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Monday, February 23, 2015

Why Bitcoin Could Explode With The "Shadow Economy"

Bitcoin’s most visible advocates have spent much of the last year begging congress to go easy on their baby so it can grow into the new powerhouse payment system they so badly want it to become in the global economy.

The economy has been mostly inhospitable, probably because Bitcoin’s future remains uncertain in a hostile environment of conflicting tax and regulatory schemes, efficient competing payment systems and public apathy. But as Jon Matonis pointed out in a Forbes piece back in March 2012, Bitcoin may find a surer footing in the unregulated “shadow” economy that has been expanding globally in the wake of the 2008 crash.

Of course, many Bitcoin fans don’t want to think that such an incredible new invention will be forever known as the currency of drug dealers. But the shadow economy isn’t just the black market; it includes all unreported income. All over the U.S., Americans are increasingly going off the books as they pursue opportunities to generate income in the face of ongoing structural unemployment, Obamacare mandates, and other issues that appear to be facilitating an expansion of the “informal” or “shadow” economy. As its growth collides with the growth of internet usage for day to day business, Bitcoin could become the payment method of choice for the millions of Americans for whom working off the books is the best option available.

As U.S. News & World Report reported last year, the decline of the labor force participation rate to 30-year lows is believed by some economists to reflect a shift to the off-books economy. The percentage of Americans who are "unbanked" or "underbanked" likewise rose from 25.8 percent in 2009 to 28.3 percent in 2011. Many of the underbanked are poor or have bad credit. But the rise in consumer spending over the last few years is larger than the sagging labor market suggest it should be. This may indicate that substantial unreported profits are being reaped. These “shadow” entrepreneurs appear to be electing to keep their earnings-- from consultant, dog walking, babysitting, repair or even online sales businesses-- off the books.

Economists estimate the shadow economy may reach about $2 trillion worth of US GDP. Much of the informal economy is happening online, with billions of dollars in profits on sites like Etsy and eBay. The latter is considering adding Bitcoin to its menu of payment options. This move alone could mean a bright future for Bitcoin as a currency option for shadow entrepreneurs who don’t want to leave bread crumbs for the IRS to follow.

Internationally, the shadow economy is a much larger piece of the pie. By 2020, the Organization for Economic Cooperation and Development (OECD) predicts it will employ two-thirds of the world’s workers. It is also the world’s fastest growing economy, already second in size to the U.S., and is likely to be the largest source of new jobs in the coming years—all unregulated, untaxed and off the record. While mainstream consumers may be unimpressed with Bitcoin’s alleged benefits—better anonymity than dollars, better security and cheaper transactions than credit cards—those who need that anonymity for more than just buying mushrooms for the next Phish concert may find investing in bitcoins more interesting.

Despite the negative connotation, the shadow economy’s existence can prevent the real economy from falling apart during lean times, according to some economists. Milton Friedman pointed out that shadow economies are stimulated by overbearing government regulations and excessive taxation. As governments reeling from the impact of 2008 apply new banking restrictions in an effort to stabilize their own institutions, they are likely to find growing numbers of people comfortable going off the books. With access to consumer technology getting cheaper and easier around the globe, cryptocurrencies and anonymizing networks will likely play a significant role as anonymity grows in importance, internet penetration deepens and cash transactions continue to decline.

Tightening capital controls, the introduction of bail-ins, a rise in financial warfare against non-compliant companies, banks and governments, as well as the push by some nations to embrace a cashless society have become the new standard response to the world’s growing economic and debt problems. The vision may not be unified among global leaders, but it is part of an increasingly appealing menu of policy options they have proven more than willing to exercise.

Countries such as Cyprus, China and Argentina have already seen a surge in Bitcoin adoption as a means of circumventing capital controls. Immediately following the advent of a “deposit tax” and strict capital controls in Cyprus, Bitcoin saw a surge from $47 to $88 in just a week in March 2013 as foreign investors sought safe haven from the new policies. Similarly, China’s “sophisticated arbitrageurs” have used Bitcoin to circumvent the country’s strict capital controls, often through falsified trade invoices and offshore exchanges. Argentines flooded into Bitcoin in 2013 to hedge against the instability of the Peso. Since then, the overheated market has cooled. But as investment pours into the Bitcoin market infrastructure and related blockchain technologies, improvements could be around the corner.

Governments around the world committed to crackdowns on free market interactions may find the winds of change sweeping their authority from under them. When a crisis strikes, governments have usually reacted by removing existing options. Markets react by providing new ones. With technology empowering the average person today in ways that encumber restrictions, it is increasingly difficult to see how government will win out in the end.

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