Bitcoin Changing View of Traditional Currency

Operating outside the existing financial system


Bitcoin has been getting a lot of public attention lately, with the media telling the world that hackers attacked Bitcoins exchange Bitstamp, MtGox and possibly other Bitcoin exchanges.

Mt. Cox has gone dark on Feb. 25, with its website only stating, “In light of recent news reports and the potential repercussions on MtGox’s operations and the market, a decision was taken to close all transactions for the time being in order to protect the site and our users.”

Bitcoin is electronic cash or a digital currency that is introduced as an alternative to the traditional payment system and operates outside central banks and traditional financial institutions.

But the greatest impact of virtual currency is not its value, but that it “fundamentally changed the way we think about money,” said a Dec. 2013 article on the readwrite.com website.

Discussions centering on Bitcoin refrain from stating as to whom will benefit most from holding or trading with Bitcoins. They cite that Bitcoin hasn’t been in the market long enough to even guess as to how it will impact the financial environment and who would be the losers and winners.

“There is a large potential upside from investing in this disruptive technology, but the risks are very great. It’s not for everyone. My advice is to treat it like buying a lottery ticket,” said Simon A.J. Winder in a Nov. 2013 article on his blog.

Impact of Bitcoin on Central Banks

Bitcoin, being outside Central Banks control and bypassing traditional financial institution, could impact how it will be treated in the long run. Experts state that Bitcoin could be regulated, dismantled and be no more than a fad.

According to media reports, some Central Banks throughout the world have warned citizens of the respective country that they will not accept Bitcoin as a legal tender in the near future.

The European Central Bank (ECB) published a report in 2012 about the use of Bitcoin.

“A widespread substitution of central bank money by privately-issued virtual currency could significantly reduce the size of central banks’ balance sheets, and thus also their ability to influence the short-term interest rates,” said the ECB report.

The report concludes that any user faces several risks because the Bitcoin system is not regulated and overseen by governmental institutions. Therefore, there is a “credit, liquidity, operational and legal risk” to the user.

At the time of the report, ECB decided to remain aloof of the Bitcoin issues because of the small percentage of users. However, it would reexamine the issue periodically.

A review of the ECB report by the Libertarian News states that in reality, the central banks are not concerned about the risks to the consumer, but to the risk of losing power.

Technical and Security Risks to Bitcoin User

ECB spoke of several risks faced by Bitcoin users. Some of the risks have materialized.

Two of the major Bitcoin exchanges, MtGox and Bitstamp, reported in 2014 and 2013 that they had to suspend operations because of technical and security issues, with the technical issues being a glitch called malleability.

MtGox explains malleability as “a bug in the bitcoin software [which] makes it possible for someone to use the Bitcoin network to alter transaction details to make it seem like a sending of bitcoins to a bitcoin wallet did not occur when in fact it did occur.”

The media reported of recent hacker attacks on Bitcoin exchanges. But Bitcoin exchanges, such as Bitstamp and MtGox, denied attacks by hackers. Although an article on the TechCrunch (TC) website said that cyber-attacks are a possibility because the exchanges have become rather prominent in recent times.

“There is value locked up in Bitstamp and others, making them obvious targets,” said the TC article on Feb. 11.

However, stolen Bitcoins cannot be used, because Bitcoins are marked by the owner and a “digital trail is left by bitcoin transactions,” according to an article on the MIT Technology Review website.

Therefore, the most likely goal for stealing Bitcoins is to destabilize the Bitcoin market, according to the wired website.

It’s just like the run on banks. The Bitcoin owner gets cold feet and converts the Bitcoins back into money. This brings into play the economic theory of supply and demand. The more Bitcoins are in the market, the lower the price. This is another form of market manipulation. Once the price is down, the manipulator will buy Bitcoins and then wait for the price to rise before selling, making a nice profit.

The German Federal Financial Supervisory Authority (BaFin) disagrees with wired and states that Bitcoins can be lost or stolen, just like regular money.

“The BTC, which are still registered in the network, are irrecoverably lost for such user because he no longer has any control over them,” said BaFin in a Feb. 17 article.

Regulating the Bitcoin Environment

Regulating the Bitcoin environment has been discussed, but Germany’s BaFin is the first agency to publish a comprehensive article as to how Bitcoins are regulated in Germany.

“BaFin has qualified BTC with legally binding effect as financial instruments in the form of units of account pursuant to a section,” under the German Banking Act.

It continues that Bitcoins “are not legal tender either, and therefore qualify neither as foreign currency nor as foreign banknotes and coins.”

BaFin qualifies its statements by stating that not all transactions using Bitcoins are subject to regulatory authorization. But in the commercial environment, certain transaction may be subject to authorization by BaFin under the German Banking Act. Without such authorization a transaction might constitute a criminal offense.

For example, authorization is required when a transaction is considered proprietary trading, which results when a firm profits from trading in the market. The BaFin article points to different elements that would require authorization.

The U.S. has not gone as far as the German authorities. Benjamin M. Lawsky, Superintendent at the New York State Department of Financial Services (NYDFS) spoke in a February meeting at the New America Foundation.

According to Lawsky, NYDFS envisions to roll out a regulatory framework for virtual currency firms operating in New York in 2014. However, it is no easy task and only the future of virtual currencies can tell if “they will become an important part of the future financial system – or primarily a tool for illicit activity.

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