Virtual Currencies – Where Next?


Introduction

There’s a rush and excitement around virtual currencies.  Much of it is being driven by social media giants, and the expected virtualization of everyone’s wallet that NFC will soon bring.  But which virtual currencies have the greatest potential and do these pose any threat to the fiat currency regimes of the physical world?  This article looks at these topics in more detail.

Growth

“Measured in real-world U.S. dollars, virtual transactions total $2.1 billion a year in the U.S. and $7.3 billion globally, according to Sometrics’ founder and chief executive, Ian Swanson. That is up 61% since 2008.” ~from Bank Technology News.

Many companies, not just start-ups, are getting into the virtual currency market.  Facebook, Visa, American Express and even the big banks see the possibilities of owning, controlling and growing private digital currencies.         But what’s fueling this rise?  What is everyone getting so hopped up about?

Arbitrage –  The most obvious eye popping opportunity is exemplified by the rise and fall of BitCoin.  The graphic below comes from Wired Magazine, and shows the phenomenal investment opportunity you had for in 2010.

Tax Shelters –  Corporations, the rich, pension funds, hedge funds, and others with too much money are always looking for some way to hide their capital gains from the taxman.  What better way than to invest in digital assets using a virtual digital currency?  Talk about off the books.  But wait…. is that legal?  Well it’s not regulated, at the moment, but governments around the world are aware of this phenomenon and many are watching it closely.

Deflation/Inflation Hedge –  Particularly pertinent today, the potential for fiat currency de-valuation or appreciation in the face of mounting debts and uncontrolled deficit spending has given everyone with significant wealth an interest in finding a liquid, hedge to the big 3 ( dollar, yen, euro ).  Gold has been the traditional favorite in this spot, but with gold prices soaring and the threat of a bubble looming….the need for alternatives is strong.

Power – Less obvious on the radar is the sheer power that comes from managing an entire economy’s money supply.  A currency in isolation isn’t much.  The dollar without the U.S. economy is little more than paper.  What people find valuable in the dollar is the ability to buy goods and services from the single largest economy on earth.  For that reason the dollar provides a very stable store of value and means of exchange.  Similarly if a private virtual currency were to achieve such economies of scale…..say….dominating the global internet commerce business, then one could imagine the influence available.  Even large physical economies like the EU and Japan ( and their respective central banks ) would need to listen to the issuer of such a currency.

Who Will Lead?

So there are three types of virtual currency players in the market today:

The Wildcats  – These are the Ven and Bitcoin makers ( among others ).  They’ve built their virtual currencies and are asking people to adopt it.  It’s a hard road, with little incentive to convert your hard earned dollars, euros, or yen outside of arbitrage….it seems unlikely they’ll gain wide adoption.

The Closed Social Media Economies – With a captured market that has goods only purchasable using their currencies, these companies have modeled the very structure and incentives that make our modern physical economies today.  The challenge is extending this concept outside of Facebook ( or whoever ) to other sites.  But, the base is there.

The Banks – Ah….the banks.  Long ago, private currencies were common place in Scotland and the Wild West of America.  But when a bank went belly up…so did its currency….leaving all its depositors and paper holders staring down an empty well.  Banks have a ready made market in their dealings with the wealthy, corporations, hedge funds, pension funds, etc.

The Transaction Grabbers – This is PayPal, Google, and maybe Isis. They’re seeking a sliver of the transaction fee market from their mobile payment platforms.  But there’s no reason these players couldn’t introduce a virtual currency of their own.

So which group has the highest potential?  My money would be in Google Dollars and Goldman Sachs Coins.  This isn’t to say innovative new players won’t spring up, but the transaction grabbers and the banks already have the real audience needed to leverage a virtual currency and the financial wherewithal to make it a reality.  Clout is important here.

Challenge to Fiat Currency

Private digital currencies at the moment pose no threat to the world’s central banks.  But innovation has a way of challenging commonly held assumptions….especially ones as stodgy and long standing as government issued currency.  The internet has flattened the economic landscape and opened opportunities for global domination.  The digital, internet economy is owned by no country, no government.  There are no regulations guiding which currency an e-commerce site should use.  There’s nothing to stop someone from trying to capture this global digital economy and manage its money supply.  Therein lies the opportunity for those quick enough, connected enough and risk-averse enough to realize it.

Summary

Virtual currencies are still evolving, but growing fast.  Watch for the Transaction Grabbers and Banks to start making big moves in this space as near field communication and e-wallets become ubiquitous. Historically wildcat banking thrived in the lawless west….today it is thriving in the unregulated digital frontier.

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