Digital Currency

Digital Currency Term Research Paper
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Digital Currency Term Research Paper
Introduction
The year 2008 will continue to be remembered in the history of the United States. It was the same year that saw a crash in the financial market that began in the U.S. and later spread over to European and Asian countries, thus sparking the global financial crisis (Chuen, 2015). During the beginning of the same year, Bitcoin, a peer-to-peer decentralized digital currency, was developed. In November 2008, Satoshi Nakamoto first published a white paper on the Internet through the Cryptography Mailing List after the global financial crisis. This paper would be later be considered an important contribution to the world although it was not originally published in any academic journal. Nakamoto's paper has generated increasing interest due to its timing and proposals. The white paper seemed to be a direct response to a lack of confidence in a reserve currency and the central authority which control the money supply. Digital currencies, such as Bitcoin and supportive blockchain technology represent developments in financial service products and systems with the potential to facilitate more transparent and efficient global commerce. Digital currency is any form of currency which is solely available in electronic or digital form rather than the traditional currency that can be in physical form. Similar names referring to digital currency include electronic money, cybercash, or electronic currency. Since most digital currencies do not depend on intermediaries, the technology lowers transaction costs for individuals and businesses and has emerged as a major mode of processing electronic payments. Cryptocurrencies have a clear potential for continued growth due to such attributes. Like traditional currencies, virtual currencies can also attract criminal activities such as money laundering. While there have been several benefits and snags that have been underscored by supporters and critics of digital currencies, there is a legal grey area surrounding virtual currencies. While certain regulators such as the Financial Crimes Enforcement Network (FinCEN) have attempted to clarify such regulatory framework, there is a need for policymakers and regulators to further clarify legal issues surrounding virtual currencies to facilitate wider adoption of cryptocurrencies (Levin, O’Brien, & Zuben, 2015). Regulators and Congress have expressed the desire to protect citizens from fraudulent engagements that use digital currencies. However, the fact that cryptocurrency has been used by criminals to defraud the public does not digital currencies are inherently flawed or fraudulent. Regulators such as the U.S. Commodity Futures Trading Commission (CFTC) guides cryptocurrency regulation. This paper explores the history of digital currency, differentiates between soft and hard digital currency, and virtual versus traditional currencies, and centralized and decentralized systems in digital currencies. A discussion on regulatory frameworks in digital money transactions also forms an important part of this paper.
History of digital currency
David Chaum published a research paper in 1983 and introduced a novel idea of digital currency (Baron, O'Mahony, Manheim, & Dion-Swarz, 2015). Seven years later, Chaum founded an electronic cash company, Digicash in Amsterdam to further his ideas and research however, he had to file for bankruptcy and close down the company in 1998. The first widely used digital currency was e-gold that was introduced in 1996. PayPal, which was U.S. dollar-dominated digital currency service was later introduced in 1998. 2009 saw the launch of Bitcoin and marked the beginning of decentralized digital currency supported by blockchain technology. While Bitcoin was the first digital currency that was introduced in 2009, there were previous attempts at establishing online currencies supported by encrypted ledgers. Examples of these earlier attempts are B-Money and Bit Gold, which were formulated between 1998 and 2009 but did not fully develop. In 2008, an anonymous person by the name Satoshi Nakamoto posted a paper entitled “Bitcoin – A Peer to Peer Electronic Cash System” that would later facilitate the development and public availability of the Bitcoin software in 2009 (Marr, 2017). During the same period, a process that created Bitcoins and recorded and verified Bitcoin transactions on the blockchain began. Bitcoin was first valued in 2010. Since Bitcoin was only mined and never traded, it was challenging to assign a monetary value to the digital currency. However, for the first time in 2010, someone decided to sell their coins and swapped 10,000 coins in exchange for two pizzas. Rival digital currencies emerged in 2011 as Bitcoin began gaining popularity. The concept of encrypted and decentralized currencies also started to gain traction. These alternative or rival currencies are known as altcoins and their purpose is to improve on the original design of Bitcoin by maintaining anonymity, improving speed, or offer some other benefits. Namecoin and Litecon were the first altcoins to emerge but there are more than 1000 cryptocurrencies today in circulation. In 2013, the price of Bitcoin crashed and immediately after Bitcoin hit $1000, it began to drop. Many investors suffered massive losses as the coin dropped to about $300. It took more than two years before Bitcoin reached $1000 for the second time. 2014 saw an increase in scam and theft cases linked to Bitcoin. In January the same year, Mt.Gox, the world’s largest Bitcoin exchanger was put offline and owners suffered losses of 850,000 Bitcoins. In 2016, enthusiasm began to grow around the Ethereum system that uses digital currency, Ether to facilitate apps and smart contracts running on the blockchain. The arrival of Ethereum was characterized by the emergence of Initial Coin Offering (ICOs). ICOs are fundraising platforms offering investors to trade shares or stocks in startups. In 2017, Bitcoin reached a $10,000 mark and continued to grow (Marr, 2017). this growth is attributed to the increase in areas where Bitcoin was accepted. It is during this time that the market cap of all digital currencies increased from $11bn to more than $300bn (Marr, 2017). Towards the end of October 2019, Bitcoin was valued at $9,225 compared to the price in April 2017 that was $1,349.19 (Szmigiera, 2019). In summary, the Bitcoin value has remained relatively stable since its creation in 2009.
