Virtual Currencies – A Question of Trust

MEDIA ROOM

And the unknown doesn’t exist only at consumer level.

The virtual currencies phenomenon

Regulators are having clear difficulty in tackling the virtual currencies phenomenon. A year has gone by since the publication of the European Central Bank’s analysis of Virtual Currencies and little action appears to have ensued within the EU’s institutions. Still, even after 12 months from the publication of the ECB’s report – within which period the number of Bitcoins in circulation have doubled – it is disappointing that regulatory authorities in the EU and in the rest of the developed world haven’t taken any clear stance as to whether or not they intend to recognise and/or regulate these schemes. The prevailing uncertainty is discomforting and poses several risks to naive consumers who are becoming increasingly interested in such virtual currencies, based on their mis-perception that such currencies could present investment or other opportunities, or real alternatives to traditional forms of money.

What is a Virtual Currency?

The ECB’s paper provides the following definition: “a virtual currency is a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community”. An observation to be made is the fact that the unregulated nature of such currencies is proposed to us as a defining feature of virtual currencies. If we define these as necessarily unregulated, it is clear that anyone with enough technical competence or financial backing, looking to create a new virtual currency, can do so without the obligation of seeking any licence or permit from the regulators. The truth is that it will most likely take a scandal to provide the necessary motivation to establish the clear regulatory treatment for virtual currencies.

Fiat money – fiat lux!

Bitcoin certainly represents the single most recognized form of virtual currency today and poses a real risk to the credibility of virtual currencies, particularly because there cannot be any element of trust in a virtual currency controlled by a person or entity that has jealously guarded its identity from the public domain. The central “trust”

issue with Bitcoin lies firmly rooted in the fact that the identity of its creator, Satoshi Nakamoto, remains unknown. This Japanese pseudonym is all we have as a clue about the identity of the otherwise unknown creator of Bitcoin. Moreover, the rules governing the supply of such a currency remain unclear to say the least. Whilst it appears to be widely accepted by technologists that the currency may be legitimately earned by resolving complex computer algorithms, many questions keep surfacing including:

  1. What interest does Bitcoin’s creator have in resolving these algorithms?
  2. Could Bitcoin actually be an (illusory) incentive for the world’s technological community to commit their computer processing power towards resolving a critical computational problem identified by the currency’s creator?

III. What protection would there be for consumers holding Bitcoins in the case of a “wipe-out” of its servers?

  1. Who is Nakamoto?
  2. Why should anyone trust Bitcoin?

Keep Calm and Go Virtual… or maybe not!

Bitcoin cannot be considered to be safe money. It undermines the function of acting as a store of value since its value depends on the proper management of the currency by Bitcoin, and it is not really conceivable to entrust the fruits of one’s labour to the whims of the unknown operators of this currency.

Bitcoin aside, all virtual currencies share the same fundamental risk. They are not regulated and do not involve any kind of supervision or oversight. No one appears to be accountable for their acts, and there is nothing comparable to an investor / depositor protection compensation scheme in place. As a consequence, users bear all of these risks themselves. The prevailing uncertainty in respect of the correct regulatory treatment of such virtual currencies and their issuers is in nobody’s interest, except the virtual currency issuers themselves. Merchants, businesses, entrepreneurs and consumers continue to suffer the consequences of the ambivalence created by the lack of regulatory direction from the relevant authorities.

Where to from here?

Whilst we should certainly look towards embracing the incredible potential that technology is unlocking in many aspects of our lives, regulators’ obligation to protect consumers against the risk of being defrauded of their hard earned money remains paramount. The Bitcoin currently in circulation having an accumulated value of less than €2 billion in no way exonerates regulators from providing such protection. This value is growing exponentially and evidently becomes more material should there be any jump in the virtual currency’s market value. The delay on the part of governments and regulators to take concerted action in taking positive steps towards imposing more transparency on virtual currencies and their operators continues to create risks for merchants and consumers. It provides a huge window of opportunity for ill-meaning characters to create unregulated currency schemes and carry on their activities, however shady, with little, if any, risk. Traditional fiat currencies will be challenged and radically changed or replaced, within a relatively short time-period, and if law and order are to be preserved it is up to the world’s governments to act fast and ensure that the development of alternative forms of money is conducted within a framework of fundamental principles intended to preserve financial stability in the long run.

This article by Dr Andrew J Zammit, featured in financemalta.org and martindale.com.