Posted on Feb 17, 2017 by Rick Falkvinge

How cryptocurrency will cripple today’s governments – and they won’t see it coming




Cryptocurrency will cripple governmental ability to collect taxes, and they won’t see it coming. When it’s already happened, expect major changes to take place in how society is organized on a large scale – but also expect governments to act in desperation to retain control.

As bitcoin launched in 2009, most early adopters saw its disruptive potential. While bitcoin has stalled for some time approaching a valid use of the term “stagnation”, cryptocurrency in a larger context is still just as disruptive. In 2011, I stated that bitcoin (cryptocurrency) will do to banks what e-mail did to the postal services. This is not just true, but it will be even more brutal to governments, and by extension, governmental services.

Now, governments love anything that smells like innovation, because it means jobs, this magic word that smells of magic unicorns to anybody in government. Therefore, people who like innovation are nurturing this bitcoin thing, this cryptocurrency thing, this ethereum thing (as if governments made a difference, but still). Lots of startups in tip-of-the-spear financial technology means that their government may get a head start over other governments. They have no idea that cryptocurrency will radically scale back the power of government, not just their own one, but also all those other governments over which it seeks a competitive edge.

Individual people in government can also love bitcoin because it gives them something to do. More specifically, it gives them something to regulate. Fortunately, other people in government see that this gives them something to do, which is to hold those government regulators with an overdeveloped sense of order somewhat in check. You’ll hear no shortage of wannabe regulators saying that “bitcoin is bad because it’s being used in crime and contraband trade!”, to which I usually respond, “well, bitcoin is a currency, so I mean you put it in relation to the US Dollar, which then… is not used in crime and contraband trade, is this the argument you’re using to support your position?”, at which point the discussion generally changes topic.

This completely disregards the observation that bitcoin and cryptocurrency were designed to not submit to regulation in the first place. Well, at least not governmental regulation. It is heavily regulated – but by its source code, and by its source code alone.

The reason this will cripple today’s governments — today’s idea of what a government is and does — is because today’s economy is built on one layer doing actual work and three layers of abstraction on top.

At the first and bottom layer of our economy are the individual people doing all the actual work.

The second layer on top of the first is the abstraction we call corporations, which is a way to organize our economy and optimize transaction costs.

The third layer on top of the second would be banks, which handle money for corporations and individual people in a middleman gatekeeper position.

Finally, the fourth layer is the government, which takes advantage of the banks’ gatekeeper position to siphon off taxes from money flows in order to fund itself and governmental services. In other words, layer four completely depends on layer three for its operations – or at least for the relative simplicity of funding its operations.

Now, what bitcoin and cryptocurrency do is make away with the banks – cutting them out of the loop entirely, making them redundant, obsolete, dinosaurified. This resulting absence of anything where banks used to be creates an air gap between the functional part of the economy – people and corporations – and governments who want funding.

The way governments want to tap all money flows in order to fund itself is not entirely unlike how the surveillance agencies want to tap all information flows in order to have an information advantage. In this way, the deployment of cryptocurrency is to tax collection what deployment of end-to-end encryption is to mass surveillance. The government can no longer reach into money flows and grab what it wants, but will be dependent on people actively sending it money. The government can’t point a gun at a computer and have it give up its money; you can only make a computer operator feel very sorry for not voluntarily producing the keys to that money. So the government is no longer able to collect taxes without the consent – even if coerced and forced consent – of the people being thus collected.

The deployment of cryptocurrency is to tax collection what deployment of end-to-end encryption is to mass surveillance.

Governments, and individual people in government, have no idea about this bigger picture. They’re far to wrapped up in things-as-usual to notice. They won’t see it coming until it’s already happened.

When this happens, there will be no shortage of people in government who suddenly want to regulate cryptocurrency – only to find out it will be as effective as regulating gravity. When this happens, government as we know it will be redefined from a coercive Colossus able to take what it wants and do what it wants into a construct that actually depends on people wanting to fund it. This will be a very interesting time to live in. While today’s governments will see themselves as getting crippled, I suspect most citizens will regard it as unquestionably healthy that governments will actually begin to depend on the approval of the people at large.

We’re just beginning to see the changes to society that the Internet brings. This is one of them.

(Note: I write cryptocurrency and not bitcoin on purpose here, just as I’d prefer proclaiming the success of social media over the success of Myspace.)

