Issues Surrounding the Creation of Virtual Currency - Case Study Example

Issues Surrounding the Creation of Virtual Currency Student’s Name Institution Tutor’s Name Course Date 1. Issues Surrounding the Creation of Virtual Currency 1.1. An Overview of Virtual Currency Scheme Virtual currency schemes, such as Linden and Bitcoin Dollars, are a product of a uniquely designed monetary system and are considered to be greatly decentralized as they are not controlled by any central monetary system. Linden and Bitcoin dollars can be purchased from any platforms provided that the selected ones are favorable to the supplier as well as the purchaser. Although the virtual currency scheme seems to be so decentralized and quite open, the creation and introduction of new money into the system can only be done by rewarding the “miners”. In the virtual currency system, the “miners” are responsible for “validation of transactions carried out using virtual money” (ECB 2012, p. 24). The supply or circulation of money in the virtual currency system is not affected by directives of any virtual central bank; the supply entirely depends on the behavior of the interested users who are expected to use the virtual money for a specific purpose. The circulation and supply of Lindens and Bitcoins are technically and skillfully “designed and are expected to occur at a predictable pace” (ECB 2012, p. 24). It is difficult for participants or the central authority in the virtual currency system to alter the supply or flow of money in this system given that these factors are already pre-determined. The virtual currency system, according to its participants, is supposed to be free from economic crises such as inflation and deflation. The fact that it has been pre-determined that the supply of the virtual dollars would reduce up to as low as 21 million, can bring about deflation or inflation in the virtual currency system as many people may decide to hoard the dollars and release them when the supply goes down (ECB 2012, p. 25). 1.2. Issues Affecting the Creation of Virtual Currency Schemes The virtual currency system has made it easy for majority to sell and buy digital content. Many people continue to rely on the virtual currency system to trade digitally because the system is open, decentralized and controlled by any central monetary authority. As a result of the decentralization of this system, it is adversely affected by a number of issues, which include creation of monetary value and implementation of monetary policy among others. 1.2.1. Creation of Monetary Value It is difficult to set a common and rigid monetary value in the virtual currency system due to the fact that the system is totally decentralized. The value of the dollars traded in this system keeps on fluctuating and seems to depend on the time and events that are carried out in the system. Bitcoins, for instance, can fluctuate in value within a few days. According to Mt. Gox, one of the sites where Bitcoins are exchanged with traditional currencies, the value of the currency on April 9, 2013, which was roughly $US200, rose to $US266 on the following day and eventually dropped to $US160 after just two days. It becomes difficult to set a permanent monetary value for the dollars traded in the virtual currency system if “their value keeps on fluctuating” (ECB 2012, p. 26). Apart from the issue of unpredictable value fluctuations, the virtual currency system seems to operate like a Pozi scheme, with a one-sided exchange. In the virtual currency system, it is easy to purchase Bitcoins and other dollars, but it becomes very difficult to sell them back. The buyers of these dollars have to wait until “new participants join the system before they can retrieve their funds” (ECB 2012, p. 25). This implies that without the new comers, the holders of these dollars can never sell them to get back their funds. Since it is difficult to predict when new participants will join the system, it becomes difficult to set monetary value for Bitcoins and Linden. The fact that Bitcoins and other dollars used in virtual currency system are not issued by banks, but “mined” and controlled by people with huge access to PC software and computing power, makes it even more difficult to control their value. The computers are supposed to be used to ensure that there a steady supply of these dollars; however, in most cases, the technique has failed to regulate the supply of the dollars causing “fluctuations in their values from time to time” (ECB 2012, p. 27). 1.2.2. Implementation of Monetary Policy Like in the case of creation of monetary value, it is also difficult to implement various monetary policies in the virtual currency system. Despite that fact that virtual currency is different from the plastic gift cards or paper gift certificates, it is still subject to most state and federal gift certificate laws, especially when it is sold or purchased on a prepaid basis. The state and federal gift certificate monetary policies, such as the Disclosure Act of 2009 and Credit Card Accountability Responsibility, affect the account “balances and digital records in the virtual currency system” (ECB 2012, p. 27). With the application of the gift certificate monetary laws, it always becomes difficult for most participants in the virtual currency system to control the supply and flow of the currency in the system. The laws seem to put a restriction on the suppliers to impose fees on the currency accounts and may require a supplier to provide funds for the virtual currencies that are not used. The laws, however, may not apply in cases where the issuer and the buyer have a written promise