In October 2012 the European Central Bank published a remarkable study on “Virtual Currency Schemes”. At that time, the Bitcoin exchange rate was still stable (about 12 USD per Bitcoin). But only a little later, in the beginning of 2013, the Bitcoin rally started reaching its peak rate of 237 USD in April. This rally led to an intensive worldwide discussion about the nature, challenges and threats of virtual currencies. The ECB report includes two case studies of the virtual currencies Bitcoin and Linden Dollar (of the Second Life virtual community). Based on its findings, it proceeds to discuss the relevance of such private unregulated (at least at the time being) currency schemes for central banks, published as an official view of the ECB.
The ECB is not worried at the moment because the volume of virtual currencies is still low. Therefore it does not see them as a threat to financial stability. But the ECB notes that such virtual currencies could have a negative impact on the reputation of central banks.
Exchanges are the link between the old world of banking and the new world of crypto-currencies; they play a vital role in supporting the growing Bitcoin economy. If Bitcoin hopes to continue rapidly gaining new users it needs this bridge between the old and new systems to be up and functioning. While Bitcoin is in no way dependant on a link to the traditional banking system, its smooth transition into mainstream use certainly is.
Unfortunately these bridges which make up the exchange market are concentrated and often broken. This leads to concerns over reliability and security, which can cause market panic and extreme volatility. As Bitcoin enters the mainstream a wave of new businesses, services and software developers have recently dedicated their efforts to solving this problem. Their task will not be easy, and the while the exchange rate has seen some recent stability, there is a long way to go before obtaining bitcoins can be called user friendly and reliable.
In their ‘Chart of the Day’ post Bloomberg notes that “An increase in the value of bitcoin, the world’s largest online currency, may fuel concerns that virtual money could undermine the role of central banks.”
Doug French is Senior Editor at Laissez Faire Club and a former President of the Mises Institute. In a new post he supports “Currencies of the Future” (i.e. Bitcoin) and argues that “The answer to the currency question may not be to reform government” but instead to make “an end run around the government’s iron grip on the monetary system.”
The ECB recently released a report on “Virtual Currency Schemes”. It is, in parts, surprisingly well done. It includes a good definition of money, it recognizes that virtual currencies are ‘digital cash’, it discusses Austrian economics and even quotes Rothbard, Hayek and Mises! The guys that put this together are smart and understand “Virtual Currency Schemes” i.e. Bitcoin.
But the piece can be summed up with this line… Should Bitcoin ever truly catch on, it will damage the current banking system and threaten “financial stability”.