Bitcoin as an Innovative Payment Currency in Germany: Development of the e-Gold Standard

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Citation

Journal of International Business Research and Marketing
Volume 2, Issue 2, January 2017, Pages 33-42


Bitcoin as an Innovative Payment Currency in Germany: Development of the e-Gold Standard

DOI: 10.18775/jibrm.1849-8558.2015.22.3005
URL: http://dx.doi.org/10.18775/jibrm.1849-8558.2015.22.3005

Aleksandar Arsov

PhD in Economics, Independent researcher

Abstract: Recent years have witnessed the advances of e-money systems such as Bitcoin, PayPal and various forms of stored-value cards. This paper adopts a mechanism design approach to identify some essential features of different payment systems that implement and improve the constrained optimal resource allocation in Germany. Bitcoin is a digital, decentralized, partially anonymous currency, not backed by German or any government or other legal entity, and not redeemable for gold or other commodities. Bitcoin relies on peer-to-peer networking and cryptography to maintain its integrity. Compared to most currencies or online payment services, such as PayPal, bitcoins are highly liquid, have low transaction costs, and can be used to make micropayments in Germany. Although the Bitcoin economy is flourishing, Bitcoin users are anxious about Bitcoin’s legal status. This paper examines a few relevant legal issues. The research question is to investigate how supplementary digital terminating currency Bitcoin can provide a superior fallback position as e-gold standard in Germany and worldwide. Digital self-liquidating e-Gold ounce could be distributed immediately to voters by using swipe cards used by some governments for transit facilities. Bitcoins as e-Gold ounce do not provide a viable medium of exchange because of the cost of their purchase, creation and/or exchange.

Keywords: Bitcoin, Digital currency, e-Gold standard, Ounce

Bitcoin as an Innovative Payment Currency in Germany: Development of the e-Gold Standard

1. The role of the Bundesbank

Oversight is an important role assumed by the Bundesbank in the field of payment transactions. This task is clarified with the latest amendment to Section 3 of the BBankG and is also recognized by the Treaty and the Statute as a primary task of the Eurosystem. Its aim is to ensure smooth payment transactions and encourage efficiency and security. In practical terms, this function is exercised largely by means of the general agreements on procedures and standards jointly developed with the banking sector and via institutionalized dialogues in various official bodies. Moreover, the Deutsche Bundesbank itself offers services in the field of payments and processing and thus assumes an operational function. Additionally, the Bundesbank carries out a statistical survey on payment services every year, which has to a certain extent been of limited scope and on a voluntary basis so far. To improve the data – an important basis for the performance of the oversight role – the Bundesbank is considering implementing a statistical regulation in the near future. Such a regulation would entitle the Bundesbank to collect statistics from all credit institutions in Germany. In exercising the oversight function, close cooperation between the bodies overseeing payments and the BaFin is of fundamental importance. In the field of electronic money, the Deutsche Bundesbank also cooperates with the Federal Agency for Security in Information Technology (BSI) and takes advice from this body, as systems with electronically stored units of value are subject to a special security test. The legal foundation for banking supervision is the KWG. The aim of this law is to safeguard the ability of the banking sector to function and protect creditors by monitoring the credit standing and liquidity of banks. The law aims to achieve this objective by respecting the principles of a market economy. Under the KWG, the supervision of banks is primarily the task of the BaFin, which, however, performs this task in cooperation with the Deutsche Bundesbank. The Deutsche Bundesbank is above all involved in the ongoing supervision of banks and in analyzing reports and notices from banks. In addition, however, it is involved in quality control in connection with the minimum requirements for the trading activities of credit institutions (MaH) and internal risk models.

