Bitcoins Are An Expression of Property Violation

X
Story Stream
recent articles

I don't want to spend too much time on HFT here, particularly since Michael Lewis has brought so much warranted attention at, I assume, far greater detail and entertainment. I do, however, think there is an aspect of this modern "evolution" that highlights a growing disparity and the retracement toward soft type of what can only be described as feudalism. Maybe there is inevitability in the transformation of technology, particularly as it relates to "markets" and information, but that should not necessarily constitute an entirely new order.

There has existed a practice going back to Chicago pit trading, as my colleague Doug Terry was intimately familiar, called zero plus scalping. It was a market maker's intention to limit the downside of any order position. Market makers provide liquidity through their order books, requiring them at times to take positions. That creates risk for both the trader and the firm.

In seeking to mitigate such basic risk, traders attempted to take advantage of their speed and their place in the queue to anticipate any negative "tic." A tic is a movement of one increment in either direction. So if your order is suddenly "elected", that is, you execute a trade, on the buyside you want to avoid a down tic (where you would lose money being long). If you know you can move to the front of the line in the order book and realize a huge increase in trading and speed of analysis, that risk can be fully, or nearly so, eliminated.

Zero plus scalping means that upon "election" you survey the order flow at a far faster pace than anyone else and determine the next tic, at least to a reasonable tolerance. If that tic is anticipated to move against you, your front place in the order book assures that you can offload your position to the next order in line before any trades move the price (or even the NBBO in these HFT times). In other words, you trade in and out before anyone else knows there is a move.

That offers a foolproof way to if not make money, to never lose it. As ZeroHedge pointed out last month, inside the IPO prospectus of HFT firm Virtu there was a disclosure that in the 1,238 days of trading since its inception the company has lost money on only one of those days. Now there is certainly far more going on at Virtu than solely zero plus scalping (for all I know this was detailed by Michael Lewis), but that result stands out in terms of a different character to these "markets" than existed previously.

HFT's have numerous additional strategies for accomplishing largely the same thing, to not lose money. Momentum ignition and spoofing are some of the more insidious, and potentially illegal, but that is not my main point here. The human equivalent of market makers, when that actually happened, took risk in their activity. Not only did they take on risk, they willingly accepted it as part of their fiduciary duty to "markets."

The removal of risk in the process of "providing liquidity" may seem a subtle distinction, but there is a chasm of form and philosophy. Risk is the central formulation of all of finance. At the heart of all of it lies this idea of the potential for loss. That potential, and the searching for it and through it, is a fundamental restraint on human behavior. People with something to lose act far differently than those with nothing to fear, no losses on their radar.

It may only seem related to HFT by the nature of technology, but recent proclamations about Bitcoin have further highlighted the nature of monetary restraint. A few weeks back the IRS issued rulings about crypto-currencies that firmly placed them within the grasp of taxing authority. In other words, you cannot avoid taxation by paying employees in Bitcoins instead of dollars. Further, the IRS is subjecting merchandise trade to its $600 filing limitation - if you paid two Bitcoins to Overstock.com for a new flatscreen you are supposed to issue Overstock a 1099 (this is not a joke).

Worse than that is the treatment of Bitcoins for the purposes of taxation on the individual owner (and they are owners). From the IRS:

"If the fair market value of property received in exchange for virtual currency exceeds the taxpayer's adjusted basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency."

When you paid two Bitcoins for that flatscreen from Overstock, you are supposed to calculate the value of the Bitcoins at which they were attained and compare that to the fair value of the flatscreen. If the latter is greater than the former, the IRS has ruled it a taxable gain. And that subjects you to a further taxation test about whether that gain is "capital" or "ordinary."

"The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer. For example, stocks, bonds, and other investment property are generally capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset."

The statutory reasoning behind allowing the US dollar to hold special dispensation not afforded to crypto-currency is that timeless and ages-old concept of convertibility. However, here the idea of convertibility is turned completely around and bastardized by modern equivalence.

"Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as "convertible" virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies."

In this formulation, Bitcoins obtain this taxable status unlike legal tender because they are property. I should actually be more specific because this is the entire distinction here, namely that Bitcoins and crypto-currencies are personal property; legal tender is the property of the US government.

So in the annals of modern monetary belief and canon, US government property overrides any and all personal property. That is the exact inverse of traditional convertibility. Under a true gold standard, "money" (as opposed to simply currency) is defined as property and falls under property law. Currency is a derivative claim upon true money, but it is secondary to the laws of possession and property. This was not just understood as a basic formulation, it used to be self-evident.

Legal tender could only reach as far as the government itself owned such property, typically in the form of both gold and silver coin and bullion. Any disillusioned folk or person so inclined of his volition could remove himself from the system entirely by conducting commerce absent any and all finance. Trade was the apex. To the extent that government could interfere, it could only do so under the terms of property which are far more favorable to the individual than the government.

This is not to say that there was or is no role for government, only that such a role is axiomatically defined by its respect for property. That formed the basis for the challenges in the Reconstruction era as the nation, now recombined, struggled to accept or deny this intrusion of paper onto possession. The first of the so-called Legal Tender cases, Hepburn vs. Griswold, turned on this very idea. Henry A. Griswold sued Susan P. Hepburn charging that her use of Greenbacks, paper money, was tantamount to theft of property. Because Greenbacks were legal tender, therefore intended to extinguish all debts public and private (as it says today on Federal Reserve notes), Griswold was bound to accept the terms (on a pre-existing contract).