About Rick Falkvinge

Rick is Head of Privacy at Private Internet Access. He is also the founder of the first Pirate Party and is a political evangelist, traveling around Europe and the world to talk and write about ideas of a sensible information policy. Additionally, he has a tech entrepreneur background and loves good whisky and fast motorcycles.


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29 Comments

  1. LennStar

    I think the only government who might have a tiny bit of clue of this are the Chinese. China will be the canary – if that autocratic “One-Party-State” country with its enormous economy cannot handle bitcoin, then no other can.

    8 months ago
    Reply
  2. Nicholas Salinas

    Amazing article!

    8 months ago
    Reply
    1. Joe Smith

      wrg

      1 month ago
      Reply
  3. Adam Ricketson

    There will still be plenty of things the goverment can tax — land being the most obvious.

    8 months ago
    Reply
    1. Sven

      Yes. I posted a similar comment, should have posted it as a reply to yours – sorry ’bout that.

      8 months ago
      Reply
  4. Antimon555

    I wrote a long comment, thinking that you underestimate the government and was wrong in the following:
    “I suspect most citizens will regard it as unquestionably healthy that
    governments will actually begin to depend on the approval of the people
    at large.”

    But then I realized that the only place people in general actually seem that authoritarian, is the Internet. AFK it’s more like 50/50 or even more freedom-liking. Maybe I’m just in a weird geographical place where people are like that, but I think there is something deeper going on, one part chilling effects and one part automated filtering (not filter bubble, this is for everyone) making the dislike of particularly surveillance and filtering/censorship largely invisible. (Cui bono points to the corporations selling and using personal information.)

    So, you are probably right. At least 50% of people would like that.

    8 months ago
    Reply
  5. Sven

    Ouch.. comparing Bitcoin with Myspace, that’s harsh 🙂

    8 months ago
    Reply
    1. Sven

      Anyway. Cryptocurrencies taking off? Well, the govt may still keep *demanding* taxes paid in their state currency. If not transaction taxes, then head taxes, or house taxes. So there would still be demand for the currency – people will need to aqcuire it in order to pay their taxes. People will even have to work to aqcuire state currency. People will need salaries paid in the state currency. And then the government can remain in control like today – by keeping track on state currency flows, people’s paychecks etc.

      Cryptocurrencies will be disruptuve, but may not for certain be able to crush governments’ means to collect taxes.

      8 months ago
      Reply
      1. Antimon555

        Pfft. I have many reasons to believe Bitcoin won’t be successful, mostly because of regulation or an outright ban, and lack of anonymity, but what that economist is saying seems like bullshit. He, despite saying so, seems to ignore the fact that there is a limited total amount of bitcoins, much like gold, but tulips are plants that multiply. Also that the transaction fees goes to the miners and are re-spent (like the salaries of bank employees), and not just vanish. He also seems to have a huge issue with the relatively anonymous and without-government-control nature of it, maybe hinting at something…

        8 months ago
        Reply
        1. Sven

          > … re-spent (like the salaries of bank employees), and not just vanish

          Interesting point.

          Off topic, but your statement there shows good insight IMO on why the regular banking system will NOT necessarily ultimately suck up all the money in the economy. An otherwise very prevalent myth. “Boohoo, the banks create money as debt” etc.

          8 months ago
          Reply
          1. Antimon555

            That myth is however true AFAIK. Either that or debt will keep increasing indefinitely, even though “money”, or maybe we should say “partial lack of debt”, is still circulating. Do some research on Fractional Reserve Banking.

            8 months ago
          2. Sven

            I’ve done some research and I believe I understand where the myth comes from.

            Yes, all bank money (deposits) is created out of thin air as debt (when loans are extended to clients). Yes, banks then expect interest payments to be made in addition the repayment of the loan principal. So, the myth then becomes:

            “Hey, how can the loans ever be repayed to the banks, if a portion of the created money must be used for interest payments? Either the interest payments will have to be made using *new* money – created from new loans, which causes a spiral of accelerating debt which ultimately will wreak havoc the economy. Or – if new money is *not* issued – the banks will just suck up all the money in the economy”.

            This logic is not good enough however IMO. Your insightful comment – banks have *costs* (such as salaries) and so constantly has to make payments thay leak back out into the economy – provides one answer. Another “cost” is defaulted debt – loans that are never repaid.

