Why governments are wary of Bitcoin

Since its introduction in a 2008 whitepaper, Bitcoin (BitcoinUSD) has generated controversy and news. Enthusiasts herald its launch as the advent of a new and fair monetary system. Critics point out the cryptocurrencyits role in criminal activity and lack of legal recognition as evidence that it is “rat poison squared.” The reality is probably somewhere in between.

Meanwhile, governments around the world are keeping an eye on Bitcoin and taking action when they can. Some, like El Salvador, have done so adopted it as currency. Others refuse to recognize it as legal tender, treat it like a commodity or property, or even ban it entirely. In 2023, the European Union adopted a framework for regulating cryptocurrency.

Among other things, Bitcoin can allow a country’s citizens to undermine government authority by circumventing capital controls it imposes. It also facilitates nefarious activities by helping criminals evade detection. Finally, by removing intermediaries, Bitcoin can potentially throw a wrench into the existing financial infrastructure system and destabilize it.

Key points

• Governments around the world view Bitcoin with caution because it has the potential to upend the existing financial system and undermine their role within it.
• In its current form, Bitcoin presents three challenges to government authority: it cannot be regulated, criminals use it, and it can help citizens evade capital controls.
• Bitcoin and cryptocurrencies will continue to be viewed with distrust by established authorities until they can monitor and control them more effectively.

Bitcoin cannot be regulated

To understand why governments are wary of Bitcoin, it is important to understand the role fiat currencies play in a country’s economy. Fiat refers to conventional currencies issued by governments. Fiat money it is backed by the full faith and credit of a government. This means that governments promise to make the borrower whole in the event of default.

The U.S. government relies on the Federal Reserve, a central bank over which Congress has only partial authority, to manage the circulating money supply. The transaction cycle in the US economy, involving borrowers, lenders and consumers, is based on a chain of trust between the parties involved in the transaction. The Federal Reserve, the lender of last resort, is the last stop in that chain, lending only to depository institutions.

Bitcoin supporters argue that the Fed creates money out of thin air (i.e., the currency is not backed by physical assets). By manipulating the money supply in the US economy, they say, the central bank also produces financial bubbles and crises.

Proponents also argue that through a series of intermediaries, such as banks and financial institutions, governments distribute and regulate the flow and use of money in an economy. Therefore, they can dictate how it is transferred, the sectors in which it is distributed, track its usefulness, and tax the earnings of individuals and businesses as income.

Bitcoin undermines the cycle of trust

Fans of Bitcoin’s decentralized system say it has the potential to dismantle the system described above. Its network is argued to eliminate intermediaries and, by extension, elements of the governance system.

Supporters believe that if cryptocurrency were adopted, a central bank would no longer be necessary. This is because cryptocurrencies can be produced by anyone running a full knot. Plus, automated peer-to-peer transfers between two parts on the Bitcoin network This means that intermediaries would no longer be required to handle and distribute currency.

The chain of trust underlying the current financial infrastructure becomes an algorithmic construct in the Bitcoin network. A transaction is generally not included in the central ledger unless a specific majority of nodes approve it.

In theory, simplifying operations between individuals and various actors in the Bitcoin blockchain network can reorganize the current system. The financial infrastructure is decentralized and the power to increase or decrease the supply of currency is not assigned to a single or group of authorities. Therefore, in the new framework, the role of governments in managing and regulating economic policy through intermediaries may become superfluous.

Bitcoin can circumvent government-imposed capital controls

Governments often institute capital controls to prevent currency outflows because exports could devalue the value of their currency. For some, this is another form of control that governments exercise over entities within their jurisdictions. In these cases, Bitcoin’s stateless nature comes in handy for evading capital controls and exporting wealth.

One of the most notorious cases of capital flight using Bitcoin occurred in China. Citizens of the country have an annual limit of $50,000 for purchasing foreign currency. A report from Chainalysis, a cryptocurrency forensics firm, found that more than $50 billion moved from East Asian Bitcoin wallets to wallets in other countries in 2020, meaning Chinese citizens may have converted the currency local in Bitcoin and transferred across borders to evade government regulation. Not all of the $50 billion is believed to come from China or capital flight, but it shows an increase in capital movements in the form of cryptocurrency compared to previous years.

Bitcoin is used in illicit activities

The ability to circumvent a country’s existing financial infrastructure is a blessing in disguise for criminals because it allows them to disguise their involvement in such activities. The Bitcoin network is pseudonymous, meaning that users are identified only by their addresses on the network.

It is not easy to trace the origin of a transaction or the identity of the individual or organization behind the address. Beyond that, the algorithmic trust generated by the Bitcoin network eliminates the need for trusted contacts at both ends of an illegal transaction.

It’s no surprise that bitcoin is criminals’ preferred channel for financial transactions – there have been many criminal trends using bitcoin over the years. Most recently, in its analysis of crypto crime trends in 2023, Chainalysis found that ransomware, darknet activity, and sanctioned entity transactions were the most significant illicit activity.

Why is Bitcoin a threat to the government?

Many believe that Bitcoin has the potential to disrupt financial systems set up by governments. However, it has not yet seen enough global adoption to threaten financial systems.

What is the US Government’s Bitcoin balance?

It is difficult to determine how much the US government holds, but it is said to be as many as 200,000.

How many Bitcoins does the Department of Justice hold?

In fiscal year 2023, the US Department of Justice collected 212 digital assets and had a final balance of 136. The top digital assets seized by the Department were Wave, Bitcoin, and Monero. The Department disposes of these assets by auctioning them, transferring them to other entities for use, or by other means.

The bottom line

Bitcoin has become a touchstone for controversy since it was introduced to the world in the aftermath of the financial crisis. Some governments are wary of Bitcoin and alternate between criticizing the cryptocurrency and investigating its use for their own ends.

While Bitcoin has the potential to change or even improve existing financial infrastructure, the cryptocurrency ecosystem is still riddled with abuse, scandals, and criminals, but so are existing systems.

Government positions on issues change over time, and if the more accepting legislative stance of recent years continues, Bitcoin could become more integrated into global society.

The comments, opinions and analyzes expressed on Investopedia are for online information purposes. Read ours warranty and exclusion of liability for more information. As of the date this article was written, the author does not own cryptocurrency.

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