Last week, the European Central Bank (ECB) released its in-depth report on Bitcoin and virtual currencies. The paper titled “The Relevance of Virtual Currency Schemes for Central Bankers,” which is the first central bank study to look at the emergence of Bitcoin, a decentralized digital currency that is the most widely used virtual currency.
The purpose of the report is to clarify, define, classify and address virtual currencies in a “structured approach.” Officials at ECB put virtual currencies into three different categories: closed virtual currencies (Type 1), unidirectional flows (Type 2) and bidirectional flows (Type 3).
It also states that virtual currencies have no physical legal tender counterparts, no physical regulations and no government oversight. ECB notes that the issuer is in complete control of the supply management and governing the “scheme.”
“Virtual currency schemes do not pose a risk to price stability, provided that money creation continues to stay a low level,” the report stated. “[Virtual currency schemes] tend to be inherently unstable, but cannot jeopardise financial stability, owing to their limited connection with the real economy, their low volume traded and a lack of wide user acceptance.”
October’s report investigates as to why virtual currencies are being established. One of the reasons is that the owner of the virtual currency is attempting to incite user participation, while others may try to garner revenue. Another important factor is that these virtual currencies may actually compete with the established currencies, such as the United States dollar, the euro and the Chinese yuan.
However, virtual currencies could pose a threat to the “real financial system,” the report authors explained. The report cited the case between China and Q-coin and warned that the success of virtual currencies could have a significant impact on a country’s money supply.
“In addition, several online games rewarded users with points that could be exchanged against Q-coins and ultimately also against yuan in the black market. The virtual currency had evolved into an illegal money scheme,” the report said. “In June 2009, the Chinese authorities decided to ban this currency for trading in real goods in order to ‘limit its possible impact on the real financial system.’”
Companies, including American Express and Visa, are trying to get into the market as well. In September of last year, American Express acquired Sometrics, a company that helps video game makers create virtual currencies, for $30 million. In Feb. 2011, Visa bought PlaySpan Inc. for $190 million plus performance bonuses.
“At this stage, it is very difficult to come up with a reliable figure for the size of the virtual goods market,” the report added. “On the one hand, there is no universal criterion of what the virtual goods market encompasses. On the other hand, innovations in this field are growing and spreading significantly and, therefore, it is nearly impossible to gather the information necessary to provide a complete picture of the virtual communities and virtual currency schemes that exist.”
Although it did not provide an estimate of how much virtual currency is being maintained in the world, it did state that it is primarily concentrated in Asia and the United States. “They all indicate that the size of the virtual goods market is far from reaching its potential and that it will grow in the future.”
The history of Bitcoin and the premise of virtual currencies, according to the study authors, can be attributed to the Austrian school of economics and its many scholars, such as Friedrich Hayek, Carl Menger and Ludwig von Mises, and the Austrian business cycle theory. The report even references Hayek’s 1976 paper “Denationlisation of Money.”
“The theoretical roots of Bitcoin can be found in the Austrian School of economics and its criticism of the current fiat system and the interventions undertaken by governments and other agencies, which, in their view, result in exacerbated business cycles and massive inflation,” the report explained.
In the end, the report urges that further studying of the issue is needed to understand the full capacity of virtual currencies.
“A similar problem exists with regard to the quantitative information and statistics that would be needed in order to assess the speed at which these virtual currency schemes are growing and the point at which they could become a real threat,” the report forewarns.