binding the transaction. A supplier of virtual currency should, as a result, formulate properly designed consumer disclosures that illustrate the terms and conditions guiding the transactions involving the virtual currency. Another monetary policy that seems difficult to implement in the virtual currency system is the state unclaimed property laws. The unclaimed property laws directly apply to currency breakage in the system. In the virtual currency system, breakage refers to dollars that were bought, but were never cashed against virtual products for which they were taken. Under the property laws, a supplier of virtual currency is supposed to pay the value of the currency to the states if it remains unclaimed after the dormancy period (ECB 2012, p. 27). The fact that the issuers of the dollars in the virtual currency system only have online user accounts makes implementation of unclaimed property laws in this currency system quite complicated. For the implementation of unclaimed property laws to be successful in the virtual currency system, the participants should know who needs to be responsible for the issues of unclaimed property. The participants should inform the issuer about their claims in advance to avoid facing surprises when the dormancy period elapses. 1.2.3 Privacy, Security and other Social Issues Privacy and security issues are another problem that makes creation of the virtual currency system a difficult task. The fact that virtual currency system is entirely conducted online and is not controlled by any central monetary system makes it prone to a number of privacy and security issues. Since the participants in the system can only provide their details when purchasing the virtual dollars, it becomes difficult for the dealers to comply with requirements such as the Payment Card Industry Data Security Standard. It is also risky for participants of the virtual currency system to engage in practices, such as sharing of customer information and joint ownership, since it is difficult to trust people who carry out online transactions (ECB 2012, p. 26). Lastly, the virtual currency system poses problems to its users who do not understand clearly how the system operates. The system does not promise high returns to the users; the people who stand to benefit most are those who can predict the fluctuations in price of the virtual currency and sell their dollars when the prices are high. Another group that can also get high returns in the system is the hard-working “miners”, who are rewarded heavily for maintaining a steady supply of currency within the system. Consequently, the virtual currency system poses great financial risks to the participants and should not be considered as a viable investment (ECB 2012, p. 27). 2. How to Engineer Depreciation of the Linden Dollar The Linden dollar is a virtual currency that is used to create a virtual community called the Second Life. Second Life was created to provide its members with a relaxed environment where that can easily exchange the aspects of lives including likes and dislikes. The community is considered by its members (residents) as a real world. The residents, who are the members of this virtual community, interact with one another and “carry out business transactions without any restrictions” (ECB 2012, p. 28). There are a number of strategies that can be used to engineer the depreciation of the Linden dollar to enable the Second Life economy to operate as freely as possible. Firstly, the economy should not be allowed to operate as freely as it is the case now. This implies that the residents should not be allowed to buy from and sell the Linden dollar to one another without the permission of the Linden Lab. The residents should also not be allowed to exchange Linden dollars with US dollars without the Linden Lab’s consent. This will make it possible to decrease the value of the Linden dollar without losing the confidence of the residents in the dollar. Secondly, the residents of Second Life should be barred from trading virtual products and services in a free market as it is the case today. Although the Second Life economy was created to enable its residents to trade freely in virtual products, it could be difficult to engineer the depreciation of the Linden dollar if the “situation of the free market was left the way it is” (ECB 2012, p. 30). The virtual products traded in Second life include vehicles, buildings, animations, hair, and jewelry among many others. In order to effectively engineer the depreciation of Linden dollar, the Governor of the central bank in Second life should create a market in which the prices of these virtual commodities are set and residents use the prices that are determined by the bank. Thirdly, the price of virtual land, which is used as one of the factors of production in the Second Life economy, should be valued by the central bank to prevent the residents from “buying and selling the land as one of the products” (ECB 2012, p. 31). When land is valued this way, it becomes difficult to control it as a significant factor of production. The issue of the land should be left in the hands of the Linden Lab and not the residents. Lastly, the residents should be encouraged to participate in the development of the community to make the value of the Linden Dollar depreciate. If the residents participate in various business activities in the community, it will be possible to lower the value of the dollar as no resident will be thinking of exchanging the dollar with any currency outside Second Life. Reference European Central Bank 2012, Virtual currency schemes, viewed 29 April 2013, . Read More