Issues Surrounding Virtual Currency Schemes - Case Study Example

Issues Surrounding Virtual currency schemes Name Course Tutor Date Introduction Bitcoin is a form of virtual currency scheme that was developed by Satoshi Nakamoto in 2008. Bitcoin (BTC) is a system that transfers cash electronically. Virtual forms do not have a central authority that regulates them. The mode of operation entails an open source cryptographic protocol (Nakamoto 2011. p. 9). The transfer of money in this system purely relies on a digital mode and does not use an intermediary. Centralized financial institutions such as the national banks and central banks have a primary role of regulating the production, distribution and use of the monetary items. This is aimed at giving value to currency. Virtual currencies do not have intermediate financial institutions in their chain and therefore, they are unregulated. People in a virtual community only use the currencies. They only people who can control the system are the people who develop those (Amores, Paganini & Motta 2013. P. 14). To obtain the money, one has to either purchase it using the real money or increase stock by taking part in stipulated activities that could include advertisements. It is one thing to admit that the currency though not readily accepted is already in use in some parts of the world. The virtual currency interacts with the real money and real economy from two perspectives. One of them is that, the financial institutions that regulate the real money for instance the central banks have allowed the real money to be exchanged with the virtual currencies at the point of purchasing the virtual currency. The second level of interaction occurs when the virtual money is used to buy real goods. Goods and services can only be traded using a legal tender (Schurman 2011. P. 23). This can be interpreted to mean that though the operation of virtual currency is still small, it has been legalised. It can be passed that its impact could have been assumed to small no wonder it was licensed. However, questions are arising over the practical functionality of the virtual currency schemes. Several issues have been put forward questioning whether the system can be relied upon. This paper analyses these issues and questions whether it is practical to incorporate such a system to be into the economy. The issues It is a fact that virtual currency systems have proved to be important in a few areas during financial transactions. The assumption at the onset of the project was that the area of operation of the virtual scheme was small and as such the effect he system could cause was not postulated. There are chances however, that continued use of the virtual schemes would have a substitution effect of the financial institutions charged with the responsibility of regulating the flow of money (Ju 2012. P. 17). Such institutions include the central and national banks. It is now that the application and expansion of the virtual currencies has become a concern by the money regulators. The use if the money is now a daily activity. Remember that the money relies on servers and does not use intermediary financial institutions to regulate its activities. Large organizations including the European Union have raised their red flags over the risk of incorporating the scheme into the general and financial economies. The first of these issues is that the rate at which the virtual schemes are growing is having a negative effect as mentioned above on central banks. Those who manage the financial regulators hold this view (Caughey 2012. P. 33). They clearly understand that some of the economies sensitive markets such as the stock markets are run through speculations and most economies apply theories that are translated from paper to practical. The risk here is that once the public internalizes that the expansion of the virtual currency scheme emanates from the failure by the central banks to do its work then issues that may adversely affect the economy and especially the sensitive sectors will arise. Some of the consequences may be too much to be borne by some economies. Another fear is that the activities of certain virtual schemed are very small and cannot threaten the stability of economies. However, international criminals and skilled money launderers may take advantage of the poor means of regulating the scheme to perpetuate their activities. If incidences of people stealing using credit and debit cards then a scheme such as the virtual currency that is not regulated is not safe(Caughey 2012. P. 37). There are issues surrounding the legal framework pertaining to the activities of the virtual schemes. Therefore, the uncertainties provide a loophole that can be exploited by criminals. Fears exist in the sense that the legality of the scheme may end up becoming a subject of individual nations the way bating is. Such a case would harmful effects on economies across the world. The scheme, as mentioned several times is not regulated except by the developer who is interested in making more profits. Questions are raised over the levels of operations, credit, legal risks and the liquidity