Is vir­tual money as good as gold ?

China Daily (Canada) - - COMMENT -

Vir­tual cur­ren­cies have at­tracted the at­ten­tion of both the me­dia and pol­i­cy­mak­ers around the world re­cently. Al­though vir­tual cur­ren­cies aren’t es­pe­cially new, the at­ten­tion paid to them has been. Vir­tual cur­ren­cies are those used in elec­tronic, gen­er­ally Web­based trans­ac­tions. They are not is­sued by gov­ern­ments, which many view as pos­i­tive at a time when con­fi­dence in gov­ern­ments is low.

At­ten­tion has fo­cused on bit­coins, the sup­ply of which is de­ter­mined by an al­go­rithm. De­mand for the vir­tual cur­rency grew with the me­dia at­ten­tion and the ex­change value of a bit­coin reached a peak of more than $1,200, al­though the value has sub­se­quently dropped nearly 30 per­cent as spec­u­la­tion in the vir­tual cur­rency has de­creased since pol­i­cy­mak­ers have started pay­ing more at­ten­tion to it.

China re­cently banned fi­nan­cial in­sti­tu­tions from trad­ing bit­coins, and Nor­way has de­clared bit­coins to be an as­set not a cur­rency, which has im­por­tant im­pli­ca­tions. For­mer US Fed­eral Re­serve chair­man Alan Greenspan de­scribed bit­coins as a “bub­ble”, which also sug­gests that vir­tual cur­ren­cies should be re­garded as as­sets, be­cause as­sets have bub­bles, cur­ren­cies be­come over­val­ued.

Bit­coins are not the only vir­tual cur­rency; oth­ers have ex­isted for some time. Com­puter games of­ten have their own cur­rency, with play­ers earn­ing units of the cur­rency or tools or char­ac­ters through their skill at play­ing the game. In some cases, a vir­tual cur­rency can be pur­chased us­ing real-world money, which en­ables the cal­cu­la­tion of a vir­tual to re­al­world ex­change rate. This trade has been go­ing on for at least a decade, and sev­eral gov­ern­ments were quick to note that in­come earned from such trans­ac­tions should be sub­ject to tax.

So what are the key is­sues when it comes to a vir­tual cur­rency? There are four ques­tions to an­swer:

First, who con­trols the sup­ply?

Match­ing the sup­ply of any cur­rency to the level of de­mand determines the value of the cur­rency. This is what cen­tral banks try to do in the real world. The same prin­ci­ple ap­plies for vir­tual cur­ren­cies. If the sup­ply is not con­trolled, the value of the cur­rency is likely to dis­ap­pear. If the cre­ator of the cur­rency ceases to ex­ist, the com­puter game com­pany goes bank­rupt per­haps, the value of the cur­rency is also likely to dis­ap­pear. Sim­i­lar risks ap­ply in the real world — coun­tries cease to ex­ist, and their cur­ren­cies may then cease to have value — Con­fed­er­ate dol­lars, any­one? How­ever, as gov­ern­ment sys­tems col­lapse less fre­quently than com­pa­nies, real-world cur­ren­cies should be safer. Sec­ond, is it safe? Mod­ern real-world cur­ren­cies gen­er­ally have some le­gal guar­an­tees. Hold­ers of a real-world cur­rency in a bank­ing sys­tem have par­tial pro­tec­tion from fraud or theft. Vir­tual cur­ren­cies, not be­ing is­sued by gov­ern­ments, have less pro­tec­tion. As vir­tual cur­ren­cies are en­tirely elec­tronic they could be con­sid­ered more vul­ner­a­ble to cy­ber­crime than a real-world cur­rency, al­though real-world bank ac­counts can be hacked too. Third, is it money? Any­thing ac­cepted as a “medium of ex­change” for goods and ser­vices is money in some sense. How­ever, there is an im­por­tant dis­tinc­tion when it comes to tax, as Nor­way has so oblig­ingly high­lighted. The tax treat­ment of money and as­sets dif­fers. If a re­al­world cur­rency ap­pre­ci­ates, do­mes­tic sell­ers of that cur­rency are rarely sub­ject to tax. If an as­set ap­pre­ci­ates, do­mes­tic sell­ers of that cur­rency will be sub­ject to tax. If gov­ern­ments con­sider vir­tual cur­ren­cies to be as­sets, not money, then hold­ing vir­tual cur­ren­cies will in­cur taxes not levied on hold­ers of real-world money.

Fourth, what is a vir­tual cur­rency worth?

For an econ­o­mist, this is an easy ques­tion to an­swer. A vir­tual cur­rency is worth what some­one else is pre­pared to give in ex­change. A vir­tual cur­rency is of no value, un­less some­one else is pre­pared to ac­cept it in ex­change for goods or ser­vices that are of some use or value. If no one is pre­pared to give up some­thing use­ful in ex­change for a vir­tual cur­rency, then the vir­tual cur­rency is not worth the bytes it is writ­ten with.

There is no com­pul­sion to ac­cept vir­tual cur­ren­cies. Real-world cur­ren­cies have some com­pul­sion. Cred­i­tors are — gen­er­ally — legally obliged to ac­cept a real-world cur­rency in set­tle­ment of debts. More­over, taxes are levied on real-world cur­ren­cies. This cre­ates an au­to­matic de­mand for real-world cur­ren­cies, which is lack­ing for vir­tual cur­ren­cies. No one has to ac­cept vir­tual cur­ren­cies in set­tle­ment for any­thing, and gov­ern­ments are un­likely to re­act pos­i­tively to any at­tempt to set­tle a tax bill with bit­coins.

There is an in­ter­est­ing com­par­i­son to make be­tween vir­tual cur­ren­cies and gold. On the most im­por­tant ques­tion— as to what a cur­rency is worth — the an­swer is the same for both vir­tual cur­rency and gold. The value of gold is sim­ply what­ever any­one else is pre­pared to ex­change it for. In real-world terms the value of gold has fallen 27 per­cent from its 2013 peak — a per­for­mance that is eerily sim­i­lar to the fall in the value of the bit­coin. Gold is also gen­er­ally treated as an as­set not a cur­rency, the ex­cep­tion be­ing some gold coins, and sub­ject to more tax than a real-world cur­rency.

In a sense, there­fore, gold was the first vir­tual cur­rency — at least af­ter 1971 when the ten­u­ous link be­tween re­al­world cur­ren­cies and gold was sev­ered. Given the wild fluc­tu­a­tions in the value of gold — what it can buy — over the past 40 years, that may not be ter­ri­bly re­as­sur­ing for those hold­ing mod­ern vir­tual cur­ren­cies. The au­thor is a se­nior global econ­o­mist with UBS.

WANG XIAOYING / CHINA DAILY

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