The Great Paradox of Bitcoin: If It Ever Succeeds, It’s Doomed

Will Bitcoin ever become a major competitor to the world’s more conventional currencies? It certainly has some advantages over existing payment networks, thanks partly to its technical structure and partly to the fact that it’s largely free of regulation. But Henry Farrell argues that its freedom from regulation is a chimera:

Up to this point, regulators have largely tolerated Bitcoin as a curiosity and experiment….But if Bitcoin were ever to threaten to become a truly decentralized payments network, owned by no one, and with no one e.g. capable of implementing Know Your Customer rules, regulators would know very well what to do with it. They’d introduce regulatory guidances and pass laws to freeze it off from the regular financial system. Very possibly, Bitcoin could still survive at the margins (as the Hawala system has survived). However, it would be isolated, and in no position to threaten Visa or Mastercard, let alone the underlying payment and messaging services that really underpin the world financial system.

If Tim Lee and other Bitcoin fans want to make the case that Bitcoin can become a major payment network, they need to do one of two things. First, they could show that the U.S. and other major states would not feel threatened by a well-established payment system that they couldn’t control. Second, they could show that a Bitcoin financial network would survive the opposition of hostile states that have enormous control over the actually-existing financial systems that Bitcoin needs to connect to, as well as regulators, police, etc. I don’t see any very plausible arguments that would support either claim. It’s perfectly possible that the underlying technologies of Bitcoin (which help solve some interesting problems of trust and exchange) can be deployed to other valuable uses. But Bitcoin is doomed as a payments network — the very point at which it looks as though it is likely to be widely deployed is the point at which governments, like that of the United States, will crack down on it.

This is almost certainly correct, and the interesting question, I think, is whether Bitcoin and its ilk can figure out ways to operate on a large scale without being effectively shut down by real-world governments. At the moment, I don’t see any way they can do that, but it’s not impossible that this will change in the future.

The evolution of the internet itself provides conflicting guidance as an analogy. Generally speaking, national governments have had considerable difficulty regulating internet content. It’s just too distributed and fast moving. So perhaps digital payment networks similar to Bitcoin will eventually thrive because they pose similar problems to would-be regulators. Like kudzu, they’ll simply be impossible to contain.

On the other hand, countries like China have shown that internet content can be regulated. It merely requires sufficient motivation. And even less authoritarian governments have managed to throw a lot of sand in the gears when they rouse themselves to action. Given that regulating commerce and money is easier than regulating content, this bodes ill for the future of Bitcoin. There’s not much question that it can harried into uselessness if national governments decide to do it.

Still, there are lots of currencies in the world, and it’s possible that a medium-scale version of Bitcoin could stay alive by remaining fairly modest in its connection to any one currency, but fairly large when all of its connections to all the world’s currencies are added up. This might cause problems of coordinated action that would end up defeating national regulators, especially if there were dozens or hundreds of different digital currencies to deal with. Maybe. Possibly. I’m not sure if the arithmetic here would ever add up to anything significant, but I’m also not sure it’s impossible.

But if I had to put money on it? I’d say Bitcoin is doomed in the medium-term future. Farrell is right: it can be a bit of a curiosity, but if it ever enjoys wider success, that very success will kill it.