Global Virtual Currency--Brief Overview.

• Author: Abboushi, Suhail

INTRODUCTION

Advances in encryption and network technologies are introducing transformational changes in the valuation, exchange and accounting of economic assets and commercial transactions, and the recent emergence of virtual currency (VC), which makes possible exchange of economic value between parties without the involvement of traditional clearing house or bank, is a notable example of transformation. VC does not fit the legal concept of real currency because real currency (RC) banknotes and coins are issued by sovereign government whereas VC is not issued nor protected by government. Nor does it measure up to the economic role of real money due to the sharp volatility of its value which undermines its role as a medium for money transactions and purposes such as starting a savings plan for future financial security. VC is issued and exchanged without the backing of sovereign government, and VC-related account ledgers maintain complete and secure records of all transactions without the need for a central registry. The development holds promise for some benefits but also poses serious risks. VC is new and growing rapidly and is constantly open to newer technologies and innovations from interested participants in its global open source system, all of which make the future of VC not easy to predict, long term or short. So, an appropriate question to start with is: What is virtual currency?

VIRTUAL CURRENCY AND HOW IT WORKS

Given the newness of the phenomenon and its rapid change, suggesting a universal but encompassing definition of VC is a challenge. That being said though, core features or dimensions can be defined: (1) VC is a form of digital currency (DC) which is digital representation and measurement of economic value for an object or transaction; (2) it is issued by nongovernment party and remitted for the exclusive use by another private party; (3) it is denominated in units of account of its own system that may or may not be exchangeable to real currency; and, (4) it is used as a medium of exchange similar to RC but does not have legal tender status in any jurisdiction in the world. It is not illegal, but it also is not protected by government. Now, as for the basic or generic concept of digital currency mentioned in (1) above, it covers a wide array of DCs ranging from simple "promises" or IOUs such as digital 5% coupon issued by a retailer and retrieved as digital code on mobile device, to digital currencies backed by tangible economic assets such as gold or national currency, to the more sophisticated and increasingly popular "cryptocurrency," the algorithms used to exchange economic value between parties using principle of cryptography that are secure and unbreakable. The most famous cryptocurrency at the present is Bitcoin, the current leader in VC industry as measured by its market value, volume, and growing acceptance worldwide, and the symbol for which is similar to the dollar sign $ with B in place of S as shown in the following table. Table 1 identifies types of digital currency ranging from the simple digital payment system such as Pay Pal, to the cryptographic cryptocurrency, their units of denomination, and key features or examples.

To further explain the nature and characteristics of VC in general and Bitcoin in particular, it is compared to US home currency and a foreign currency (as in the case of Euro used in the US) on the dimensions of intrinsic value, legal tender, medium of exchange, structure, supply source, cost of production, risk of inflation, and the possibility of the issuer being the lender of last resort. A summary of these issues is presented in Table 2.

VC can be non-convertible to RC and operates within a closed system with restrictions on transactions outside its virtual online domain, or convertible that allows exchange to RC, and can be used for purchases and commercial transactions in real economy especially that a growing number of businesses have started accepting VC especially Bitcoin. Not unexpectedly, convertible VC, Bitcoin in particular, does more business with real economy than non-convertible closed VC.

VC system must have organization structure to oversee issuance and redemption of payments, monitor circulation, and control transaction settlements, and this structure can either be decentralized or centralized A decentralized system, most notably Bitcoin, operates free of a centralized administration, where transactions are done electronically between participating Bitcoin account holders. The system operates on a myriad of software protocols, such as Bitcoin's SHA-256 which is cryptographic hash functions, to initiate and complete remittances and verify accuracy of transactions, and ultimately record them in a virtual public ledger that contains all accounts. In Bitcoin, the work of verifying transactions and recording them in the ledger is done by a global network of Bitcoin participant account holders referred to as "miners" because they are rewarded by "mining" for newly created bitcoins, and who are generally speaking equipped with special computers (such as ASIC machines) referred to as nodes, and the complicated work of transaction verification and recording they do is referred to as "mining" (Brito...