His lawsuit was brought under the Fifth Amendment's due process clause, where property cannot be simply taken by government action. Legal tender, in this case argued by Griswold, amounted to confiscation of property (true money) and was thus unconstitutional. The Hepburn case was ultimately decided in favor of Griswold, and against the "paper money men", as they were described by Chief Justice Salmon Chase (who, ironically, was Secretary of the Treasury when fiat Greenbacks were unleashed). However, it was overturned and surpassed by two subsequent cases with unusual intrigue surrounding both.

The point here is not political relevancy but rather the establishment of property rights that can be surpassed by government interest beyond simple taxation. In the case of Hepburn, the compelling government interest was war, and civil war at that. But if a case might be reasonably argued and made for government interest in civil war, it does not follow that such interest compels compliance in any and all cases. That there is clear jurisprudence in favor of the intrusion government interest is not a point of major contention here, either.

Obviously there has been legal and statutory basis for removing monetary property going back to Hepburn. That was certainly the case for Executive Order 6102, but by then money as property had already been surpassed by expediency of economic and banking evolution. The Federal Reserve's founding and institution provided a moment in which gold and silver could easily be replaced by legal tender - substituting personal property for government property. Thus the challenge is not in the legal authority to do so, but to be reminded of the consequences of doing so. Further, it was never meant to be a straight line from monetary expediency intent on easing the affairs of citizens to monetary control for their own good (whether they agree or not).

Subsuming monetary property rights concluded the matter for the entirety of the twentieth century, namely that Americans had no means of escape or withdrawal from systemically induced monetary conditions. The affairs of the whole economy could from that point forward only be conducted by the government, and not in any sense a true marketplace. Legal tender is, as Griswold observed, a confiscation not only of property but of rights.

In the monetary arena, there is no such thing as personal property. Everything is subject to politics. That includes no less than subsuming economic function under the paradigm in which banks receive preferred treatment as the primary dispensers of legal tender (which no longer takes such form as described even by IRS rulemaking referred to here). Too big to fail has its roots in property law - had money retained its possession qualities in 2008 the citizenry would have easily overcome the rule of the economist PhD's by simple withdrawal. The people's judgment of corruption would thus have been permanent and irreversible.

That very fact, a dispersed power structure based on personal property rights, is simply too terrifying for elite decision-makers in this country and elsewhere. To counteract that terror is to reduce economic theory to one-sided privilege whereby financial actors obtain separate quasi-legal status. It is here into which HFT has crafted its "niche." They are allowed to zero plus scalp and make "money" through such operations because they are literally agents of legal tender enforcement. Current monetary policy, that features no other options without personal property rights, has created, by fiat, this condition where stock prices are to be managed and conveyed rather than discounted.

Bitcoins are an expression of dissatisfaction with that monopoly, and thus a restoration of property rights includes emphatically the ability to control and traverse commerce and finance on terms other than what is forced upon by the government's various and sundry agents. That speaks not just to the painful incompetence of policy itself, but to the current supremacy of government over individuals. This philosophy extends to the fiscal side as well, since current monetarism subsidizes further government economic and regulatory intrusions. Without property rights, there is no legal mechanism to regain such control.

There is no doubt that the IRS' intent with regard to crypto-currency is to maintain the illusions of monopoly. But by restoring the idea of money as property, even in an obvious reversal of historical traditions of truly free trade, they may have opened the door to existential challenges to legal tender in the twenty-first century. What happens if Bitcoins progress to the point they no longer need to be convertible? The IRS rulings here cease to apply. At that point Bitcoins, or whatever crypto-currency can stand on its own, become both property and currency, i.e., true money. Competition with the government monopoly of legal tender then ensues which likely leads to a singular solution - either the dollar as fiat currency gets replaced or it gets reformed into something far more workable and, more importantly, no longer centralized where government rights continue to supplant all others.

Of course, there is a world of difficulty to arrive at that point, but the door is open. Clearly, the IRS ruling intends on being an impediment toward that direction, but it is now established rulemaking. That may not mean much when hostility to this upset (to go along with contempt for individual economic decision-making) is widespread throughout the rule of current political proportions. Though the powers that be will not simply fade quietly into the good night, this is a baby step in the right direction - I have said before that I harbor high hopes for Bitcoins, if not for their own adoption then in playing some role as catalyst to real and actual reform.

The most fundamental displacement of current legal tender economics has been the perpetual upsetting of risk. That includes the price of risk, as intruded by interest rate targeting, but also in the very behavior of agents. The net result on both accounts, and others, is a hierarchy not of merit but of connection and governmental expedience. Alongside that is economic malaise covered by asset inflation and bubbles, with excuses and recoding serving to cloak such dysfunction as both acceptable and "the best we can do." Governments' compelling interest is not civil war, but mere assertion that restoring monetary property would be disastrous, a counterfactual without falsification, and an assertion that completely ignores the causation and pathology of exactly the last disasters. As of now, without political will, there is no opt-out feature. Money as property would be both the remedy and the empirical evidence against that very counterfactual.

 

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

Comment
Show commentsHide Comments

Related Articles