            Now you would perhaps respond that “hey, ok, but at least a *portion* of those interest payments stay with the banks, and are never spent back out into the ecenomy – so the problem still remains exactly as depicted in the story, albeit perhaps somewhat slower”.

            Yes, some bank money ends up sitting still, unused, here and there. Income not spent. Saving. This is indeed true. How this is resolved is another topic (- I’ll urge you to do some research yourself, but it has to do with government deficits).

            This is not however a problem with *banking* per se – it is not only banks that can let their money sit still unspent. *Any* economic entities can do that. It is not a sign of a corrupt and logically impossible banking system. It is no more than the general problem of: How can the economy keep running and growing if some income each year ends up sitting still unspent here and there?

            8 months ago
          3. Antimon555

            No, that’s not the one I’m thinking about. This doesn’t even require interest. Say there’s a bank, Person A owns 300 000 monetary units (€, $, £, SEK, doesn’t matter), and deposits them into the bank. Person B takes a loan of 200k, and pays Person C with them, Person C deposits them in the bank, Person D takes a loan of 150k, and pays person E with them, Person E deposits them in the bank.

            Now there are apparently 650 000 units, spread as 300k on person A, 200k on person C and 150k on person E, but there are really only 300 000 units. At the same time there a debt of 350 000 on persons B and D. There’s more debt than there is money.

            It works as long as people doesn’t withdraw too much at the same time, but that limit creeps down (as a percentage, or as units per person if the number of persons increase, which we do) as more of the virtual money is created – which it is, as prices, mostly of real estate, rise and the interest drops, making loans more attractive to take.

            8 months ago
          4. Sven

            I really don’t agree with that this is how it works, nor that there’s a problem here. This is the typical story about how fractional reserve banking works.

            What you call “virtual money” is also sometimes called “bank money” or “inside money”. And this stands in contrast with “real money”, sometimes called “base money”. (Base money is constituted by bank reserves and cash in circulation.)

            Now, according to the “fractional reserve banking” story, there is a risk of *bank runs* because banks can run out of reserves (if too many people withdraw their money at the same time). (I guess this would mean that they all would withdraw *cash* then.)

            I don’t think there’s a risk of that at all (at least not in sovereign fiat money systems). Nowadays, there is (as far as I know) typically a central bank stepping in, providing more reserves whenever needed by banks (sometimes at some cost for the banks). This mechanism is in place in order to – prevent bank runs! (At least it was originally in the US when they created the Fed, as far as I know). So the supply of reserves is *elastic*. My guess is that there is no end to the amount of reserves that can be issued, the central bank can – and will – always supply as much as is needed. (Perhaps under the condition that the bank is solid, i.e. balance sheet is OK, the bank holds up to whatever capital requirements that are in place etc).

            Sure there can be bank runs, but for other reasons (a bank going bankrupt for example), but a lack of *reserves* is never a problem. “Real money” vs “virtual money” is not an issue.

            Another thing: In your example, I guess person A had 300k in cash and deposited it with the bank. That money then became part of the bank’s reserves. If I understand you correctly, the bank subsequently *could* make a loan to person B *just because* it had these reserves?

            I would say that this is not how it works. Imagine that person A had *not* deposited these money. The bank could *still* have made the loan of 200k to person B! If the bank is in solid standing and there is a solid customer wanting a loan, the bank can make the loan – irrespective of their current reserve standings. Reserves don’t matter. (The banks balance sheet matters and the capital requirements in place in the regulatory system – sometimes a bank is not allowed to make new loans during certain periods. But reserves don’t matter.)

            For systems where there is a reserve requirement in place (which is true for the US I believe (10%?), but not the UK or Australia, 0%!), the bank will acquire the reserves *after the fact*, typically at the end of the same day. I think they call this Open Market Operations. Banks borrow reserves from each other. And if there is a lack of reserves in the banking system as a whole, banks acquire reserves from the central bank, which can supply it – as much as is needed (I think in the US they call this central bank function the Discount Window.)

            In my opinion, reserves don’t matter and bank runs are nothing to worry about, and the “Fractional Reserve Banking is Horrible” story is kind of flawed.

            8 months ago
          5. Sven

            I really don’t agree with that this is how it works, nor that there’s a problem here. This is the typical story about how fractional reserve banking works.

