Virtual currencies or crypto-currencies, led by bitcoin, have experienced a tremendous growth in popularity. Until recently, few had heard of them, much less used them.
But their development, with all of its benefits as well as issues, has been remarkable and continues transforming the financial landscape. However, virtual currencies operate outside the banking system and are still not recognized as currency by states and governments. Accordingly, it is yet to be widely accepted by the various players involved in domestic and international commerce.
International arbitration, now commonly used and respected, originated under similar circumstances. Thus, I believe bitcoin has a lot to learn from international arbitration.
Let’s start from the beginning. What is bitcoin?
Bitcoin is a virtual currency held in a “digital wallet” on your PC or cellphone. Payments are sent from one account to another (like with PayPal) and an encryption system verifies that the transactions are legitimate, something which is ultimately corroborated by other bitcoin users.
One of the principles of bitcoin is that there is no central bank or government backing it, and its value fluctuates. It was valued at a few cents when it was created in 2009, but rose to $1,000 at the end of last year. This has resulted in speculation and controversy, and has served as ammunition by those trying to discredit it.
One of these events was the bankruptcy of Mt. Gox (one of the oldest and largest bitcoin exchange operators) and Flexcoin, which caused a sudden drop in value of the virtual currency to $200 from $700, although a few days later it was trading at above $600 again).
Bitcoin is used globally, including in Asia, Europe and the United States. The number of transactions is on the rise, now hovering at around 100,000 per month.
A growing number of businesses are accepting bitcoin, including retailers such as TigerDirect and Overstock; and physical bitcoin exchanges are cropping up. Naturally, governmental authorities are paying closer attention to bitcoin.
Money Or Object?
Fed Chairwoman Janet Yellen referred to bitcoin as a “useful, innovative method of payment which has made a space for itself outside of the banking system.” Indeed “space” and “outside” are some of the challenges facing bitcoin—governments do not recognize it as a currency.
In the United States, for example, the Internal Revenue Service has classified bitcoin as property rather than currency. As a result, a transaction with bitcoin results in a trade, similar to selling gold or stock. Thus, if the price of the bitcoin increased by the time the user made a transaction, the user must pay taxes for the difference.
Additionally, users will have to report to the IRS any transaction valued above $600, as well as every instance where bitcoin is used to pay salaries, wages, rent and other forms of compensation. If bitcoin was treated as a foreign currency, ordinary tax rates—not capital gains—would apply, and losses would be easier to deduct.
How to bring bitcoin inside the system and gain acceptance from governments around the globe is something bitcoin can learn from international arbitration.
For bitcoin and other virtual currencies to become widely accepted, they need to become stronger on their own account by creating some rules and procedures that can harmonize their use.
Here there is a clear analogy with international arbitration, the private method for resolving international trade disputes. The comparison is possible as both come from private alternatives to mechanisms that normally fall under the realm of governments. In one case dispute resolution, and on the other economic transactions.
For hundreds of years the preferred method for dispute resolution was to use the courts created by each country, with the judge appointed by each government. However, in international trade, neither party in the conflict wanted the judge to be from the opponent’s country. Thus, the need for an alternative to these government courts: a private tribunal with independent individuals tasked with deciding the dispute, and paid for by both parties.
But this process was neither recognized nor condoned by governments (as with bitcoin). Indeed, it was even illegal in many places. This made it difficult to enforce the decisions made by the private tribunals.
Recognizing these challenges, parties involved in international commerce created rules, procedures and other tools to harmonize the system, and also lobbied their governments to enact statutes to legitimize the process.
It took time, but now, international arbitration is a widely accepted private method for dispute resolution. Many countries have enacted laws that facilitate the process, as well as signed international agreements for the recognition of arbitral awards.
Bitcoin needs to follow a similar path. Although almost every country has its own currency, virtual currencies have become a private alternative for transactions in national currencies. Making bitcoin widely accepted, as is international arbitration, will not be a simple process.
The good news is that there are many across the globe that would like to achieve this goal. What remains is for them to create regulations, alliances and commitments, so that the system can become universal.
International trade was successful in creating a completely private dispute resolution system outside the courts established by governments, but widely recognized and accepted by governments across the world. The same is necessary for bitcoin and all virtual currencies to succeed: a system that works independent of governments but is recognized by them.
Virtual currencies are promising as a technological way of facilitating international trade and reducing financial intermediation, often costly and obsolete in this digital world.