Tuesday, December 10, 2013

Is a 'democratic' crowd based cryptocurrency just as fair as the traditional ones?

Having gone through my daily portion of Bitcoin-reads (and being somewhat sceptic), it struck me that one of the compelling arguments of collective currencies: 'money to the people' is highly flawed. It is the strong resentment against governments and financial institutions that makes many people believe that it would be good to take the power of money-creation out of governments' hands. But what would happen if we would indeed forget for a moment about the governments?

Crowd based currencies: exclusive and leading to private gains
As nice as it appears, these new currencies will then not be as evenly spread as the current ones in existence. There is quite bit of knowledge and expertise involved in obtaining, developing and working with new crowd-based currencies. So the 'democratic' nature of these currencies is not as democratic as we may think. The amount of people that may vote and can use cash is considerably wider than the amount of people able to use or make virtual currencies. 

We should realise ourselves that in essence, any currency, whether it is a government-owned or private in nature, leads to a certain distribution of value and wealth for the issuer and among the user base. And the question that is not being asked, at present, is whether the new crowd-based currencies will distort the distribution of value and wealth in society? Nor do we ask ourselves the question if we would prefer to be subject to the consequences of behaviour of (collective) private entities, manipulating a currency while we can't influence them, instead of a government structure (however flawed it may appear).

The redistribution of value that can occurs with these new currencies may look democratic, but that is a wolfe in sheep' s clothes. Effectively the new currencies are and will be the domain of private individuals trying to seek private gain rather than anything else. And there is no guarantee whatsoever that this constellation will have the interests at heart of all people in society. It will be Darwins' survival of the fittest all over again, which will exclude certain groups of citizens from participating fully in society. As democratic as a crowdbased currency looks: you will still be a puppet but on a different string, with unknown gains being made by unknown players in the value chain of this collective currency.

Currencies should be as fair as possible
Thus, the claim that crowd-based exchange mechanisms or digital currencies are more democratic than the existing ones must be strongly rejected. They are not and they lead to a very uneven an undemocratic redistribution of value in society. The central question in this debate should be which institutional design prevents the most harm from being done. 

Despite all the existing flaws that may be present in our governments or current monetary situation, the truly democratic currencies and those that may do the least harm are those operated by the governments that we can vote in or out.

Wednesday, August 21, 2013

Bitcoin legal classification in Germany: much ado about ... ?

These days I noticed an interesting discussion in my Twitter time line and on the web on the fact that the German government has 'recognized' Bitcoins (even as legal tender, as cnbc reported for some time). There were many reports on the matter, outlining that Bitcoin is apparently gaining further acceptance among regulators. But as the reports were a bit confusing I felt it would be good to track the sources.

German MP Schäfflers enquired about tax-treatment for Bitcoins
It turns out that a German MP, Frank Schäfflers, has been asking his Ministry of Finance how the taxation rules applies in situations where people use Bitcoin as an instrument of trade/payment. And later on he asked a follow up question whether or not the use of Bitcoins as a payment mechanism would be exempt from VAT (as is the case with German legal tender). Here is the link to the source documents.

The German Ministry of Finance outlined in its response that:
- commercial transactions where bitcoins are being used for payment, have the tax regime on the basis of the transactions' commercial nature; so the use of bitcoins doesn't disturb the regular taxation rules,
- goverment agencies are still discussing how to tax the value increase of bitcoin holdings over a year,
- bitcoins are not legal tender, nor e-money, but a form of private currency which classify as 'Devisen oder Rechnungseinheiten': under the German supervision law (article 11, sub 7).

The Rechnungseinheiten can be translated as unit of accounts, but the explanation of the German Ministry of Finance is that this definition covers - amongst others- all private currencies or units of accounts which are not based on legal tender. Essentially is a catch-all definition to capture any sort of privately agreed payment mechanism that can be used in multilateral clearing or settlement.

The regulatory logic: classification rather than recognition
While to the observer it may appear that the German regulator is leapfrogging into the modern world by outlining the status of bitcoin, the reality may be less exciting. The German Ministry of Finance merely outlined how, given the existing rules on taxation and payments, bitcoins qualify under their supervision law. This is rather a technical exercise and it can be seen that only for income tax issue (what to do with bitcoin holdings that change in value), they haven't yet got an answer.

So yes, the bitcoin has a legal status, but then again: any new development, instrument or technology already is subject to the law book. The fact that the Ministry has now pinpointed the article of the law book where they think the object fits, may therefore not be so spectacular.

If we look at the Netherlands, a similar situation appears. Anyone is free to determine whether to exchange services by paying for them or by using other forms of payment. . I could buy a bread in exchange for washing a car. And if the bakery would accept bitcoin rather than washing their car, it would work as well. The use of bitcoin can be considered payment in kind. Given this regulatory payment mode, our legal system is already recognising alternative forms of payments.

The same holds for the taxation part. The VAT rules on services do not change if the payment leg of my transaction is different. And the income tax rules don not change either. The Dutch rules state that if you hold something which has value, it must be registered on the tax declaration. In this declaration, the bitcoins in a wallet thus show up as the money in my bank account does.

