentage of transactions made into a seperate and secret private cryptocurrency account. Especially for online business this would be very easy to implement. The percentage could be adjusted to an optimum between the amount of risk the business owner is willing to take and the amount he stands to gain.
CONCLUSION
Without state interference it is clear that the change from fiat to crypto would happen in no time at all. There is no benefit to using fiat over cryptocurrencies for the average person. The main difference between the two is centralization. The ideal cryptocurrency is fully decentralized, whereas fiat is fully centralized. Full decentralization may not be realisable but less than full decentralization definitely so, and as we move away from full centralization, people around the globe will start to note the benefits and a movement is started in the direction of less and less centralization. The one to suffer from this move is the state, as it loses the main sources of its power, namely the ability to inflate the money supply and to tax its subjects. We can therefore expect the state to react violently in an attempt to keep its position of power. A reasonable expectation is the regulation of cryptocurrencies, and especially the banning of privacy oriented cryptocurrencies. These keep the state from observing your spending and saving behaviour, and taxing becomes much harder. Other cryptocurrencies are less of an issue when the state mandates that you tell it your cryptocurrency addresses so it can monitor them. For you or me it would be easy to make another address that we keep secret, but for businesses this becomes much harder.
I am not alone in the sentiment that privacy oriented cryptocurrencies will play a massive role in the future. For example, John McAfee has tweeted the following:
I am inundated by people asking me for recommendations on cryptocurrencies. If you would use your heads you would figure out that the privacy coins (anonymous transactions) will have the greatest future. Coins like Monero (XMR), Verge (XVG), or Zcash (ZEC) cannot lose.
— John McAfee () December 13, 2017
So in conclusion, stock up on privacy coins and get ready for the ride.