            What you call “virtual money” is also sometimes called “bank money” or “inside money”. And this stands in contrast with “real money”, sometimes called “base money”. (Base money is constituted by bank reserves and cash in circulation.)

            Now, according to the “fractional reserve banking” story, there is a risk of *bank runs* because banks can run out of reserves (if too many people withdraw their money at the same time). (I guess this would mean that they all would withdraw *cash* then.)

            I don’t think there’s a risk of that at all (at least not in sovereign fiat money systems). Nowadays, there is (as far as I know) typically a central bank stepping in, providing more reserves whenever needed by banks (sometimes at some cost for the banks). This mechanism is in place in order to – prevent bank runs! (At least it was originally in the US when they created the Fed, as far as I know). So the supply of reserves is *elastic*. My guess is that there is no end to the amount of reserves that can be issued, the central bank can – and will – always supply as much as is needed. (Perhaps under the condition that the bank is solid, i.e. balance sheet is OK, the bank holds up to whatever capital requirements that are in place etc).

            Sure there can be bank runs, but for other reasons (a bank going bankrupt for example). Lack of *reserves* is never a problem. “Real money” vs “virtual money” is not an issue.

            Another thing: In your example, I guess person A had 300k in cash and deposited it with the bank. That money then became part of the bank’s reserves. If I understand you correctly, the bank subsequently *could* make a loan to person B *just because* it had these reserves?

            I would say that this is not how it works. Imagine that person A had *not* deposited these money. The bank could *still* have made the loan of 200k to person B! If the bank is in solid standing and there is a solid customer wanting a loan, the bank can make the loan – irrespective of their current reserve standings. Reserves don’t matter. (The banks balance sheet matters and the capital requirements in place in the regulatory system. But reserves don’t matter.)

            For systems where there is a reserve requirement in place, the bank will acquire the reserves *after the fact*, typically at the end of the same day. I think they call this Open Market Operations. Banks borrow reserves from each other. And if there is a lack of reserves in the banking system as a whole, banks acquire reserves from the central bank, which can supply it – as much as is needed. (I think in the US they call this central bank function the Discount Window.)

            In my opinion, reserves don’t matter and bank runs are nothing to worry about, and the “Fractional Reserve Banking is Horrible” story is kind of flawed.

            8 months ago
          6. Sven

            Yes, this is is another well known story. It’s flawed.

            8 months ago
          7. Antimon555

            How is it flawed?

            8 months ago
          8. Carlson Sven

            Well, it’s not *that* flawed, I’m sorry for being so terse. Also, I should have added “in my opinion”. I’m not an expert. It’s just that I disagree with some of the terminology and descriptions. I may have a different mental model of banking than you seem to have. My views here are derived from MMT (Modern Money Theory).

            Also, in hindsight I don’t think I understood your last paragraph..?

            I agree that bank runs are possible etc, and that the banking system can be fragile (as shown by the financial crisis I guess). If that’s the gist of your story then we’re in agreement.

            What you call “virtual money” is also sometimes called “bank money” or “inside money”. And yes, this stands in contrast with what you may call “real money”, sometimes referred to as “base money”, “high powered money” (HPM) or “outside money”. (Base money is typically defined to be constituted by bank reserves and cash in circulation.)

            So I would have told your story like this:

            * Person A deposits some cash (previously held in a matress) in a bank. The bank now has some reserves.

            * Some other people take loans from the bank. All of that borrowed money ends up as bank depositis. Thereby the “bank money” supply is increased (with the exact amount of the loans in total)

            * The bank money supply is now larger than the amount of reserves in the banking system

            * This is normal (but disliked by people arguing for “Positive Money”)

            * (Does the bank really need reserves before being able to make the loans? Did person A really have to deposit that cash? Well, in Australia, UK, Sweden, Canada (I believe) the reserve requirement is currently down to 0%. So reserves is not a regulatory limitation for making new loans. In some other nations it’s larger, sometimes 10%. But there are always capital requirements. A bank with a sucky balance sheet is not allowed to make new loans. Also, it will be more vulnerable to a liquidity crisis.)

            * In a crisis, there is a possibility of a bank run. If *one* bank gets into minor liquidity trouble, it can of course always borrow reserves from fellow banks (in the interbank lending market)

            * Or it could borrow reserves from the central bank. But this starting to get uncomfortable, and is a sign that the bank is in bad standing

            * The bank can regain market confidence by reduce its lending (i.e. don’t make new loans, awaiting people paying back old loans)

            * In a large crisis, several banks may get into trouble. The government/central bank could step in, or the banks could fall.

