Global Economic Environment.

Individual Essay by Anastasiia Korshunova, MIM student, id st039790

Potential influence of bitcoin currency and technology on financial system.
Last year bitcoin as the cryptocurrency gained popularity, which immediately
reflected in its exchange rate to USD, for example. The major international companies
announced that they are now accepting bitcoins as means of payments, including Dell,
Microsoft and more distant from the IT world Subway and Victorias Secret1. That gives a
sence of legitimacy to a currency, that for the anonymity of money transfers was widely
used in the grey zone of economics and known mostly for that. However, that does not
mean, that these major companies expect cryptocurrencies to replace fiat money, most
importantly, US dollar: most of them use bitcoin transfer to USD services of
intermediaries like CoinBase or BitPay2. So which potential impact may Bitcoin and
cryptocurrencies in general have on financial system? The note is structured as follows:
firstly the brief background towards history, supply and contragents involved with
bitcoins is given, then the overview of the current state of Bitcoin, and potential
influences of cryptocurrencies and underlying technologies onto the world financial
system.
Background.
Bitcoin is the first known cryptocurrency, created by a person or a group of person
under the pseudonym Satoshi Nakamoto in 2008 as decentralized peering online payment
system. In its initial documentation, Bitcoin claimed to resolve the question of How do
we digitize currency and payments in a way that isnt reliant on archaic, inefficient
systems?3 This system up to nowadays has following characteristics: it is decentralized
and up until recently anyone could be an issuer of bitcoins, which actually means
1 Chokun J. Who Accepts Bitcoins? http://www.bitcoinvalues.net/who-accepts-bitcoins-paymentcompanies-stores-take-bitcoins.html
2 Davidson J. No, Big Companies Arent Really Accepting Bitcoin. 09.01.2015
http://time.com/money/3658361/dell-microsoft-expedia-bitcoin/
3 OBryant D. Bitcoin vs Gold vs USD: Why Cryptocurrency is the future. http://coinbrief.net/bitcoingold-usd

serving the systems transactions by finding unique hash, encrypted information about
concrete bitcoins transactions, and receiving predetermined by the initial algorithms
amount of bitcoins. However, this process with time becomes more and more resource
consuming, so that individual PCs, which in 2009 were able to mine bitcoins, no longer
are capable to do that and specific computers are issued for individual miners, organizing
themselves into pull and spreading the value of bitcoin received among participants, and
mining farms, for example like the largest one located in China, generating about 25BTC
a day4, while on the regular PC it is possible to generate 0.1BTC per week at most with
all necessary equipment.
The whole amount of bitcoins ever possible to generate and use is limited to 21
million with ability to break one bitcoin into about 10 million smaller units, called
satoshis, also divisible. For now there exist 13965875 bitcoins5, and the last one is to be
mined in 2130.
For now, bitcoins provide merchants with an incentive to use them, because the
transaction costs are much lower than 2-3% imposed by credit card processors. However,
with diminishing return to the miners, and with rising mining costs, the transaction fees
are subject to discussion as to heighten them.
Bitcoins are stored in electronic wallets, which are anonymous. However, the
system is designed in such a way, that any transaction becomes known to all system
participants. Once the wallet is for some reason lost, or hacked, the money is lost and no
one is entitled to return it. The wallet is a file stored on a computer, so as any important
file, it needs to be backed up, even the paper form will do, with proper storage. The
vulnerability of bitcoin as cryptocurrency reflected in bankruptcy of Japanese stock
exchange Mt.Gox, which had software security problems.
Current evangelists of bitcoin as the currency of the future, investing into the
bitcoins, bet onto the network effects, so that the supporting the bitcoin community will
eventually bring most value to all its participants. 6 The latter consists not only of
enthusiasts, individual and collective miners, developers of new algorithms to mine
4 Franco E. Inside the Chinese Bitcoin Mine That's Making $1.5M a Month. 06.02.2015
http://motherboard.vice.com/read/chinas-biggest-secret-bitcoin-mine
5 http://blockexplorer.com/q/totalbc

