In the years since Bitcoin first entered the public eye, it has gone from a relatively obscure and fringe cryptocurrency to an increasingly mainstream digital asset. Indeed, it appears that the crypto initially known for its fully anonymous features is in the process of becoming an accepted and legitimate payment method and asset.

The price of one Bitcoin (measured against the USD) has increased 400-fold since mid-2013, to over $40,000 this February. At the time of writing, its market cap is over $830 bn and Bitcoin is not the only significant cryptocurrency – CoinMarketCap estimates the total market cap of all global cryptocurrencies at over $1.4 trillion, roughly the 2020 GDP of Brazil.

While public interest in the digital currency has ebbed and flowed roughly in tandem with its price movements in recent years, several notable announcements by large firms point towards increasing mainstream adoption. Tesla recently announced it had purchased $1.5bn of Bitcoin and would begin accepting it as a payment form. On the consumer side, in November 2020 PayPal announced users would be able to trade the cryptocurrency and Mastercard announced it would allow select cryptocurrencies onto its network just this week.

With this increased value and usage, comes increasing regulatory attention. For taxation purposes, most countries consider cryptocurrency to be property. In the UK, for most investors, HMRC considers cryptocurrency a financial asset, meaning they are liable for Capital Gains Tax (charged at either 10% or 20%).  However regular trading or mining may result in classification as financial trading activity, causing eligibility for income-related taxes. This could push the effective tax rate over 40%, depending on individual incomes.

However this is still an emerging area – a recent OECD report on taxing virtual currencies recommended policymakers provide clear guidance and legislative frameworks, simplify rules to support improved compliance and align the tax treatment of virtual currencies with other policy objectives.[1] Paradoxically, this increased regulatory interest and infrastructural support, despite not fitting well with the initial ‘spirit’ of cryptocurrencies, in 2021 may benefit their value. The mere fact that the OECD is writing on optimal regulation, HMRC is publishing guidance and one of the world’s largest companies is buying in, all helps build institutional confidence.

Currently only some UK banks (such as Barclays, RBS and Nationwide) support purchases and deposits from cryptocurrency exchanges. Challenges converting cryptoassets into traditional currencies are likely still putting off some potential users. However, as regulatory oversight increases, these barriers are set to decline, reducing transactional frictions and further supporting the movement of cryptocurrencies as a valuable digital commodity, into the financial mainstream. A greater pool of potential users, able to buy and sell cryptocurrencies with reduced transaction costs, is only likely to bolster demand.

Potential market disruption, however, may come from an unusual source – the world’s leading central banks.

While traditionally, the management of currency is the role of central banks, the potential disruption of cryptocurrencies poses unique challenges. Amusingly, on their website, the Bank of England (BoE) cautions ‘anyone buying cryptoassets should be prepared to lose all their money’.[2] The BoE’s Governor, Andrew Bailey, recently argued that no existing cryptocurrency has a structure that supports usage as long-term means of payment, due to their lack of government backing and resulting volatility.[3] However, a centrally supported cryptocurrency would not face this challenge, giving rise to increasing attention on Central Bank Digital Currency (CBDC) projects.

This is not just a pipe dream – the Swedish Central Bank, the Riksbank, is testing the technical feasibility of issuing its own cryptocurrency, e-krona, based on blockchain technology. The BoE is slightly further behind, but Andrew Bailey has indicated that their own CBDC is likely in the future. Indeed, the BoE is part of a group of central banks (including Japan, the EU and Switzerland) collaborating on the study of digital currencies and their potential uses. This could introduce significant disruption to the cryptocurrency market. 

There are also developing environmental concerns on the horizon. Data from the Cambridge Bitcoin Electricity Consumption Index shows that Bitcoin accounts for 0.40% of the world’s total electricity consumption, more than the whole of Argentina. Rising prices only further incentivise miners to run more machines, in turn increasing the environmental impact. Any potential carbon taxes or other policy deterrents could incentivise production towards less energy-intensive cryptocurrencies, such as Litecoin or Dogecoin.

The last few years have seen cryptocurrencies begin to make it into the mainstream, a trend we expect to continue. However much is unusual about their growth. It is notable that greater regulatory attention is partially facilitating this uplift – hardly a typical economic phenomenon. Similarly, potential market disruption from central banks is highly atypical. This also creates an interesting paradox for cryptocurrencies – if CBDCs emerge as popular options, this paradoxically undermines their initial claim to ‘decentralise finance’.

[1] https://www.oecd.org/tax/tax-policy/flyer-taxing-virtual-currencies-an-overview-of-tax-treatments-and-emerging-tax-policy-issues.pdf
[2]https://www.bankofengland.co.uk/research/digital-currencies
[3] https://www.reuters.com/article/uk-britain-boe-bailey-idUSKBN29U21Q

For more information, please contact:

Carlos Fatas cfatas@cebr.com  Owen Good ogood@cebr.com phone: 07367 065075