As for the legal tender part of the discussion: I view that as an overrated concept. While in earlier times, the concept of legal tender meant that the other entity in a transaction had to accept the notes and coins, this obligation has been struck out of our Dutch law book many years ago. But it still lingers in the mind of many people and may of course in some other countries still be more relevant.

Future developments
What I find most interesting about the news is the quick and fast coverage that new forms of payments and regulation get in the media and with the public. We can see that the developments are positioned as the story of the recognition of bitcoin by the regulator or as the coming of age for bitcoin. Regardless of the angle of these reports, it is clear that things are happening and moving in the area of private, digital, distributed currencies. And it will be interesting to see this area develop further.

Wednesday, May 08, 2013

The proposed EU-directive on Bank Accounts: wrong tool

Today, the European Commission will announce a proposal for a Directive on Bank Accounts that covers the following areas:
- comparability of bank account fees: the aim is to make it easier for consumers to compare the fees charged for bank accounts by banks and other payment service providers in the EU;
- bank account switching: the purpose is to establish a simple and quick procedure for consumers who wish to change from their current bank account to a different one, with the same or a different bank or other financial institution;
- universal access to bank accounts: the aim is to allow all EU consumers, irrespective of their country of residence or financial situation, to open a payment account, which allows them to perform essential operations.
 
With the proposal the Commission continues its standard policy towards the financial sector: ride the road of regulation as long as the sector is still unpopular with the public. It has done so with regulation 2560 (on fees) which had to motivate banks to speed up intercountry payment processing in Europe and it has in a similar vein used the regulatory process for the Payment Services Directive. Repeatedly we see the banking sector respond with initiatives to improve operations and just as repeatedly we see the European Commission and Parliament find that this was not sufficient and move forward with regulation.
 
At face value, the goals of the Commission with this Directive seem laudable. But what would interest me most is the degree with which the Commission has done its regulatory homework. Quite some time ago, there were EU-initiaves and rules on 'better regulation', which meant that a solid cost-benefit analysis would be required by the Commission before proceeding with further regulation. In the process of discussing switching cost, the Commission did not follow these rules however (see blog).

I remember that at the time I was amazed by the ease with which the Commission bypassed the work done by an EU expert group on user mobility in bank accounts (of which I was a member). The consequence was that, without having proper data as to the degree of problems experienced, the nature of the problems in different countries, the discussion remained a yes/no discussion. So I was quite interested to see if in the mean time there is more hard evidence on the table to determine the nature of the problem that needs to be solved (and to see if it is a European or a national problem).

A quick look at the impact assessment tells me that not much has changed. It is essentially a fast forward reasoning towards the norm that unless everyone in Europe switches bank accounts quite a lot, the market is evidently failing and thus regulation is necessary. Furthermore there is a blind eye as to the different types of service providers: the document assumes all players to be banks with a full service package. In terms of analysis, it is skewed as it misses one alternative explanation for low bank switching rates. That explanation could be that, from a consumer budget point of view, it is more economical and rational to use the scarce time to chip off a small percentage of other purchases (mortgage or lending percentages, tablet-purchases or mobile phone subscriptions) than to spend a lot of time comparing and switching banks and earning very little revenue in the process (see also the presentation here that discusses which assumptions lead to which regulatory preference).

Seeing the current state of discussions (a directive proposal) it seems hard to imagine that the plan would be withdrawn or modified seriously. Still, it would be useful if the Commission had done their homework a bit better and at least had chosen a proper regulatory tool. If indeed the provision of bank accounts accross the EU is a concern, why not choose Universal Services Obligation as the regulatory mechanisms, that is most suited?

We used this mechanism before in Europe, to designate the amount of public telephone's that had to be available to the public. And setting it up for banking isn't hard to do (read this Tilburg University Report) but it does require one thing: a better cost/benefit analysis:
Furthermore, designating all banks to take care of the product dimension of a Universal Services Obligation (e.g., consisting of only a basic bank account service) may be the most effective way of implementing it, provided that the USO has a minimal scope. However, with regard to the geographical dimension of a USO, designating all banks leads to unnecessary cost duplication, so that it is worthwhile to consider other options, such as self-regulation and a franchising mechanism in combination with an auction. In addition, technological developments in a sector are very relevant when assessing the need or desirability of universal service obligations. By interfering in these processes without having made it clear in advance that there is a problem, such developments may be distorted; hence the importance of carrying out a cost-benefit analysis as a starting point.

I think the citizens of Europe are best off with goverments that only regulate when the facts are evident and the tools of regulation are properly geared to the problem at hand. At this point in time, with this Bank Account Directive, I believe we are heading for another emotion-based, cost-increasing all-in Eu-wide regulation, which underlying problems (if any) could have been solved much cheaper and easier by using other more appropriate regulatory tools.


PS. The post is updated at 1823 to include some of the impact assessment data.