By Michael Jefferson:
Increasing international trade, multi-currency holding, public distrust in the banking system and a regulatory barriers that are seen to hinder the free-flow of capital. All of these suggest that a global digital currency, one that is not linked to a particular sovereign state or the fortunes of a company, is a natural development as we move towards a more inter-connected and easier to access global economy. Currencies such as the dollar, euro, pound or yen are internationally traded floating currencies that are a token of the underlying assets and economic power of it’s a sovereign nation (or in the case of the euro group of sovereign nations). This allows people to have an understanding of what that token means. Given this what place is there in the financial system for digital currency?
If you look at the most successful digital currency so far, Bitcoin, we have seen vast swings in valuation which has seen it go from under $20 in February 2013 to over $1,100 in November 2013 to around $620 at the time of writing in March 2014. There have also major infrastructure issues around security with the bankruptcy following breaches at one of the main exchanges MtGox. This is on top of high profile coverage of Bitcoin’s possible use for illegal activities on websites such as the Silk Road. These trust and infrastructure issues do not help deliver the confidence in the system that could enable it to build overtime and become a real competitor to the current financial system.
In the case of Bitcoin these issues are perhaps understandable given its origins as an open source currency developed by the anonymous Satoshi Nakamoto which anyone can mine. We are still in the ‘Wild West’ years of digital currencies. Bitcoin only came on the scene in 2009. Everyone is rushing to be involved and the potential gains for speculators seemingly engulf those that see the potential for building something useful and stable. These problems are fixable and as experience grows in the use and security for digital currencies I have no doubt that these concerns will fade away for the users.
Perhaps the bigger question for digital currencies to address is the underlying problems which causes the volatility – what it represents. We know what a dollar is and although we may not think about it in this way it is a token that is backed up by the US government and by extension the biggest economy in the world. Nowhere is the representation of the backstop for a currency more evident than during the 2008/9 financial crisis in the UK. The government stepped into to bail a number of banks including one of the world’s biggest banks at the time, RBS, because of the impact it would have on the pound and UK economy its possible default would have. In the year (March 2008 to March 2009) around the bank bail outs of October 2008 the pound lost almost 30% of its value against the dollar.
Here is your problem in digital currencies – what does is represent and where is the backstop? Digital currencies are an agreement between parties which then is only crystallised in value when exchanged into a currency, there are no economic indicators we can look to for an understating of where this floating currency will head. With digital currencies it is not yet the case and so its success will be valued on its efficiency and integrity in carrying out transactions. The lack of an underlying assets leaves it open to huge swings in value, which make most players nervous. It would be an understandable for a digital currency to grow into the international currency of choice allowing easy transactions and hassle free conversion not dependent on locality, but nations and regulators have vested interests in the status quo which will be a big obstacle in the next stage of development.
Michael Jefferson works in public affairs for an international bank. He has extensive experience in public policy and international relations from his current role as well as from his time working for the UK Government on international trade. He has an MA in Japanese from St Catherine’s College, Oxford specialising in Japanese politics and international relations.