If a virtual currency is to appeal to the mass market, it will need to provide what users of more conventional currencies want – a reliable, liquid store of value and a means of exchange. Virtual currencies might be hailed as digital disruptors, but unless the disruption is to the benefit of the end user it is wasted effort.
It should therefore come as no surprise that bitcoin actually seems to be metamorphosing into something of a conventional currency.
Understanding Virtual Currencies
Perhaps a brief pause for definition is needed. For the purposes of this argument, a virtual currency is a unit of exchange that exists online only – it is not backed by any physical stock of wealth – and it can be transacted online in a manner whereby the entities to the transaction are not apparent.
Bitcoin is by no means the only one, nor was it the first, but it is the most well-known. It is a cryptocurrency; its supply is increased only by an algorithm which limits issue of new bitcoin.
Many competitor currencies now use very similar algorithms to control the issue of the currency. More trading venues are developing to serve this nascent industry, which is of course an attraction to potential traders in virtual currencies.
For instance, Thomson Reuters recently responded to customer interest in bitcoin by launching a bitcoin page on its flagship desktop, Eikon. On it the company reports prices and dealing volumes on the most established and liquid of bitcoin exchanges, Bitstamp. Bitcoin is by far the most widely accepted of virtual currencies and is by an order of magnitude the most traded. So Bitstamp’s liquidity and its comparatively long history as a bitcoin exchange means analysts can see years of price and volume history presented in a consistent way.
Taking Physical Form
To return to the idea of making bitcoin available in a physical form – depending on the extent to which this can be achieved, its entry into the physical world could facilitate its wider use as a means of exchange. The vision at the moment is of bitcoin being available on a computer chip, which the user could simply insert into your computer and transact.
The more readily available the physical bitcoin – and the more comfortable consumers are with using it – the more popular and more viable it would be in both physical and virtual form. Users could skip seamlessly between using it in both its virtual and physical embodiments. The ability to buy bitcoin in physical form with cash would also eliminate the need to establish an account to buy it online – a potential link that risks the user’s anonymity.
However, this anonymity is also one of the challenges for acceptance, because it means the bitcoin is associated with grey market activity. Moreover, those grey market consumers need to be aware of the real extent of the risk of that anonymity being compromised. A virtual currency operates on a variation of a chain log: in other words, it logs and stores under one account number all of the account transactions that take place. Should the name behind the account number become known, so does the owner’s entire transaction history.
At the same time, bitcoin is gaining increasing traction with mainstream retailers. For them, the anonymity of the customer is of no importance and its use in conventional transactions is helping establish its legitimacy.
Bitcoin has also hit the headlines as an investment, of course. Recently its value has been very volatile since its peak around a year ago. This volatility is too great for bitcoin to function as an attractive or reliable means to secure wealth. On the other hand, speculators will always be attracted to sources of volatility, and so it has been with bitcoin.
This is not the inflationary volatility we might see with conventional state-backed currencies. The fact that there is no government involvement is one of the great appeals of such currencies to many users. There is no central organisation controlling or manipulating supply to meet macroeconomic ends, such as inflation. Virtual currencies should, in theory, be free from inflation; with most of them, the algorithms enable supply to grow steadily over time, so at any point the number of bitcoins (or similar cryptocurrency) in circulation is inherently limited. Hence there is no inflationary growth in any conventional sense.
This might work in favour of virtual currencies if inflation begins to rise in conventional currencies. In a less stable global economy, virtual currencies might seem a better bet as a store of value.
Mainstream Acceptance: Barriers and Enablers
Among the obstacles to greater acceptance of bitcoin is the risk that comes for early adopters. Users of conventional state-backed currencies do not have the worries that virtual currency users might have of seeing their holdings disappear due to technical failures. Indeed exchanges can fail, destroying in their wake links to people’s virtual holdings, which is what happened with Mt Gox.
Transactions cannot be reversed or undone. There is no consumer protection infrastructure, so if you buy the goods and they do not arrive, there is no authority to which you have any recourse.
The US Treasury Department has indicated that that it broadly accepts the concept of using virtual currency as a means of exchange. The UK’s Treasury department recently issued a call for views on the extent to which the government should support and help to develop such currencies. Governments generally have remained fairly tolerant, given their potential for enabling the financing of underground activities. All governments are no doubt curious as to where all this is headed, and of course they retain the de facto power to shut down any currency by simply imposing sanctions – forbidding retailers from taking any particular currency as payment.
All of this arguably overlooks an even greater digital disruptor – Apple Inc.
The new Apple Pay system does not afford users the same degree of anonymity, but it does allow them to create and monetise a lot of their existing units or accounts. They can utilise air miles or hotel loyalty points as medium of exchange, and could potentially open up a range of ways in which people can exchange one form of payment for another. Such loyalty points can be seen as currencies; clearly they are not anonymous and certainly there is now the potential to exchange them.
The hardware is ubiquitous – many consumers worldwide now have a phone which can run the requisite software. Furthermore, technology will surely develop to make virtual currencies more user-friendly, and hence more widely accepted. One can easily envision a world where not only airlines and hotels but chain restaurants, gas stations, food and beverage producers all issue their own currencies via loyalty programmes backed by real goods and service. Indeed, it is even conceivable that private individuals could issue their own currency.
If such a system captures the imagination and wins the confidence of phone users, the potential is almost limitless.
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