bitcoins more efficiently, or buyers, but also of institutional investors, like Reid Hoffman
(LinkedIn founder), Tim OReily, or Adam Draper, founder of Boost VC Accelerator,
which since November, 2014 works only with Bitcoin companies, working with
payments, exchanges and mining technologies.7
Current state.
As a currency, Bitcoin possesses certain characteristics, common with other
cryptocurrencies: the number in issue; the method of creation; the exchange rate regime;
payment of positive, negative, or zero interest on balances8.
Jeff Garzik, a Bitcoin developer for the payment processor BitPay noted, that the
vast portion of Bitcoin volatility is accounted for not by mining itself, or technical
trading, but rather by the media, so it tends to follow media cycles, not hardware or
mining9. So, recently the Bitcoin became overheated, formed a bubble, which eventually
vanished, and now the price and exchange rate of bitcoin are believed to be stabilizing
with a slight uprising trend. 10 The major role in bubble formation is also due to trading
bot, occupying major for the time stock exchange for bitcoins, Mt.Gox, exchanging
regularly large amounts of USD per BTC. Another factor, which is still in place, is the
perceived status of bitcoin currency as means of savings, not transactions. Such notion
arises from limited money supply, causing bitcoins holders offer less BTC for sale.

6 Cawrey D. LinkedIn Founder Talks Bitcoins Future at San Francisco Conference. 01.02.2015
http://www.coindesk.com/linkedin-founder-talks-bitcoins-future-san-francisco-conference/
7 Draper A. Boost VC Is Going Full Bitcoin. 21.11.2014 http://www.medium.com/@adamdraper/boostvc-is-going-ful-bitcoin-c6ec65017bd6
8 Greenham T., McCann D., Ryan-Collins J. Financial system impact of disruptive innovation: Working
paper for the United Nations Environment Programme inquiry. 05.02.2015
http://www.unep.org/inquiry/Portals/50215/Documents/Disruptive%20Innovation_Inquiry%20Working
%20Paper_%20NEF.PDF
9 Volastro A. CNBC Explains: How to mine bitcoins on your own. http://www.cnbc.com/id/101332124
10 Long K. Bitcoin market starts to mature. 24.10.2014.
http://www.euromoney.com/Article/3393649/Category/9544/ChannelPage/0/Bitcoin-market-starts-tomature.html?copyrightInfo=true

So here we see, that, as a currency, which is only about 6 years old, Bitcoin
exchange rate swings may be explained mostly by short-term behavioral models and
long-run purchasing power parity state. The purchasing power of Bitcoin suffers greatly
due to its volatility and almost no goods or jobs possible to be bought by bitcoins are
actually denominated in bitcoins (mostly in dollars). However, the bitcoin is still
spreading, so likely is further development in direction of bitcoin entrepreneurs paying
suppliers and workers by bitcoins, thus boosting the demand. 11
Fairly recent report12 sums up the determinants of the bitcoin value according to the
empirical research in the following way: regular currency price determinants, such as
supply and demand, the latter in case of bitcoins with predetermined supply being more
important; demand is driven by size of bitcoin economy and velocity of bitcoin
circulation and is likely to affect bitcoin value also in the long run; speculative trading
affects the value; all other factors controlled for, macroeconomic factors do not exhibit
statistically significant influence.
Potential influence.
Speaking broadly, in the long run, wide adoption of cryptocurrencies, functioning
like bitcoin would amend certain determinants of world financial system. These are:
-first of all, right of seigniorage of national governments, because the amount of
issued coins is limited, this leads to government inability to implement quantitative
easing. The absence of the latter therefore reduces risks of currency wars, inflows of hot
money to emergent money economies and asset bubbles formation, trade protectionism
and capital controls reinforcement
-ability to choose the fixed exchange rate and the impossibility trilemma: therefore
the two policies remaining for the governments could be capital mobility and monetary
policy autonomy. In this regard bitcoin differs from gold standard, with which it is often
compared, as opposed to fiat money: its value fluctuates, as shown above. However, gold
11 Inside the Bitcoin economy. R.A. 11.04.2013
HTTP://WWW.ECONOMIST.COM/BLOGS/FREEEXCHANGE/2013/04/EXCHANGE-RATES
12 Ciaian P., Rajcaniova M., d'Artis Kancs The Economics of BitCoin Price Formation. 2014
http://arxiv.org/ftp/arxiv/papers/1405/1405.4498.pdf