1.1 Payment systems of the Deutsche Bundesbank

Continuing the tradition of the former Reichsbank (i.e. its explicit mandate to handle payment transactions), the Deutsche Bundesbank is actively involved in processing payments, with the aim of achieving the following goals:1. An adequate share of cashless payments in general; 2. The promotion of large-value payments in particular; 3. Subsidiary participation in retail payments; 4. The provision of payment systems/services which are neutral with respect to competition; 5. The promotion of safe and efficient procedures; and 6. Contributing to a reduction in processing times. The Deutsche Bundesbank fulfils its statutory task of ensuring the processing of domestic and international payments by providing a neutral giro network available to the banks in the various banking groups and offering its services in the area of cashless payment transactions to holders of Deutsche Bundesbank accounts in 118 branches and seven computer centres and two payment transaction points (as at year-end 2002). Banks have the option of using the Deutsche Bundesbank’s facilities instead of private giro networks or groups of banks. Against the backdrop of the close connection between the implementation of monetary policy and the processing of payments through the central bank, the Bundesbank pays particular attention to the encouragement of large-value payments. These payments are processed through RTGSplus, which at the same time provides a connection to the TARGET system. Together with the banking sector, the Deutsche Bundesbank developed this new liquidity-saving large-value euro payment system, combining the features of the two-previous large-value payment systems, the Euro Link System (ELS) and the liquidity-saving hybrid system Euro Access Frankfurt (Elektronische Abrechnung Frankfurt; EAF), to form one single real-time gross settlement system, which can be used for both domestic and cross-border payments in euros. It went live on 5 November 2001. The EAF was closed at this time, whereas the ELS will still be operated mainly as a communication channel to RTGSplus until the end of 2004. The new system is a means of gaining electronic access to the Deutsche Bundesbank, which has provided for this kind of access since 1990. In addition, the Bundesbank also offers an electronic procedure intended specifically for the handling of mass payments (credit transfers, cheques, and direct debits), namely the Retail Payment System (RPS).

1.1.1 Cash payments

The euro is the German currency and was introduced on 1 January 1999. At that time, it only existed as book money or as electronically stored units of value, with banknotes and coins continuing to be denominated in DEM. After its introduction as cash on 1 January 2002 the euro became the only legal payment medium in Germany; nevertheless, the DEM, which was the only legal payment medium until then, could still be used until the end of February 2002 according to an agreement between the Deutsche Bundesbank, the ZKA, and the German retailer association. The German banknotes and coins in circulation could be exchanged cost-free at banks at least until this date; thereafter the Deutsche Bundesbank guarantees the exchange of DEM to the new currency. Banknotes are available in seven denominations (EUR 5, 10, 20, 50, 100, 200 and 500) and the coins in eight (1, 2, 5, 10, 20 and 50 cents and EUR 1 and 2). The German 1, 2 and 5 cent coins have an oak leaf on the back, the other cent coins a picture of the Brandenburger Tor in Berlin, and the euro coins the eagle as the German heraldic animal. In addition, there are very small quantities of DEM 10 coins, although these are primarily for collectors and therefore rarely used in payment transactions. Banknotes and coins are legal tenders, although there is no obligation to accept more than 50 coins, or in the case of commemorative coins no more than EUR 100. At the end of 2001 total currency in circulation – including cash in bank vaults – amounted to EUR 82.9 billion, of which EUR 76.5 billion was in banknotes (92.3%) and EUR 6.4 billion in coins (7.3%). Cash in bank vaults amounted to EUR 14.9 billion. Although the share of card-based payments is rising continuously, cash payments still amounted to 68.8% of the value of all retail payments in 2001.

1.1.2 Non-cash payments

In Germany, cashless payments are effected by means of credit transfers (49.8% of the total number of cashless payment transactions in 2001), cheques (2.3%) and direct debits (36.4%). The usage of debit and credit cards is steadily increasing, reaching in total a share of almost 11.3%. Other types of payment, such as special payment instructions via Deutsche Postbank AG, but also payments made with prepaid cards, are relatively insignificant (less than 1%).

