The noise about virtual currencies and cryptocurrencies is getting louder by the day. At present there are about 146 such currencies in existence with Bitcoin being the clear market leader with a market capitalization of $ 8,188,054,811. The latest addition to this market is the entry of Auroracoin which has been labelled as a move in which “a nation breaks the shackles of fiat currency”.
The currency follows a format similar to those of other virtual currencies such as Bitcoins and Litecoins. However, the major difference is that on March 25, 2014, Auroracoins will be “airdropped” into the accounts of all Iceland citizens i.e.:- each individual will be allotted 31.8 Auroracoins and will be able to transact using the same. This process has been made possible due to the already existing national ID database which contains details of all 330,000 Icelanders.
Baldur Friggar Odinsson, the creator of Auroracoin, seeks to use this currency as both a political statement and an alternate currency. The reason for its creation is the stringent capital controls which have been imposed by the Icelandic government in order to recover from the crisis that led to the collapse of its banking sector in 2008. The then existing condition of oversupply of money led to an erosion of savings whereas the subsequent measures have restricted their ability to hold and use of foreign currencies. This has led to stifling of investment and entrepreneurial ability.
Mr Odinsson is a radical who believes that people need an alternative from the “unholy alliance” of the banks and governments, which forces people to use fiat currencies for their transactions. He has sought the support of the global community and other cryptocurrency traders in accepting and validating the currency. This support is essential as in theory the “Auroracoin” has no inherent value, its value and its subsequent ability will only be determined by the degree of acceptance and confidence that it enjoys.
The experiment raises essential questions of the manner in which one seeks to understand these new “assets”. The basic question which needs to be answered is should governments have monopoly over currency or should this ability be opened up to market forces, like it is for any other product. The answer to this question is not simple at all. In order to attempt an answer to the question, one needs to analyze the various components of a virtual currency.
In essence, there are two aspects to any virtual currency; first and the popular aspect is the “money” aspect which means it performs functions of money such as medium of exchange, store of value and the like. In this classification it competes with the other legal tenders which are state issued currencies. The general advantage which it claims over state issued currency is the lack of sovereign control. This means that its value is not contingent on monetary decisions and the State exercises no control over its supply. Every virtual currency seems to advertise the fact that there are a limited pre-ascertained number of units which will be issued. This means its value will not fluctuate on the basis of excessive mining. This step seeks to provide greater protection to the savings of individuals.
The second and the lesser known aspect is using it as a “mode of transfer”, which in my opinion is the more relevant part of a virtual currency. Reducing the cost of transferring funds from one jurisdiction to another or even within jurisdiction provides massive upsides in terms of transfer of capital in the society. The reduction in transactional cost will be immense because if a company which is providing Bitcoin wallet services is to establish itself as a more efficient method of transfer of funds than an American Express or a Western Union; they will have to undercut their markets by charging minimal commissions and offering the same level of certainty.
While the vision of the developers is to create a peer to peer currency; I believe that legitimacy can only be obtained by providing confidence to both users and governments. This aspect is challenging as government regulation would no doubt increase credibility but this would come at the cost of giving the government regulatory powers and that would put major constraints on the disruptions and objectives of virtual currencies.
A good way to start analyzing the utility of virtual currencies is to be put them in scenarios and predict their movements. This analysis would yield better results if we try to understand the movements of virtual currencies while assuming that they are widely held, traded and accepted. The scenario I propose is that of a financial collapse which is followed by quantitative easing and devaluation of fiat currencies by States. The 2008 crisis saw huge surges in investment in gold. Would the unstable markets lead to a flight towards bitcoins or would there be a different outcome if unike gold, bitcoins are being used to buy consumer products and make other payments?
Please weigh in with your opinion on this post; I look forward to reading what people think of the aforementioned scenario and the idea of Auroracoins. In the coming posts, I will seek to look at the legal aspects of virtual currencies and their treatment for taxation and foreign exchange purposes. Do let me know if there are things that are unclear in this post. I will try to explain them in my next post.