Virtual currencies and the money market

Virtual currencies are in vogue. Bitcoin is the most prominent one, but there exist many others. Until now, their share in overall economic transactions is very small, not to say negligible. But in general they have the potential to become parallel currencies to the various national currencies. Monetary globalization goes virtual and here we have a problem:

Virtual currencies are issued decentralized and are – in general – available worldwide. That is why we cannot just adopt the models of parallel currencies as they imply centrally issued currencies. Also, von Hayek’s theory of denationalization of money assumes institutions that issue money. So we have to find a different way to include virtual currencies into monetary theory. Assuming that virtual currencies really become a substitute for national currencies as payment vehicles, we integrate virtual currency supply and demand into the Keynesian money market equilibrium. Together with the equation of exchange it is possible to find some preliminary results for the central banks and to identify possible problems that may occur for monetary policy. The central bank is no longer the only issuer of money in the economy. Therefore, the overall money supply as a sum of national and virtual money supply is no longer in total control of central banks. Monetary policy loses part of its impact on the economy as it influences only one of the payment vehicles. The central bank is obliged to respond much stronger to money demand changes to achieve or keep the national money market equilibrium. It gets much harder for a central bank to control inflation or to target price stability.

For researchers one of the challenges is the decentralized nature of virtual currencies as all hitherto existing theories and models for parallel currencies are based on centrally issued currencies. The role of central banks has to change or at least to adapt to this new and innovative monetary system if virtual currenciesare to really become accepted as equivalent payment vehicles. We use a very simple model framework and our assumptions are strict in some sense. Nonetheless, we will check the model empirically in a next step.