alike, it allows individual import and export of bitcoin units and, if widely accepted,
capital movements would not be offset.
-ability to influence exchange rate through interest rate and inflation;
-deconcentration of financial regulating abilities, which, however, could concentrate
in large entities, serving the system and mining new bitcoins.
In the short to medium term the size of impact of virtual currencies certainly
depends on the amount of users, trusting its money status, but also, which is probably
more important, on amount of goods and services, traded for bitcoins, the size of bitcoin
economy. Another important factor is whether bitcoin would be largely accepted as a
commodity or a virtual currency, which is now still a debatable question, and in most
countries bitcoins are legally perceived as sort of commodity, ownership of which should
be taxed. Such notion is spread also among other important players of financial system,
as institutional investors and hedge funds heads.13
Bank of England expressed worries, that uncontrollable capital flow to
cryptocurrency will cease its ability to regulate inflation. Ministry of Finance of Russian
Federation emphasized the ability to perform distant anonymous transactions for illegal
goods and activities, also the terrorist organizations; also it emphasizes uncontrolled
emission of money in such system, although German Gref, for example, expressed
interest to invent regulation measures for similar systems, keeping up with such
tendencies of world finance14. Bank of Thailand after indecisive regulation towards
bitcoins circulation in the country decided to ban the exchange of bitcoins to the foreign
currency. Bank of Brasil, although initially resistant, grew more permissive towards
bitcoins and especially underlying it system. Currently, to various extents, bitcoins are
banned in Bangladesh, Bolivia, Ecuador, Russia, and Vietnam.15

13 All about Bitcoin. Global Macro Research. Top of Mind. Goldman Sachs. Issue 21. 11.03.2014
http://www.paymentlawadvisor.com/files/2014/01/GoldmanSachs-Bit-Coin.pdf
14 Bank of Russia warns about harm from bitcoin. 27.01.2014
http://www.bbc.co.uk/russian/business/2014/01/140127_central_bank_bitcoin_warning
15 Legality of bitcoin by country http://en.wikipedia.org/wiki/Legality_of_bitcoin_by_country

Aside of spelling out aspirations of cryptocurrencies enthusiasts, Bitcoin is valuable

more as a new global electronic money transmission mechanism, the system itself, as it
was initially proposed, which is already noted as disruptive innovation, for it is fast and
low cost across the borders. The impact in this sphere is illustrated by Fidor, German
bank, which adopted decentralized payment system, based on opensource software, thus
allowing its customers send money without time lags and high expenses. This shows
potential of such systems to other established financial institutions. 16 Such adoption may
speed up the financial flows across the world, potentially being as one of the factors for
resetting financial globalization. More direct implication is growing net savings due to
less payments in online retail and remittances, adding up to USD162 billion savings in
online retail and about 8,9% saving per each remittance payment 17. Another benefit for
local banks, for example, is within implementation of such P2P protocol, namely it is
ability to raise local spending power. The potential gains for people, requiring
microfinancing arise from the made easier with bitcoin system organization of closed
loop community credit clearing systems. One of which, Swiss WIR, offers financing
within its system, making money available in particular during economys downturns.
However, for that there either needs to be state acknowledgement of the mechanism
behind the currency to get it used and the currency itself. Another obstacle is technical
issues, making delays in clearing transactions. The transaction completion time is about
10 minutes.
In case even if the bitcoin as a currency fails, but the changes in transferring
payments due to block chain technology adoption are adopted, there are likely such
innovations as free banking, lower transaction costs in B2B market, and possible
government benefits in easing taxes collection and lowering corruption related to
multiple agents transactions.18 Improvement of its financial services has already been

16 Greenham T., McCann D., Ryan-Collins J. Financial system impact of disruptive innovation: Working paper for
the United Nations Environment Programme inquiry. 05.02.2015
http://www.unep.org/inquiry/Portals/50215/Documents/Disruptive%20Innovation_Inquiry%20Working%20Paper_
%20NEF.PDF

