Every time a government sets out to abolish something people like, the well-liked thing moves to where it can’t be stopped. This has happened with prohibition, gambling, the war on drugs and digital piracy. Now it’s happening in China, where the government has been trying to crack down on bitcoin.
As part of an effort to control capital outflows, the Chinese central bank required bitcoin exchanges to suspend withdrawals until they could update their compliance systems. Trading on the exchanges took a big hit, but the bitcoin activity resurfaced on less formal over-the-counter venues. Here’s a chart showing trading volume at LocalBitcoins, a site where users post “advertisements”—like on Craigslist—to buy or sell bitcoin for local currency:
Blocking LocalBitcoins would be no solution, in part because people can use virtual private networks to access it anyway. Also, plenty of trading happens on lesser-known sites and on micro-messaging services such as WeChat and QQ. The latter already have their own payment systems, allowing users to build chatbots to automate trading activity. For those who prefer a more familiar trading interface, decentralized exchange software such as Bitsquare can construct an order book based on outstanding offers accumulated from other participants.
China is not alone. Peer-to-peer trading took off in Turkey after the country’s only bitcoin exchange ceased to operate, and in Venezuela after the leading exchange had its bank account closed. Russia has some of the most active unofficial bitcoin markets in the world, thanks to the country’s longstanding regulatory uncertainty.
Although centralized exchanges provide benefits, such as bringing together large quantities of buyers and sellers and guaranteeing payment, they’re not necessary for the currency’s existence. Bitcoin users don’t own physical coins, or even digital ones. They own permanent transaction histories recorded on a global ledger, replicated by participants all around the world. Even if a government shuts down every bitcoin node in its country, a bitcoin user can still transact as long as a single node is accessible overseas.
This puts regulators in a tough spot. It’s hard to control something that exists nowhere and everywhere at the same time. With peer-to-peer transactions, there are no servers to shut down, no kingpins to arrest, no warehouses to bust. Regulators can only go after local bitcoin exchanges and service providers, effectively impairing their own ability to see what’s going on.
Attempts to stamp out Bitcoin serve only to remind users why a decentralized currency needs to exist in the first place. Bitcoin gained prominence because its peer-to-peer payment system allows people to conduct financial transactions that can’t be censored by third parties. Users are free to transact with anyone, as long as they control their own private keys. The fact that many people still give third-party service providers custody of their bitcoin accounts is mostly a relic of our existing acclimation to banks. When regulators try to restrict bitcoin exchanges, they reduce trust both in the government — which can’t seem to keep its hands in its own pockets — and in any kind of third-party financial service provider that might be beholden to the government.
The best way to curb the use of bitcoin is to convince people that they don’t need the cryptocurrency. If Visa and Mastercard started processing payments for darknet markets and remittance customers, the demand for bitcoin would fall off a cliff. But that’s about as likely as China offering to ease capital controls. The US, for its part, could reform money laundering rules that effectively bar a subset of the population from the banking system. When regulations create barriers that prevent legitimate businesses from serving certain customers, less-legitimate businesses rise to meet the demand outside the regulatory system.
Markets can’t be regulated out of existence. The next best thing might be to let them operate in the open. Bloomberg