University of Arkansas System
Type of paper: Thesis/Dissertation Chapter
How Will Bitcoin and Linden Dollars Affect the Economy
The common issues with ‘Bitcoin’ and ‘Linden Dollars’ are that there have been suspicions these virtual currency schemes are operating as Ponzi schemes, there is a high level of anonymity with regards to these virtual currency schemes and that there is only one regulator who oversees the system. The issue of Ponzi schemes are justified for virtual currency schemes such as ‘Bitcoin’ and ‘Linden Dollars’ but for different reasons.
For ‘Bitcoin’ it greatly resembles a Ponzi scheme where people can convert real currency into Bitcoins but when they want to convert Bitcoins to currency they would need to find another person who wants to buy their Bitcoins. For ‘Linden Dollars’, Second Life Banks started offering very high interest rates on deposits which led to many users in Second Life converting real currency into Linden Dollars to receive these returns. The high level of anonymity is also another issue that virtual currency schemes face as there are many risks that users of these schemes may encounter.
Due to real economic transactions in Second Life, there are many people and business that have created accounts on Second Life to obtain real profits. Creating accounts on Second Life require little information and from the creation of accounts, players in the game do not know who they are actually performing transactions with as they are performing transactions behind computer screens and would not be able to judge the credibility of the other player. Due to having only one regulator who oversees the system, these virtual currency systems are decentralised and display information irregularity in the system.
For ‘Bitcoin’, due to the complexity of the system not all users completely understand how it works which leads to risks some users take without realising the consequences of those risks. Creation of Monetary Value The creation of monetary values using virtual currency such as ‘Bitcoin’ and ‘Linden Dollars’ can lead to risks and implication for users of virtual currency. The creation of these two different currencies will affect their economy in different ways due to the reason for the creation of monetary value and the amount of monetary value being created.
For Bitcoins, the supply of Bitcoins is not dependant on any monetary policy but instead is based on users performing a specific activity. This scheme by Bitcoin was designed so that the money supply would develop at a specific pace and in order to receive more Bitcoins, harder algorithms would need solved. Monetary Policy Implications There are many monetary policy implications from the use of virtual currency schemes both inside and outside of the virtual world.
The most impactful implications from the use of these virtual currency schemes would be outside of the virtual world if these currency schemes became widely accepted throughout the world. Monetary policy implications that may arise outside the virtual world would be the way that the Central Bank would introduce policies for price stability, financial stability and payment system stability. Virtual currency schemes could have a massive impact on price stability if they substantially modify the quantity of money, impact on the velocity of money and if there is an interaction between the virtual currencies and the real economy.
These factors will create different implications for current monetary policies such as exchange rates and interest rates. If the supply of money in the real world were to decrease due to virtual currency being accepted as legal tender, it will result in a change in the exchange rate between real currency and virtual currency. Virtual currency schemes could also impact on the financial stability if there is a strong connection between the real economy, high volumes of virtual currency traded and if virtual currency is widely accepted.
This will impact the financial stability if the virtual currency is unstable due to lack of maturity, confidence, low volumes traded, speculation and cyberattacks. Virtual currency schemes could impact on the payment system stability as they are not regulated or overseen by a public authority figure. This will expose users to credit, liquidity, operational and legal risks due to the currency being virtual currency which has the possibility of defaulting. Payments using real currency do not face the same situation as Central Bank money is used and the Central Bank has no default risk.