Banking and finance as we know it, has relied on one important factor; trust. A trust model requires a bank or a financial institution to act as a third party between a merchant of sale and a purchaser. In a trust-based model, it is not possible to have non-reversible transactions, as financial institutions are eager to avoid dispute. This increases transaction costs and makes small-scale transactions unfeasible.
This is where digital currency promises a breath of fresh air. Two willing parties can transact directly through a peer to peer version of electronic cash, minus the hassle of a financial counterparty, currency exchange and transactional cost. Transactions in digital currencies are facilitated by Blockchain, the underlying technology empowering this seamless exchange. Blockchain is a distributed ledger which details the payment history of digital currencies and replaces a trusted third party. Blockchain enables parties to securely send, receive, and record value or information through a peer-to-peer network of computers, and only records a transaction after confirming its validity.
Bankers have not been too happy to accept the revolution triggered by digital currencies. They struggle to appropriately define digital currencies. The European Central Bank defines a virtual currency as “a type of unregulated, digital money, issued and controlled by its developers, and used and accepted among the members of a specific virtual community”. The distributed ledger also poses hassles for the financial markets. Since there are no intermediaries, there is no way a digital currency transaction can be reversed and law enforcement is an issue when it comes to the degree of anonymity that digital currencies offer in addition to seamless, borderless transactions.
However, countries have expressed mixed reactions toward digital currencies. China treats Bitcoins as a special virtual commodity, not a currency, prohibiting banks from dealing in them. United Kingdom treats Bitcoin payments like ordinary payments for tax purposes. France and Germany have declared Bitcoin not a currency but an alternative means of payment. Russians denounced Bitcoins exchange as a “dubious activity” associated with money laundering and terrorism financing. Kenyan Central Bank declared virtual currencies as “unregulated” and warned the public against using them.
Nevertheless, usage of virtual currencies has continued to boom with more people warming up to the concept and in the process, revolutionising international payments. So popular has been the Bitcoins for instance, that there were fears the system would be unable to sustain transactions due to their rapid increase. Bitcoin has become like the official currency in the dark web.
Regulators, financial institutions and businesses need to understand potential impact of virtual currencies. Instead of fighting and curtailing them, reform in the financial markets framework to have laws keeping up with the digital evolution and technological wizardry is the way forward. The era of digital currencies is upon us now, and stopping it is well-nigh impossible.