1.1.3 E-banking and e-money

The German banking sector is currently undergoing a process of fundamental change, caused by, among other things, the possibilities offered by home banking. Here a distinction must be made between electronic banking in closed networks – as offered, for example, by the online service provider T-Online AG (a subsidiary of Deutsche Telekom AG) – and internet banking (open network). In addition to providing payment transaction services, home banking can also be used both for account management and securities transactions and for obtaining information. It was estimated that there were 19 million online accounts in Germany in 2001. It is further estimated that at the end of 2001 there were 29 million internet users, and it is reckoned that at the end of 2005 there will be 43 million. During the stock boom period (in the years 1998 to 2000) the number of customers conducting stock exchange business online doubled. The growth rates have decreased since the stock markets dropped off in 2000. Nevertheless, the increase in new online accounts is unbroken and is expected to continue as confidence in the usage of the technology increases as well. Given the rapid increase in internet use, the share of electronic commerce (e-commerce) in the total volume of trade will grow even further. Secure and efficient payment systems are prerequisites for the projected growth of e-commerce since e-commerce will only be of interest to companies and private individuals if fast, simple and, above all, secure payment systems are available. It is becoming evident that in e-commerce between companies and private households, debit and credit cards are being used for the payment of larger amounts and e-money is being used for very small to small amounts. Here the borderline between e-money based on hardware and e-money based on software is becoming blurred, as card money can also be used for remote payments via the internet. Major banks and other institutions working in cooperation with banks have developed e-money schemes besides GeldKarte, such as PayCard, CyberCash, and eCash. So far none of them has been playing a pivotal role. Indeed, CyberCash and eCash have now discontinued their operations. The expectations of rapid growth in these markets have been shattered by the fact that suppliers of goods and services and consumers have so far not accepted those payment methods.

Figure 1: Interbank funds transfers in Germany
 Source: https://www.bis.org/cpmi/paysys/germanycomp.pdf (29-04-2016)

1.1.4. Other developments

With EDIFACT a uniform global format for the processing of electronic business and trade was created. In 1997, in step 1, both the conditions for the exchange of EDI messages between the parties named in the contract and the requisite technical accessories were established with a view to handling business transactions between customers and banks via remote data transfer. In the second step mandatory, EDIFACT acceptance was introduced on 7 February 1998, a uniform global format for the processing of electronic business and trade. Since then, all banks have had to be in a position to receive EDIFACT payments. In addition, there is no longer any need to convert EDIFACT messages into a national format. The Deutsche Bundesbank accepts EDIFACT payments in the ELS within the framework of electronic access to the Deutsche Bundesbank. Because of the very small number of payments in that format the Bundesbank deliberately does not accept such payments in RTGS plus.

1.1.5 Interest Rate Policy

Under the gold standard, interest rate policy worked through bank rates (discount rates), or, more correctly, because the monetary authority in a country could set its bank rate different from that in other countries. The empirical evidence in Bordo and MacDonald (2005) shows that under the gold standard short-term interest rates differed in Germany.
The price data for a Germany on the gold standard between 1880 and 1913 reveal facts:
1. Germany experienced very little inflation when the period 1880 to 1913 is considered as a whole.
Germany 1880 – 1913 1880 – 1895 1895 – 1913 Std. Dev.
Germany 0.42 -1.26 1.83 4.73
Table: Average and standard deviation of annual inflation rates for Germany, 1880 – 1913. [www.bankofcanada.ca/]
The lack of inflation between 1880 and 1913 was achieved by countries experiencing deflation over the first part of the period and inflation over the remainder. A question arises: “Does the Bitcoin “issue” in Germany, could/should interact with/against Interest Rate Policy in developing a new e-Gold Standard?”

Figure 2: Percentage growth rates of Bitcoin, 2015 – 2040
Source: http://www.bankofcanada.ca/wp-content/uploads/2016/03/swp2016-14.pdf (29.04.2016)

Recent years have witnessed a number of retail payment innovations known as electronic money (or e-money). In some decentralized systems, such as Bitcoin, bilateral transactions can be completed only after they are verified and written into a general ledger by other users (e.g. Bitcoin miners). In addition, according to CPSS (2001), it is quite common globally that the transferability of e-money balances among end-users is restricted. Specifically, 77% of e-money systems included in that survey prohibits transferability among end-users. Bitcoin (BTC) also has a built-in feature that allows the individual making a transaction to include a transaction fee paid to the Bitcoin miner. This feature of e-money can allow for charging merchants fees or other transaction fees, which are often observed in e-money payment systems. In contrast, electronic money such as prepaid cards and Bitcoins can function even in a setting with anonymous users and setting that renders cash essential. While some e-money systems allow the issuer to track the identity and payment history of users, it can be difficult to implement in most anonymous systems (e.g., Bitcoin and prepaid card). One future extension is to explore the welfare implication of introducing a record-keeping technology into this environment. [www.bankofcanada.ca]

