As virtual currencies like bitcoin become more established, the exchange rate will be less affected by speculator perceptions, according to a staff working paper [PDF] on the value of virtual currencies written for the Bank of Canada by Wilko Bolt of the Netherlands Bank and Maarten R.C. van Oort of the Bank of Canada. Over time, excessive exchange rate volatility will not undermine virtual currency use. The 40-page paper’s aim is to determine what drives the value of virtual currencies like bitcoin, which the paper underlines as the mostwell-known virtual currency. Much of the paper attempts to quantify the factors impacting virtual currency exchange rates. It documents three main determinants of virtual currency exchange rates. Three Main Determinants The first factor is the current use of the currency to make “real” payments. Second is the decision by forward-looking investors to purchase virtual currency, thereby effectively reducing its supply. Third is the set of elements that drive consumer adoption and merchant acceptance, which determine long-term growth in usage. Bitcoin, the best known virtual currency, experienced significant exchange rate volatility at the end of 2013. The U.S. dollar exchange rate for one bitcoin was more than fivefold. During 2014, the exchange rate declined. The rapid appreciation of bitcoin’s exchange rate and its high volatility have posed concerns about its viability as a currency. Bitcoin suffers from a higher exchange rate volatility than traditional currencies. Bitcoin’s use nevertheless continues to rise, jumping from 20,000 daily transactions in 2012 to 70,000 in 2014 and 200,000 in June 2016. Exchange Rate Economics Most papers on virtual currency exchange rates do not have a formal treatment of economics behind exchange rates, a perspective that can explore the links between currency creation, network effects, speculative behavior and real growth in goods and services transactions. The authors’ […]
