IS VIRTUAL MONEY OVERCOME REAL MONEY IN FUTURE?: A CASE STUDY OF BITCOIN Tinu Joseph* (Asst. Professor, Dept. of Economics, St. Francis De Sales’ College, Nagpur) Can we think of going to a milk booth in the early morning and transferring virtual money to the shop owner’s address daily instead of giving real currency notes? If virtual money is gaining popularity at the current momentum, then the age of carrying a substantial part of our total money in virtual form is not too far. So, it is noteworthy to analyse the modus operandi of virtual money as well as compare it with the fiati or real money. Virtual money or electronic money is generally a new concept in the financial world. All forms of electronic money accepted for exchange of goods and services are considered as virtual money. Now a day it became more common that e-commerce sites such as flipkart; social network sites such as facebook; and even public transport monopoly Indian Railways etc. has created their own electronic money that can be stored in e-walletii. This is usually done by customers transferring an equal amount of fiat money to the concerned parties as well as virtual money received as gifts for huge purchases. Before coming into details of creation of virtual money, we have to know the reasons behind why virtual money is favoured in electronic transactions. In the case of fiat money in electronic transactions, the cost of transaction is more because a middle men or an intermediary is involved in each transaction, i.e, usually made through visa, master card etc. So whenever we buy or sell goods or services through the electronic transaction, the amount debited or credited is going to visa or master card server and thereafter it is passing to the debtor or creditor account after taking a processing fee. But in the case of virtual money, no third party is involved in the transaction. It is a transaction between the two parties to exchange a good or service. But the priority is that I have to have enough virtual money in my account for the transactions. For getting virtual money, I have to pay the same amount of fiat money to the owner of virtual money, so that the same is credited in my account in the payee’s website. So, whenever I buy goods and services from the payee, I can use the same instead of fiat money transactions. The advantage is that the transactions are faster and the transaction fee is smaller as compared to fiat money transactions. So, virtual money performs the function as a medium of exchange as similar to fiat money. Another advantage of virtual money is that it is safe from inflation. As inflation increases, the value of real money decreases, i.e, the purchasing power of real money decreases. That means, with the same amount of money we are able to buy a lesser quantity of goods and services than earlier. Virtual money is not affected by inflation because of low level of circulation and is also not affected by domestic real factors. But it has some disadvantages too. The virtual money is generally not accepted by all the parties. It means it is not a legal tender. There is no obligation from the law enforcing authority (such as Govt. of India) to accept the virtual money. For eg., e-wallet of flipkart is not accepted by Indian Railways or vice versa for buying goods and services. Moreover it is difficult to re-convert virtual money into fiat money. Another 1
Electronic copy available at: https://ssrn.com/abstract=2955213
drawback is that virtual money does’nt carries any interest. As a case study of virtual money, we can take the example of bitcoin, which is one of the most successful forms of virtual money. The Case of Bitcoin The bitcoin is more similar to a fiat currency. The difference is that fiat currency is created by a Government authority but bitcoin is created by private parties. The bitcoins are a private peer-to-peer (P2P) virtual currency created without any central authority, i.e. bitcoin creation is in a decentralized mode. For example, Indian rupee is printed and maintained by a centralized body called Reserve Bank of India. But in the case of bitcoins, it does not have a centralized database or authority. But it functions through bitcoin community. Anyone can be part of bitcoin community by installing a client on one’s computer or registering websites that run these clients for users. So an e-wallet is created in your account. An e-wallet functions same as our real wallet and we have to obtain bitcoin to fill it. Bitcoins can be obtained mainly by (i) accepting bitcoins as payment if we sell some good, (ii) we can purchase bitcoins through bitcoin Exchanges, or (iii) we can exchange bitcoins for real currencies such as US dollars. Once we obtained substantial amount of bitcoin in our e-wallet, this can be used for either transaction purpose, i.e to buy goods and services or we can use the same for speculation and make profit out of bicoin value fluctuations. Many e-shopping sites accept bitcoin as payment for buying goods and services. Even some of the coffee shops and other shops in Europe and Canada display the sign that bitcoin accepted as payment.
