We explain how this new form of transaction works, which has raised some challenges and doubts for modern economists.
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What are virtual currencies
Reviewing the most common definitions of electronic money from the European Central Bank and other financial organizations, virtual currency is defined as digital money, regulated or not, which is generally controlled by its developers and is accepted as valid money by a certain virtual community.
Electronic money was born in the last decade as an alternative payment system on the Internet , developing in parallel with other forms of exchange on the network. For example, in some online video games you can pay with virtual coins in exchange for a reward, even though these coins have no value in reality.
Of course, this is where an unregulated black market arises where such network exchanges can be purchased illicitly in reality.
What is a cryptocurrency?
Unlike most virtual currencies, the cryptocurrency or crypto asset uses cryptography (numbers and security codes) to make financial transactions more secure . They also have a computerized system to control the creation of units and verify their exchange value. The most famous cryptocurrency is Bitcoin, although there are others such as Litecoin or Ripple that we review later.
Types of virtual currencies
There are several types of virtual currencies depending on the flow in which they circulate and whether or not there is a central administration.
1. According to the flow of currencies
We review the typology of digital money based on the flow of currencies. We explain it in a simple way.
1.1 Closed virtual currency
It is one that can only be used as currency in a closed digital environment, such as a social network or a video game. In short, these types of coins have no connection to the real economy , although as we have already highlighted above, there may be a black market for their real exchange.
1.2 Currency flow in one direction
This concept that sounds so convoluted has an easy explanation. Digital currencies with a single flow can be purchased in reality, but cannot be converted back into physical money.. A practical example is when we buy a voucher with real money to spend in an electronic store. With that sum of money we can buy items in the online store, but we cannot convert the money back into coins or bills.
1.3 Convertible digital money
In the latter case, the digital currency has its equivalent in legal tender currencies and can be exchanged . This is the case of some currencies such as Bitcoin or Ether, which have a weight in the real economy.
Centralized and decentralized
The second classification is somewhat simpler and depends on whether there is an administration that regulates the currency.
A decentralized currency is one thatit circulates without an administrative entity that regulates its course . Therefore, anyone can create it and put it into circulation, and transactions depend on mutual trust between the parties to it.
Bitcoin, the most widespread virtual currency. | Image by: Andre Francois / Unsplah.
In the case of Bitcoin (the clearest example of a decentralized currency) its trust is based on the joint control of the same users of the currency. However, many experts point out that this type of cryptocurrency is increasingly controlled and centralized by organizations and foundations.
A centralized currency is one that circulates under the control of an administrative entity, as is the case of the euro and the European Central Bank.
The 4 most used virtual currencies
Below, we review the most common virtual currencies, their history and operation.
Bitcoin is the most used cryptocurrency. It was created in 2008 although it came into circulation in 2009. At the time of writing this article, it has an approximate value of 6,705 dollars , although it has reached 20,000 dollars, a constant variation that has caused skepticism among investors.
When using this virtual currency, we store the amount in a “digital wallet” or Wallet, with an alphanumeric code and an access code to keep said amount in a safe place. To carry out the transaction we only have to provide the electronic address of the Wallet and the amount that we want to use.
- To know more: What is Bitcoin and why will it never be profitable again?
Ether is the cryptocurrency that circulates under the control of the Ethereum system. Such a system leaves all exchange of monetary value in the hands of users. As of September 21, 2018, it has a value of 228 dollars , with a historical maximum of 230.7 dollars.
Users or companies use this currency in smart contracts (Smart Contracts) without any type of control by a regulatory body. The process is totally safe, since the transaction or exchange will only be carried out if the conditions are those agreed in the contract.
The centralized virtual currency par excellence, used by financial institutions to carry out transactions in real time. Its main advantage over other decentralized currencies is that it allows you to send or receive money in less than 10 seconds. Its fluctuation is much smaller, oscillating between 0.5 and 0.7 dollars .
Created from the Bitcoin code in 2011 and with a very similar operation. The main differences are that the transactions are faster and the fees for making transfers are much lower. At the time of writing this article, it stands at $58.04 , with an all-time high of $58.923.
What challenges do they pose?
The appearance of virtual currencies and cryptocurrencies has meant a change in the economic paradigm and entails a series of doubts or challenges that must be solved, among them the following.
The main criticism of the use of virtual currency is that its nature is untraceable. This means that it can be used for illegal purposes , be it money laundering, financing of terrorism or other serious crimes, without the authorities being able to find out the origin of the transactions.
This characteristic is rather applicable to Bitcoin, with fluctuations of thousands of dollars in just months of difference. This poses too high a risk for investors, who are reluctant to invest in this cryptocurrency. Unlike other types of investments, the market does not have a closing time (there are movements 24 hours), so there are more fluctuations in the same day.
Bitcoin fluctuations in the last year (2018). | Image from: investing.com
3. Technical problems
Tens of thousands of users use online virtual currency exchange platforms every day (some examples are Coinbase or Binance), which poses a serious risk of collapse or system crash . Faced with this problem, the sites have responded either by temporarily closing the possibility of opening an account or by improving their computer systems.
On the other hand, the electrical cost of keeping Bitcoin alive amounts to more than 47 TWh per year, twice what the entire Irish population consumes.
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? How is it interpreted?
EBA Opinion on ‘virtual currencies’. European BankingAuthority. July 4, 2014
ARREOLA, J. Seven challenges of cryptocurrencies for 2018. Forbes Mexico. February 9, 2018.
TUCKER, T. Bitcoin’s Volatility Problem: Why Today’s Selloff Won’t Be the Last. Bloomberg BusinessWeek. 5th December 2013.