One of the ideas behind digital currencies like Bitcoin and Ethereum is that no government can control the valuation of the money. While I agree wholeheartedly that this is a good thing the anonymity that digital currencies provide have created a black market for investments. In this black market you can buy and sell digital currencies without having to report your income.
More Than One Kind of Illegal Activity
What is the real danger posed by digital currency?
And this is where people become confused. They think that money laundering is the only harm that digital currencies pose to the public welfare. Money laundering is the practice of converting money that can be tied to illegal activity into some form of wealth that cannot be tied to the illegal activity. Drug dealers like to use digital currencies to avoid attracting the attention of investigators who are looking for large transactions or large bags of cash.
Illegal arms sales have also been tied to money laundering activity, as have support for terrorist activities. But what poses an even greater threat is tax evasion. If people who are not otherwise breaking the law begin speculating in the digital currencies the way they speculate in the stock markets, they’ll make millions of dollars in unreported income. They will only have to report that money when they convert it to their nominal currencies and withdraw money from the banks. Financial investigators can then start asking where the money comes from.
The Impact of Digital Currencies on Tax Revenues
All is well and good if you report this income in your tax filings. But we know some people won’t do that. And we also know that as more people use digital currencies there will be more places to buy and sell goods and services with these digital currencies. Major retailers may report Bitcoin transactions for their own income purposes but they don’t have to tell governments where their customers got the digital money.
As more wealth is hidden from government revenue streams the tax burden will increase on the honest people who pay the taxes. Even in a value-add tax system such as those in Europe, you’ll find that VATs have to be increased if the hidden economy draws too much wealth from the mainstream economy.
This shadow economy may be small at the moment but as speculators drive up the prices of digital currencies like Bitcoin and Ethereum investors will begin to sit up and take notice. Who would turn down free money if it’s tax free? And therein lies the danger for anyone who gets into that marketplace. Without real oversight these digital currencies can become a speculator’s playground. Bitcoin and Ethereum experts are afraid that anyone who controls 51% or more of the machines that confirm digital transactions could manipulate the markets, but investors with enough money could do the same thing.
What Digital Currencies Mean to Small Investors
What is to stop you from investing $1,000,000 in Ethereum and start buying and selling like crazy, especially from multiple exchanges? At the present time the exchanges require you to verify your identity to prevent direct manipulation but they cannot prevent investors from laying off losses from one exchange against gains from another exchange. By creating enough demand for a digital currency a ruthless investor can add to the inflation that drives up prices.
And what happens if a small group of investors start working together? 5-10 users could place a lot of buy orders on a small exchange, attracting the attention of other investors. Once they seed the growth of price inflation on that exchange they only need to wait long enough before selling out. And how do we know this isn’t already happening?