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Trends in crypto-currencies and blockchain technologies: A monetary theory and regulation perspective

Gareth W. Peters, Efstathios Panayi, Ariane Chapelle

arXiv:1508.04364v1cs.CRcs.CY

TL;DR

The paper asks how unbacked digital currencies can have value and how they should be treated as they interact with the real economy. It traces their history, reviews usage, monetary theory, and regulation, finding limited Bitcoin adoption alongside sharply varied regulatory responses.

  • Problem

    The paper examines how monetary theory can explain value in purely artificial crypto-currency tokens that lack central-authority backing.

  • Method

    It traces the emergence of virtual and crypto-currencies, reviews usage and investment trends, analyzes monetary theories, and summarizes regulatory responses.

  • Results

    Regulatory responses range from outright bans in China to effective treatment as money in Australia, while Bitcoin has not gained widespread acceptance.

  • Takeaways & Limitations

    Virtual currencies primarily served online gaming and social niches, while crypto-currencies sought wider internet use, but Bitcoin adoption and investment use remain limited.

  • Takeaways & Limitations

    Smart contracts remain limited by the ability of available data to describe the interactions they must encode.

Abstract

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The internet era has generated a requirement for low cost, anonymous and rapidly verifiable transactions to be used for online barter, and fast settling money have emerged as a consequence. For the most part, e-money has fulfilled this role, but the last few years have seen two new types of money emerge. Centralised virtual currencies, usually for the purpose of transacting in social and gaming economies, and crypto-currencies, which aim to eliminate the need for financial intermediaries by offering direct peer-to-peer online payments. We describe the historical context which led to the development of these currencies and some modern and recent trends in their uptake, in terms of both usage in the real economy and as investment products. As these currencies are purely digital constructs, with no government or local authority backing, we then discuss them in the context of monetary theory, in order to determine how they may be have value under each. Finally, we provide an overview of the state of regulatory readiness in terms of dealing with transactions in these currencies in various regions of the world.

1 Introduction

The paper situates virtual and crypto-currencies within fintech’s effort to reduce payment friction, contrasting centralized online-economy currencies with Bitcoin’s intermediary-free, decentralized model. It then frames Bitcoin’s speculative uptake, blockchain innovation, monetary value, and regulatory challenges.

  • Fintech and emerging currencies: Fintech firms expanded services from payments and money transmission to peer-to-peer lending and crowdfunding, alongside substantial UK investment and economic contribution.UK venture-capital funding for fintech exceeded $500 million in 2014, while the sector was estimated to contribute more than GBP 20 billion.
  • Fintech and emerging currencies: Virtual currencies generally serve online gaming and social economies, whereas crypto-currencies aim to reduce transaction costs through direct peer-to-peer payments without financial intermediaries.
  • Bitcoin uptake: Bitcoin was intended as electronic cash, but speculation has dominated its use; exchanges, merchant processors, and money transmitters are emerging around the network.Bitcoin has traded on exchanges since at least 2010 and has experienced boom-bust cycles against major fiat currencies.
  • Blockchain innovation: Bitcoin’s blockchain records all transactions in a decentralized ledger, using cryptographic proof and network participants who verify transaction blocks approximately every 10 minutes.The system rewards the first participant to provide the required verification with newly minted Bitcoins.
  • Monetary theory: The paper examines how monetary theories might explain value in unbacked digital tokens and considers the economic-policy implications of wider interaction with the real economy.
  • Regulation: Financial innovation is outpacing regulation, while Bitcoin’s transaction anonymity creates operational, money-laundering, fraud, and legal risks that governments are addressing unevenly.Regulators seek to avoid excessive burdens on financial innovation while preventing new services from circumventing traditional banking regulation.

2 Physical and electronic forms of money, and the development of crypto-currencies

The paper traces money from fiat and e-money through centralized virtual currencies to decentralized crypto-currencies, emphasizing their distinct governance, accessibility, monetary functions, and regulatory implications.

  • Physical and electronic forms of money, and the development of crypto-currencies: The paper reviews government- and commodity-backed money, cryptographic protocols enabling e-money, and online communities that first adopted virtual currencies.
  • 2.1 Fiat currency and e-money: Fiat currency is legal tender issued by a central authority and accepted because regulation and trust support it, unlike commodity-backed money, which can be redeemed for a commodity.
  • 2.1 Fiat currency and e-money: E-money is electronically stored monetary value representing a claim on an issuer, issued for payment transactions and accepted by parties other than the issuer.Examples include prepaid cards and online prepaid accounts, typically denominated in the fiat unit used to obtain them.
  • 2.2 Cryptographically secure e-money: Early electronic cash sought to emulate physical money while enabling private, secure, and anonymous payments through cryptographic techniques.
  • 2.2 Cryptographically secure e-money: PayPal, Liberty Reserve, and E-gold emerged among early e-money systems, but the latter two encountered US authorities over suspected money-laundering and criminal use; these systems were centralized.
  • 2.3 Virtual currencies to facilitate online gaming economies: Virtual currencies developed in the 1990s for messaging and gaming environments, where a central operator could regulate supply and support exchanges for virtual goods and services.
  • 2.4 Crypto-currencies: Bitcoin differs from centralized virtual currencies because it operates through a decentralized network without a central bank or financial intermediaries; its classification depends on its relationship with fiat money and the real economy.
  • 2.5 The distinct nature of crypto-currencies: Bitcoin’s internet dependence limits accessibility, while crypto-currency divisibility, fungibility, and anonymous identities distinguish it from conventional e-money; current evidence finds it does not yet fulfill money’s functions like fiat currency and e-money.Without central governance, the system also lacks mechanisms to prohibit particular sales or impose traditional transaction controls.

