Question

Since we will spend plenty of time exploring the traditional parts of the financial system, let’s discuss an emerging area which is virtual currencies. How do virtual currencies work and what role do you think they will play in the economy going forward?

Answer 1

Some of the limitations that virtual currencies presently face – such as the fact that one’s digital fortune can be erased by a computer crash, or that a virtual vault may be ransacked by a hacker – may be overcome in time through technological advances. What will be harder to surmount is the basic paradox that bedevils virtual currencies – the more popular they become, the more regulation and government scrutiny they are likely to attract, which erodes the fundamental premise for their existence.
While the number of merchants who accept virtual currencies has steadily increased, they are still very much in the minority. For virtual currencies to become more widely used, they have to first gain widespread acceptance among consumers. However, their relative complexity compared to conventional currencies will likely deter most people, except for the technologically adept.
A virtual currency that aspires to become part of the mainstream financial system may have to satisfy widely divergent criteria. It would need to be mathematically complex (to avoid fraud and hacker attacks) but easy for consumers to understand; decentralized but with adequate consumer safeguards and protection; and preserve user anonymity without being a conduit for tax evasion, money laundering and other nefarious activities. Since these are formidable criteria to satisfy, is it possible that the most popular virtual currency in a few years’ time could have attributes that fall in between heavily-regulated fiat currencies and today’s virtual currencies? While that possibility looks remote, there is little doubt that as the leading virtual currency at present, Bitcoin’s success (or lack thereof) in dealing with the challenges it faces may determine the fortunes of other virtual currencies in the years ahead.