Saturday, June 21, 2014

Does Issuing Virtual Currency Fix its Fatal Flaws?

There are quite a few fatal flaws with Bitcoins; the 10 minute validation time perhaps is the most obvious, but credit and liquidity risks with large brokers also cause concern. I do not want to examine these risks closely with this blog, rather, I want to consider the mitigation of risks if companies or governments issued virtual coins, and allow immediate validation and conversion to a fiat currency of choice.

Virtual currency must have a few characteristics that seem to me to be critical to the acceptance of the new medium of exchange including:

  • Transparency of Accounting, velocity and acceleration of funds held by the Issuer 
  • Reputation of issuer
  • Mandated reserves
  • Minimal issuer legal, credit, or liquidity risk
  • Ubiquity
  • Ease of use

If the currency becomes acceptable the issuer necessarily becomes an important large institution and not just a financial institution; define it as an issuing payment hub.  Governments need to accept these issuing payment hubs as beneficial to trade of all kinds, however sensible regulation ensuring the security of user funds, need to be in place before a single issuance takes place.

Governments also need to respect the anonymity of financial transactions except if there is probable cause to investigate a criminal act.  In the current environment, if a US firm or government entity, issued virtual money, and competed against a foreign entity, the foreign entity with clear rules of intercept for cause, trumps the warrantless search or seizure possibilities in the US.

The worst government reaction possible is a ban of the use of virtual money. That reaction invariably leads to loss of trade within the borders of the banning country, and loss of growth of small independent sellers of goods and services accessible to worldwide buyers. An intriguing government reaction would be a small tax on the use of virtual money. Users pay $1.01 for a $1.00 issuance. The penny goes into the government general coffers. The virtual money then circulates as any normal currency and exchangeable with other fiat currencies with published exchange rates. To me taxing issuance is intriguing because with growth, a small issuance tax may be able to replace more regressive taxes such as payroll taxes in the US.

Is a virtual currency the same as a small value gross real time payment system (SVGRTP)? Functionally it is, operationally it is quite a different beast. Virtual money sets up a peer to peer relationship between buyers and sellers without a third party that conducts the exchange and holds the results. Without brokers, liquidity and credit risks remain with the issuer at the time of redemption.

Next Blog: New risks to virtual money, what happens if the lights go out?

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