The subject of virtual currencies has been covered recently in several leading magazines, such as BusinessWeek, Wired, and even CNN. While all of these have discussed the impact virtual currency may have on the internet, very few have actually defined what a virtual currency is and how it differs from a real currency.
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In the past, money (currency) was usually either gold or silver and reflected a real-world value.
However, modern currency, is essentially fiat money, and is intrinsically worthless.
The prevalence of one type of currency over another in commodity money systems has arisen, usually when a government designates through decrees, that only particular monetary units shall be accepted in payment for taxes.
Fiat money is a currency that is not convertible into a physical quantity (ie gold) but is accepted as a medium of exchange by the government. Fiat money is declared by a government to be legal tender.
This latin term — let it be done — has value only because the government accepts it and says it can be used as a “legal tender”. The 50 dollar bill in your pocket is not actually worth 50 dollars. It’s just cotton with images and other text printed on it, albeit in a very sophisticated manner.
Most of us have our own idea of what constitutes a virtual currency but let’s look at some of the ways it differs for a real currency, such as the US Dollar.
1. Inflation – most virtual currencies are not subject to inflation. In other words, the coins you buy on club penguin or World of Warcraft will have the same value in 6 months time as the date you bought them.
2. Regulation – each virtual currency is controlled by the developers and have no bearing in the real world. For now, virtual currencies, to the best of my knowledge, are not monitored by government regulators and why should they are they weren’t created as a national currency.
But this might change if these virtual currencies gain traction and begin to effect real world currencies.
3. Liquidity – for now, it’s difficult to convert your linden dollars into US dollars, though not impossible. However, try changing Club Penguin coins into another virtual currency and you have a problem.
Of course, this presents an opportunity.
Why not setup a clearing house online where people can ‘cash in’ their virtual currency. Let’s say you no longer want use Club Penguin but have 100 USD worth of coins in there.
The virtual currency clearing house would act as a middle man and give you a percentage of the CP coins in exchange for US dollars.
4. Exchange rates – while most leading currencies can be converted into other currencies, there is no formal exchange rate for virtual currencies. At least not yet!
This is likely to change once Google and others see the potential of controlling currencies on the internet.
Imagine a scenario where Google has greater leverage than the Federal Reserve and you see where this could go.
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