Soft vs. hard digital currencies
Digital currencies are only available using computers or mobile devices since they are in digital forms (Gonzalez, 2015). They are considered to be the cheapest way of trading currencies because there are no intermediaries involved. While not all digital currencies are cryptocurrencies, all cryptocurrencies are considered to be digital currencies. Another important aspect of digital currencies is that they are stable and can be traded with the markets. However, cryptocurrencies are only traded through psychological and consumer sentiments that trigger price changes. Some aspects further draw a line between different types of digital currencies such as Bitcoin and PayPal. Bitcoin, which is an example of hard digital currency does not allow disputes after transactions have been effected. The amount disputed will not be reversed and banks have remained skeptic in embracing such transactions involving hard digital currencies. While not generally accepted, Bitcoin transactions are instantaneous and cheaper. More examples of hard digital currency include KlickEx and Western Union (Sadiku, Tembely & Musa, 2016). Contrary, in soft digital currency, transactions are easily reversible depending on the clearance time. Payments made through credit card and PayPal, which are forms of soft digital currencies can be reversed upon dispute. However, third-party services may be used to soften hard currencies to become soft.
Virtual and traditional currency
Understanding the differences between virtual and traditional currencies requires an exploration of how digital currencies such as Bitcoin, Litecoin, and Ethereum are produced. In conventional fiat money systems, central banks around the world cover issues such as currency stability through the regulation of the interbank interest rates via the operations of open markets. Contrary, virtual currencies are mined. Bitcoin, for instance, involves a decentralized and competitive process that utilizes specific software and hardware to solve functions involving cryptographic hashes. Hashes are hexadecimal numbers with a specific target difficulty that requires to be explored using nodes in the system to solve or create a new block (Hemfing, 2019). Depending on a programmed schedule, miners participating in solving the blocks are rewarded a specific fraction of Bitcoin usually based on their computing power. Money is a medium of exchange, a store of value, and unit of account. Unlike commodity money or traditional currency that holds its value based on its physical characteristics and is used as a legal tender, virtual currency is produced through computational processes that use a generally predictable rate. Just like traditional currencies, the price of cryptocurrencies is determined by the law of demand and supply. In the facilitation of this process, virtual currencies are traded via currency exchanges and this leads to several drawbacks. There are several regulatory barriers such as requirements to register with the U.S. FinCEN. These exchanges also need to provide an online platform that is adequately robust to prevent cyber-attacks. Another limitation with virtual currencies is that there is a small number of relevant high-volume exchanges. For instance, in December 2016, the three most important exchanges, BTC China, Huobi, and OkCoin comprised of over 96% of all trades during a six-month trade period. The last two years have seen extreme fluctuation in the exchange market. For instance, by January 2018, coinbase, bitfinex, and bitflyer, which are the three largest exchange market had utterly changed. The three companies account for 53% of the total market share in Bitcoin transactions spread across a six-month trading period (Hemfing, 2019).
Centralized and Decentralized Systems
Blockchain, which is Bitcoin's core technology, has recently become a disruptive innovation applied in many applications that have the potential to redesign the way humans interact in politics, business, and society at large (Atzori, 2017). While there is increased scholarly interest in blockchain technology, a lack of a comprehensive analysis of these applications from the political viewpoint challenges a clear understanding of the difference between centralized and decentralized systems in digital currencies. The concept of blockchain-based decentralized governance tends to challenge the varying degrees of traditional mechanisms of democracy, citizenship, and state authority (Atzori, 2017). Cryptocurrencies were designed to be largely decentralized, meaning that there is no central authority, entity or government. However, regulatory headwinds and the recent market downturn in digital currency have brought about the concept of making cryptocurrencies centralized. It is not certain whether the future of cryptocurrencies will take the approach of either centralized or decentralized or both. In decentr...