17 All about Bitcoin. Global Macro Research. Top of Mind. Goldman Sachs. Issue 21. 11.03.2014
http://www.paymentlawadvisor.com/files/2014/01/GoldmanSachs-Bit-Coin.pdf

highlighted as possible implication of such system adoption in its report by the Bank of
Canada.
For now it is not quite clear, whether the bitcoin currency or underlying it
technology will be accepted, because many analogues are present, which to some extent
may be considered better designed, evaluation of which depends also on economic
assumptions we are basing on. For Bitcoin as a currency, for example, one of such
assumptions was uncontrolled inflation due to nontransparent issue of new units of
existing currencies by the governments, resulting, for example, in redistribution of wealth
and necessity to invest. However, for now bitcoin as a currency due to its volatility does
not offer decent alternative. Major points probably to be taken from the bitcoin economy
now are the possible benefits of the technology of decentralized payment system, which
not necessarily should be that of Bitcoin.

18 Graydon C. The future of Bitcoin: its not what you think. 8.10.2014
https://www.cryptocoinsnews.com/future-bitcoin-think/

References.
1. All about Bitcoin. Global Macro Research. Top of Mind. Goldman Sachs. Issue 21. 11.03.2014
http://www.paymentlawadvisor.com/files/2014/01/GoldmanSachs-Bit-Coin.pdf
2. Bank
of
Russia
warns
about
harm
from
bitcoin.
27.01.2014
http://www.bbc.co.uk/russian/business/2014/01/140127_central_bank_bitcoin_warning
3. Bitcoin: virtual gold or global financial pyramide. Grigorij Bakunov, Dmitrij Golubovskij,
Aleksandr Plyushev, Andrej Hodorchenkov. Tochka programme on radio Echo Moskvy. Aired
24.11.2013 http://echo.msk.ru/programs/tochka/1202685-echo/
4. Cawrey D. LinkedIn Founder Talks Bitcoins Future at San Francisco Conference. 01.02.2015
http://www.coindesk.com/linkedin-founder-talks-bitcoins-future-san-francisco-conference/
5. Chokun J. Who Accepts Bitcoins? http://www.bitcoinvalues.net/who-accepts-bitcoins-paymentcompanies-stores-take-bitcoins.html
6. Ciaian P., Rajcaniova M., d'Artis Kancs The Economics of BitCoin Price Formation. 2014
http://arxiv.org/ftp/arxiv/papers/1405/1405.4498.pdf
7. Davidson J. No, Big Companies Arent Really Accepting Bitcoin. 09.01.2015
http://time.com/money/3658361/dell-microsoft-expedia-bitcoin/
8. Draper
A.
Boost
VC
Is
Going
Full
Bitcoin.
21.11.2014
http://www.medium.com/@adamdraper/boost-vc-is-going-ful-bitcoin-c6ec65017bd6
9. Franco E. Inside the Chinese Bitcoin Mine That's Making $1.5M a Month. 06.02.2015
http://motherboard.vice.com/read/chinas-biggest-secret-bitcoin-mine
10. Greenham T., McCann D., Ryan-Collins J. Financial system impact of disruptive innovation:
Working paper for the United Nations Environment Programme inquiry. 05.02.2015
http://www.unep.org/inquiry/Portals/50215/Documents/Disruptive%20Innovation_Inquiry
%20Working%20Paper_%20NEF.PDF
11. http://blockexplorer.com/q/totalbc
12. Inside
the
Bitcoin
economy.
R.A.
11.04.2013
HTTP://WWW.ECONOMIST.COM/BLOGS/FREEEXCHANGE/2013/04/EXCHANGERATES
13. Legality of bitcoin by country http://en.wikipedia.org/wiki/Legality_of_bitcoin_by_country
14. Long
K.
Bitcoin
market
starts
to
mature.
24.10.2014.
http://www.euromoney.com/Article/3393649/Category/9544/ChannelPage/0/Bitcoin-marketstarts-to-mature.html?copyrightInfo=true
15. OBryant D. Bitcoin vs Gold vs USD: Why Cryptocurrency is the future.
http://coinbrief.net/bitcoin-gold-usd
16. Volastro
A.
CNBC
Explains:
How
to
mine
bitcoins
on
your
own.
http://www.cnbc.com/id/101332124

Appendix. Bitcoin exchange rate from origin up to recently.