The theory behind the bitcoin lies within monetarism itself as developed by the famous Nobel Literate Milton Friedman. It is he who propounds the controlled growth of money supply. Likely wise, to create a shortage at the availability of bitcoins, the creatoriii has decided to limit the total supply of bitcoins to about 21 million by 2140. The mode of operation of bitcoin is simple. Since, it is a cryptocurrencyiv, i.e. a digital medium of exchange, it’s safety, integrity, and balance of all ledgers are to be ensured. A transaction is a transfer of value between bitcoin wallets that are included in the block chain. These new transactions are packed in a ‘block’ which is verified by the network through the process called ‘mining’. This work is done by a swarm of mutually distrustful parties, referred to as ‘miners’ in exchange for transaction fees and newly minted bitcoins. They are general members of the public, actively protecting the network. All confirmed transactions of bitcoin are entered into a block chain, which is a shared public ledger. New bitcoins are created by this process of mining. The rate of creation was about 50 bitcoins per 10 minutes. Every few years the creation rate of Bitcoin is halved,i.e, 25 Bitcoins in 2013-2016, 12.50 in 2017-2020, 6.25 in 2012-2024, and so on to zero in 2140. After reaching the total supply limit at 21 million Bitcoins, the incentive for miners falls entirely on transaction fees. By limiting the maximum number of bitcoins that can be created and varying the rate at which they are produced, the designers have created an artificial
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Electronic copy available at: https://ssrn.com/abstract=2955213
shortage of the currency, making it highly speculative. The current circulation of bitcoin is about 11.8 million with a market value of about US$ 2 billions (as on March 2013). Bitcoin was in news recently due to the collapse of bitcoin traded exchange in Canada named Mt. Goxv. Mt. Gox has collapsed due to hackers stolen the bitcoins stored in their e-platform. In Feb 2014, the Exchange has lost about 8,50,000 bitcoins valued about US$ 450 million and filed for bankruptcy. What has gone wrong for bitcoin is that it was generally been used for illegal activities due to it’s nature of anonymity in transactions. It was famous for Silk Road transactions vi- illegal online black market which used bitcoin as its defector virtual currency, since no personal details are required to carry out bitcoin transactions. This has invited the wrath of Federal Bureau of Intelligence (FBI) to give warning to bitcoin transactions. The future of virtual money Apart from medium of exchange, the fiat money performs some other functions too, i.e. as a unit of account and store of value. Unit of account function of money helps in measurement of value of goods and services. In order to perform this function, money unit has to maintain stability in it’s value, then only it can be used as a representative unit of value of goods and services. The value of bitcoin has been highly fluctuating, i.e. from US$ 1000 in November 2013 to below US$500 in April 2014. This limits it’s capacity to perform the function of unit of account. As a store of value, fiat money helps to store the value for some period of time and retrieve it later. This characteristic helps to store money for unseen emergencies as well as for exploiting future buying opportunities. It was Keynesvii who fully fledged explained the demand for money as a store of value. According to Keynes, people demand money primarily for three motives. First, it is for transaction motive, means to carry out day today expenses for exchange of goods and services. This undermines the function of money as a medium of exchange. Secondly, it is for precautionary motive, i.e. to meet the expenses of unexpected emergencies such as accident etc. Lastly, people hold money to make profit out of speculative activities. Keynes referred to making profits by speculations in bond values and investing money in it. Speculative demand for money is highly interest elastic and both are inversely related. As concerned with bitcoin, the primary motive for holding it was basically speculative demand, i.e. to make profit out of fluctuation in value. The bitcoin is not exactly a stable store of value because of high volatility in its value. The recent stealing of 6 per cent of outstanding bitcoins from the Mt Gox exchange reduced confidence in the currency. Consequently, the bitcoin prices dropped by 30 percent against the dollar in February, 2014. Moreover, the bitcoin lacks liquidity as it is not widely accepted by all parties. The current setbacks on bitcoin need not be considered as an end to the future prospects of virtual money. But this has to be taken in spirit to restructure itself to come out from its limitations and to achieve the total characteristics of fiat money and thereby emerge as a strong player in transactions in near future. Among the functions of money, virtual money performs well only as a medium of exchange. So, it has to go a long way to become as alternative to real money. Apart from these limitations, virtual money has got
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the capacity as universal money. More or less, it has a universal character in unbinding the boundaries of central authority since it is not under the control of any government agency. The worldwide Government regulators are hunting bitcoin by warning the users against the value fluctuations and purpose of usage, but the idea of virtual money cannot be kept hold for ever. Here we have to take into consideration of words quoted by Medger Evers, “You can kill a man, but you can’t kill an idea”. Though the legendary African-American civil right activist has quoted it under a different circumstance, still the same holds meaningful here. Let us wait and watch. ************ *The author may be contacted at
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Notes: i
Fiat Money is money that has value due to Government legal tender. For eg. Indian Rupee, the Governor of Reserve Bank of India promises to pay the bearer of Indian Rupee the specified amount. ii E-Wallet is electronic storage of money in which user can use the same at time of online transactions. iii Creator of bitcoin is still anonymous, popularly known as Satoshi Nakamoto. iv Cryptocurrencies are specifications regarding the use of currency which seek to incorporate principles of cryptography to implement a distributed, decentralized and secure information economy. v Magic: The Gathering Online Exchange (Mt. Gox) was a bitcoin Exchange based on Japan trading. Other famous bitcoin Exchanges include Slovenian based Bitstamp, Canadian based VirtEx, BIT2C in Vietnam etc. The bitcoin Exchanges functions identical to currency trading Exchanges, eg. MCXSX in India is an Exchange platform which trades Indian currency with US$, EUR, GBP & JPY. vi Silk route is usually referred to online trading market with anonymous traders without traffic monitoring. Though the name is taken from historical trade route that connects Asia and the countries of the Mediterranean, this online route is mainly used for illegal trading. vii John Maynard Keynes, is a revolutionary in economics who rejected the neo-classical free market theories with his legendary work ‘The General Theory of Employment, Interest and Money’. According to him, people will demand for liquid cash for specified three motives and interest is the reward for parting with liquidity. References 1. 2. 3. 4. 5. 6.
Rogojanu A. & Badea L. (2014). The issue of competing currencies: case study – Bitcoin. Theoretical and Applied Economics, Volume XXI, No. 1(590), pp. 103-114. George Mason University (2013). BITCOIN: A Primer for Policy Makers. USA, Britto J. & Castillo A. U.S Federal Bureau of Intelligence (2012). Bitcoin Virtual Currency: Distinct Challenges for Deterring Illicit Activity, USA. st KPMG (2013). Virtually Unregulated: Countering Virtual Currency Money Laundering in the 21 Century. U.K. Bank of Canada (2013). Some Economics of Private Digital Currency. (Working Paper No. 2013-38). Ottawa, Gans J.S. & Halaburda H. United States Department of the Treasury (2013), The Present and Future Impact of Virtual Currency. th 113 Congress, First Session, USA. *******************
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