Virtual Currency and the Financial System: The Case of Bitcoin

Abdur Chowdhury () and Barry Mendelson
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Barry Mendelson: Capital Market Investments, Inc.

No 2013-09, Working Papers and Research from Marquette University, Center for Global and Economic Studies and Department of Economics

Abstract: Technological development and the increased use of the internet have led to the proliferation of virtual communities. Some of these communities have created and circulated their own currency for exchanging goods and services. Bitcoin is currently the most popular among these virtual or digital currencies and has been in news recently because of the wild fluctuations in its "value" and also significant venture capital investment in entities associated with it.1 Bitcoin is relevant in several areas of the financial system and is therefore of interest to central banks, consumers and investors. Digital currencies are part of a broader group of virtual currencies that include credit card points, air miles, loyalty points and coupons (Chart 1). With the advent of the Internet, mobile devices and detailed consumer information, companies are increasingly using digital currencies as a marketing tool. As a result, there has been a sharp increase in the use of digital currencies, particularly for app-based coins and tokens, mobile coupons, and personal data exchanged for digital content. As these trends evolve, digital currencies have the potential to become more popular and compete with traditional currencies. This paper aims to provide some clarity in particular on Bitcoin, its role and potential future use in the financial system and the risks associated with this form of digital currency.. It will begin by providing a short introduction to the Bitcoin network as well as describe the benefits of allowing the Bitcoin network to develop and innovate. It will highlight concerns for consumers, policymakers and financial regulators. Next it will analyze the role that Bitcoin could play in the financial system. The paper will conclude by providing recommendations to address policymakers' concerns while allowing for further innovation within the Bitcoin network. An initial comprehensive overview of this kind is absent from the existing literature. This paper intends to fill that gap in the literature.

Date: 2013-12
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