A bit on the virtual currency

This article was first published in the Hindu Businessline, Investment World, September 07, 2013; Co-Author: Khemchand H Sakaldeepi, CFI, ISB

http://www.thehindubusinessline.com/features/investment-world/market-watch/a-bit-on-the-virtual-currency/article5104362.ece

The first time I heard of a currency issued by an institution, apart from the Government or the Central Bank of a nation, was way back in 2002. A relative, devotee of Maharishi Mahesh Yogi, told us about “Raam”. Raam is a currency in circulation in Holland and parts of United States, issued by the Stichting Maharishi Global Financing Research (SMDFR), a charitable foundation based in Holland. Two questions came to my mind: First, who guarantees the payment to the bearer? Second, if many more institutions start to issue currencies, wouldn't it lead to a lot of chaos?

Similar, and more, questions were raised in our minds when we heard of Bitcoin for the first time.

In 2008 Satoshi Nakamoto (a pseudonym for the person or group of people who designed the original Bitcoin protocol) posted a paper describing a cryptocurrency protocol. He created an open source client and issued the first Bitcoins in 2009 that are encrypted so that it cannot be misused or reused. This is just like a wallet (free to create) on your desktop and you can use a currency that does not belong to any country or any region or any organisation, for transactions. Instead of a central bank mining the currency, the mining of Bitcoin is done by users all across the network. There are inbuilt checks in the open source algorithm which prevents any conflicting transactions or prevents people from paying the same bitcoin to two different people.

Bitcoin can also be bought using regular currencies such as dollars, or pounds or euros. Currently, one bitcoin can be bought for approximately $107. One can payout in bits (as in computers). Free email, free calls (skype/viber), now free transfer of money! It’s an absolutely logical evolution. However, my original questions remain. Is the currency backed by some organisation/ bank /or government? No. It has value because there is demand for it. If tomorrow there is no demand, its value will be worthless. Is there a possibility of that happening? Yes and No. Regulators are seriously concerned in the US and other countries and they are watching the currency and allied activities closely. They may take extreme steps and ban the use of Bitcoin. Thailand recently banned trading in Bitcoin.

On the other hand, there is a growing community of users who are in favour of digital currency.

Will it lead to chaos? The value of the currency is definitely very volatile. It is first of its kind. There may be more digital currencies which would crop up in the future. It may lead to chaos, even network security breaches. Adopting good practices by users may be the key.

“All over the world people are trading hundreds of thousands of dollars worth of Bitcoin every day with no middle man and no credit card companies. It’s a startup currency which has never happened before” says weusecoins.com. Organizations like Amazon, Barnes & Noble, iTunes and many more accept bitcoins for transactions. The virtual currency is also very popular in China, as popular as in US and the UK, reported Rob Minto in Beyondbrics, Financial Times (July 9, 2013).

All this sounds cool but how big is it? It has definitely made some headlines recently. Cameron and Tyler Winklevoss, twins known for battling Mark Zuckerberg over ownership of Facebook Inc, have filed for an initial public offering of a Bitcoin ETF designed to allow investors to track the performance of the digital currency bitcoin. It will be just like an index that represents the bitcoins. The response to the proposal is, however, lukewarm at best.

The fear of criminal activity, money laundering, high volatility, no regulation, bubble, are all rife. So are the whole generation of users who swear by the currency and consider it an economic revolution. We are not clear about the implications of virtual currency yet. Though it is definitely challenges the way we conceive money. The question to ask is whether money as we know it is undergoing a tremendous change.