levels. The focus is always on the effect the system will have on the users if any of the systems collapses. The matter is deep because technically the duty to regulate the activities of these schemes is for the central bank (Nakamoto 2011. p. 12). The negative impact the problem can create to the image of the central bank may have far-reaching consequences. A case in point is the controversy that has surrounded Bitcoin for a long period. The scheme has been termed to be vulnerable for use by drug traffickers and money launderers. This has been associated with the complex way that can be used to identify the users. The scheme is highly anonymous. Being a digital system cases have been reported where user complain of their computers being hacked into by criminals. It has been difficult to track down the hackers. To comprehend the magnitude of the social problem posed by virtual currency schemes, the industry associations such as the Electronic Frontier, decided to suspend accepting contributions from Bitcoin. Among their reasons was the failure by Bitcoin to put measures in place to protect its clients. The systems do not have legal measures that can support a case in the corridors of justice therefore, protecting the consumers, which, is both a legal and social requirement is not possible. The other example is what happened to Mt. Gox (Ju 2012. P. 17). Its database was shacked into and the criminals accessed the e-mail addresses of the clients, their usernames and passwords. The company had to shut down all its operations to investigate the problem. Doubts have been put over the capacity of Bitcoin to manage such scenarios owing to the fact that Mt. Gox was more powerful than Bitcoin. Mt. Gox was forced to reverse the transactions carried out by the hackers. The problem would be even if the transaction is reversed or money refunded, the image and the trust would have disappeared. The virtual currency schemes lack transparency and credibility to be entrusted to handle people’s money. Overall, every user is supposed to be assured of the stability of the currency he is using. The virtual currencies do not have the surety of preserving the unit account (Nakamoto 2011. p. 16). They also do not effective means to implement their monetary policies. Their financial information is susceptible to distortion. It is good to note that major markets and especially the financial market operate on speculative principles therefore; such actions have serious impacts on price stability and monetary policies. This will deal a blow to the supply and demand of the money market. Engineering the depreciation of the Linden Dollar The operations of the Second Life can easily be controlled by the central bank. Linden Lab should be restricted on a few issues. One of the restrictions would centre on the number of people that can be subscribed to the scheme (Schurman 2011. P. 28). The records indicate that the rate at which Linden Research Inc. was recruiting members was alarming. This gives the company a broader capital base to run its activities. However, if limits on the number of people it recruit is given, then that will be the first step towards trimming down on the amount of money in terms of subscription fee. The reason behind such action by the central governor would be that the company does not have the legal authority to hold huge amounts of users that is not secured. The governor would easily exploit the surety loophole to limit on membership. The volume of transaction on the LindeX market regulates circulation of the Linden Dollar (Amores, Paganini & Motta 2013. P. 19). The central bank governor should take measures that will put price floors and price ceilings on the transactions on the island sales. The users are also charged a rental fee. By linking these activities to bating, it is possible to impose the limits of operations. The company formulates the rules of operation at the Linden lab. This should be put to a stop. That is a financial business and therefore, the rules of the game must be adopted from the central regulating institution. The company uses its grants to premium members as incentive to lure more members. The percentage to be paid as grants must also be regulated by the central bank. What is lacking in the affairs of the company is the role of the central bank. Once enough measures are put in place the Linden Dollar will checked. The powers given to the Linden Lab in regulating, managing and modification of the license rights must be withdrawn. The users are prone to misuse if such a private company continues to control such important rights. List of References Amores, R, Paganini, P & Motta, G, 2013, Digital Virtual Currency and Bitcoin, Paganini pub. New York. Caughey, M, 2012, Bitcoin, Step by Step, Kindle Publishers, New York. Ju, S, 2012, Bitcoin and Virtual currencies, journal of virtual currencies. Retrieved from: http://www.ecb.europa.eu/pub/pdf/other/virtualcurrencyschemes201210en.pdf Schurman, K, 2011, Bitcoin: Free Money or Fraud? Hyperink Bitcoin Mining Money Pub, New York. Nakamoto, S, 2011, Bitcoin: A Peer-to-Peer Electronic Cash System, Prequel Books, New York. Read More