3 Trends in the usage of crypto-currencies in the economy

Bitcoin’s uptake spans speculative trading, payment activity, criminal-use concerns, and broader distributed-ledger applications. The paper reviews these trends alongside technical constraints and emerging investment and governance possibilities.

  • 3.1 Bitcoin trading by exchange and currency: Bitcoin has become the paper’s focus because it represents more than 80% of the $4.5 billion total market capitalisation across 590 listed crypto-currencies.
  • 3.1 Bitcoin trading by exchange and currency: Trading shifted from predominantly US dollars to predominantly Chinese Yuan, highlighting Bitcoin’s speculative-investment and currency-control-evasion uses.
  • 3.1 Bitcoin trading by exchange and currency: Bitcoin’s network processes transactions through miners, who verify blocks approximately every 10 minutes and receive newly minted Bitcoins as rewards.
  • 3.1 Bitcoin trading by exchange and currency: Mining difficulty rose exponentially for a sustained period as miners added hardware, then plateaued as declining Bitcoin prices likely reduced profitability.
  • 3.2 Crypto-currency real world usage: Daily Bitcoin usage was estimated at 60,000–70,000 transactions and €15–€30 million in volume, while reports identified speed, cost, and cross-border payments as advantages.
  • 3.3 Crypto-currency as a means of facilitating crime: Bitcoin-related criminal-use evidence includes Silk Road activity and effective mixing services, although UK assessment found little evidence of widespread money laundering through digital currencies.
  • 3.4 Other distributed ledger technologies: Distributed-ledger applications extend beyond currencies to asset registries and application stacks, including smart contracts, but Bitcoin’s 1 MB blocks average about 7 transactions per second.

4 Value generation in crypto-currency

The paper examines how crypto-currencies might derive value despite lacking central-authority backing, using competing monetary theories and considering scarcity, demand, taxation, and monetary control. It also highlights potential deflationary pressures and tensions between decentralised currencies and state-controlled money.

  • Crypto-currency value is examined through multiple economic and monetary frameworks rather than a single preferred school of thought.The analysis considers how value may arise when crypto-currencies interact more widely with the real economy.
  • 4.1 Crypto-currencies as scarce economic goods and the potential of a ‘Deflationary Spiral’: Fixed or slowly growing money supplies may create deflationary pressures if the economy expands faster than the quantity of crypto-currency.The paper links Bitcoin’s fixed slow growth rate to the possibility of deflation under widespread use.
  • 4 Value generation in crypto-currency: Under a metalist perspective, crypto-currency value may reflect commodities consumed during mining, including maintenance, storage, and electricity costs.
  • 4 Value generation in crypto-currency: Crypto-currencies may retain value when rational economic agents prefer them as tradeable goods over fiat-backed electronic substitutes.
  • 4.4 How do ’outside monies’ like virtual and crypto-currencies fit into the chartal and modern monetary theory perspectives ?: Wider crypto-currency use could challenge government control over money supply and monetary-policy levers, especially if states accept such currencies for tax payments.
  • 4.4 How do ’outside monies’ like virtual and crypto-currencies fit into the chartal and modern monetary theory perspectives ?: Chartalist analysis links money’s acceptance to social debt relationships and the state’s power to determine how taxes and other liabilities are paid.

5 Views on crypto-currency from a regulation perspective

The paper surveys varied regulatory responses to virtual and crypto-currencies, balancing lower-cost, faster transactions against anonymity, criminality, and compliance risks. Regulators increasingly distinguish the currencies from their underlying distributed-ledger technologies, while monitoring possible monetary and financial-stability effects.

  • 5 Views on crypto-currency from a regulation perspective: Regulatory interpretations vary, treating crypto-currencies as e-money, private money, commodities, private property, or private units of account.These classifications also influence taxation treatment.
  • 5 Views on crypto-currency from a regulation perspective: UK consultation responses identify lower costs and faster, around-the-clock processing as benefits, alongside limited transaction controls and associated risks.The benefits are particularly noted for cross-border transactions.
  • 5 Views on crypto-currency from a regulation perspective: The ECB judged Bitcoin not yet to be full money because of high price volatility and low acceptance, while monitoring risks if virtual currencies gain mainstream adoption.
  • 5 Views on crypto-currency from a regulation perspective: UK regulatory plans include anti-money-laundering requirements for digital-currency exchanges, while New York adopted a more interventionist BitLicense framework.
  • 5 Views on crypto-currency from a regulation perspective: $5000 and a lengthy application are required for covered New York virtual-currency activities, and some firms withdrew or shut down citing compliance burdens.
  • 5 Views on crypto-currency from a regulation perspective: Outside the EU and US, regulatory activity has mostly involved warnings, with China prohibiting financial institutions from handling Bitcoin.
  • 5 Views on crypto-currency from a regulation perspective: Regulators increasingly view distributed-ledger technology as more promising than virtual currencies themselves, while identifying barriers to widespread acceptance.

6 Conclusions

The report distinguishes virtual currencies serving online gaming and social niches from crypto-currencies seeking broader internet use, while examining current usage and regulation. It concludes that regulatory responses vary widely and are constrained by crypto-currencies’ decentralised and borderless nature.

  • Virtual currencies emerged for online gaming and social communities, whereas crypto-currencies sought wider reach as potential internet currencies.
  • The report focuses on decentralised crypto-currencies because they are more likely to enter the real economy, while Bitcoin has not yet achieved widespread acceptance.Bitcoin’s use as an investment product has also remained low.
  • Regulatory responses to Bitcoin range from outright bans in China to effective treatment as money in Australia.
  • Bitcoin’s decentralised and borderless structure limits the effect of any single jurisdiction and makes regulatory arbitrage difficult to prevent.The report therefore focuses regulatory attention on companies providing services in the field.
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