            END.

            Not sure if this story differs from your view in any significant ways. But maybe it does?

            The blog Spontaneous Finance has a interesting article *critisizing* the MMT view on banking, if you’re interested – maybe you’ll like it and find you’re in agreement (although it’s complicated stuff!)

            * search for “The problems with the MMT-derived banking theory”
            * and the follow-up “A response to Scott Fullwiler on MMT banking theory”

            8 months ago
          9. Sven

            Sorry about my terse comment.

            I’ve tried to answer several times but my comments disappear. Not sure why (comment too long?)

            No, I agree with the gist of your story – that bank runs are possible (and the global financial crisis happened after all). But I would describe the system differently. And fractional reserve banking *can* be a fully functional system. Crisis is possible, but not inevitable.

            8 months ago
  6. RASHID MUGHAL

    The Future of Payment

    8 months ago
    Reply
  7. Wintyr Walton

    its cool but Robots not paying taxes replacing every worker in the car industry will kill it faster

    8 months ago
    Reply
  8. Dev.

    Good to see writers that have seen the light.

    8 months ago
    Reply
  9. Wayne Filkins

    Great article, you have an amazing outlook on this. I hope you’re right. I’m currently dealing with a lot of government corruption in what I am working on, and it would be nice to see crypto-currency put a stop to some of this corruption. It’s kind of ironic, they shut down my store for VERY corrupt / crooked reasons, meanwhile I invested my profits into bitcoin/ether/litecoin lmao. They won the battle but not the war. I bought ether at $16 🙂

    5 months ago
    Reply
  10. Randy Miller

    I think you underestimate government.

    4 months ago
    Reply
  11. Metaleo04

    Sounds good, won’t work. Hear me out before bashing my view (I love cryptos btw, and have money invest in various coins, and no I’m no selling just because the market is down right now, hold!)

    Governments collecting tax would not be majorly effected by the banks being replaced by decentralized cryptocurrencies. Let me explain –
    Companies cut out the tax and give it to governments directly before your salary is credited to your account. So it doesn’t really matter if you use a bank account, or a wallet, you still end up paying the tax because the company does it for you!

    And one could argue that not all companies pay your tax for you, in this case-
    Person A works for company B, to receive a salary A must give his ‘wallet’ address to the company. Therefore, his wallet is no longer anonymous as the company has a record of it. In turn, the government has a record of who the wallet belongs to and hence can monitor your transactions. Hence, the government can easily work out how much money you’re getting from the company and what tax you should be paying.

    So in terms of taxes, I really don’t follow your logic. Will it make the process harder? Yes. Will it make it impossible? No.
    There are definitely other ways a de-centralized currency can cripple a government. If I missed your point or am wrong, I would be more than happy to have someone explain it to me 😀

    3 months ago
    Reply
  12. Neil Dudman

    I think its a mistake to be so critical of the existance of a goverment in the future. Agreed what we currently have can not go on, but talking about a nation or region without any control or regulation isn’t realistic or sensible. If for nothing else than to ensure law and order or prevent theft or violence, 10 command ment kind of protection. I think it would be more sensible to suggest a way that a goverment should reform its financial system with the inclusion of bit currency both digical and physical of course linked, which would provide tax free exchange for the physical exchange which would generally be of smaller amounts between normal people. And also a tax, say at 20% for any digital exchange to deter speculation in the currency, or in market generally, incourage annonymous usage of the currency i.e physical. Of course the masive middle men of the financial services and tax collection would need to rethink their jobs, and alot more money would be left in the pockets of normal people, and the economy would flourish. I’m fleshing out such an idea, while looking to see if anyone else has suggested or discussed such a thing.

    3 months ago
    Reply
  13. Joe Smith

    wrong, and no such thing as abilityx, not govx, but otherx do/can do anyx nmw

    1 month ago
    Reply
  14. Andres Vite

    theres actually one thing Government can still control by the use of force, assets, the most easy are real state, goverment will not tax revenues, but instead assets, anyway will be interesting what kind of government comes, could be like cartels in Mexico or war lords in Somalia, or maybe something most advanced, like an AI worldwide system based on blockchain that controls everything, like skynet

    1 month ago
    Reply