Extrapolating from the price-level experience under the e-gold standard, there are three conjectures about the behavior of country price levels under the Bitcoin standard. In the long run, inflation in Germany would not be zero. Instead, there would be moderate deflation that would increase over time until reaching a rate of deflation equal to the negative of the rate of growth of world output around 2026. Changes in the world stock of Bitcoin are set according to the algorithm that determines how many new Bitcoins “miners” receive for verifying transactions. The percentage increase in the world stock of Bitcoins in each year from 2015 until 2040 is shown in the previous Figure. There would not be periods of deflation followed by periods of inflation as was the case under the old gold standard. Price levels of the various countries would be highly, but not perfectly, correlated, much as they were under the old gold standard. My reasoning is that under the e-gold standard, just as under the old gold standard, the money supplies in Germany would not necessarily move together, although the more tightly a group of countries are linked regarding trade and finance, the more closely their money supplies would be linked.

Utilizing the data, I present that Germany had a three financial (banking) crisis during the 34-year long period when Germany was on the old gold standard.

Conjecture: There would be financial crises under the e-gold standard. Financial crises have occurred in all financial systems, whether commodity-backed or fiat, in which financial institutions has demand liabilities that are not matched by assets with the same maturity. The e-gold standard would exhibit such maturity mismatches. Of course, such crises can be mitigated to some extent by government deposit insurance, which under the e-gold standard could be provided by fiduciary currencies issued by central banks.

Germany went off of silver and established the gold-based mark in 1872 after receiving a large quantity as reparations from France. Germany permanently left the old gold standard in 1931. This experience with the old gold standard raises a question about the e-gold standard: If it were to come into being, would it last for a substantial period, or would it be replaced by some other monetary system? An e-gold standard would have two major benefits over current fiat money standards. One is that there would be greater price-level predictability due to the known, deterministic rate at which new e-gold SDR’s (Bitcoins) are created. A second is that the resources currently devoted to hedging against fluctuations in exchange rates in e-gold standard would be freed up to be used in more productive ways.

2. Classification for supervisory purposes

BaFin6 has qualified BTC with legally binding effect as financial instruments in the form of units of account pursuant to section 1 (11) sentence 1 of the German Banking Act (Kreditwesengesetz – KWG). These are units similar to foreign currencies and not of legal tender. They include value units having the function of private means of payment in barter transactions, as well as any other substitute currency used by virtue of private-law agreements as a means of payment in multilateral settlement accounts. This makes a central issuer obsolete.

BTC are not e-money within the meaning of the German Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz – ZAG) because there is no issuer establishing claims against himself by issuing BTC. This is different for digital currencies, which are based on a central agent (e.g. Liberty Reserve). BTC are not legal tender either, and therefore qualify neither as foreign currency nor as foreign banknotes and coins.

BTC are used to settle in personal contracts amongst the users involved. For delivery of BTC, the customer receives the desired consideration in the form of an item of purchase, a service, a currency of legal tender or other commercial goods. Commercial use of BTC may, therefore, be subject to authorization pursuant to the KWG. Without such authorization, such activity may constitute a criminal offense pursuant to section 54 of the KWG. Anyone buying and selling BTC for commercial purposes in their own name for the account of third parties engages in principal broking services. These services are subject to an authorization requirement. Purchase or sale of BTC is affected for the account of a third party if the economic advantages and disadvantages arising from such transaction are carried by the principal. Furthermore, the activity must bear sufficient resemblance to commission business pursuant to the German Commercial Code (Handelsgesetzbuch – HGB), although individual rights and obligations may differ from those of a typical commission transaction. In the case of BTC platforms, the elements of a principal broking service subject to an authorization requirement are therefore satisfied if:
 the individual participants have the power to issue instructions to the platforms up to the time of execution of the order by specifying the quantity and price of the transactions;
 the respective participants do not know their trading partners, and the BTC platform acts not as a representative of the participants but in its own name;
 the economic advantages and disadvantages of the transactions are carried by the participants who wire cash to platform accounts or transfer BTC to their accounts, and
 the BTC platform is required to render account to the participants on the execution of the transactions and to transfer purchased BTC. [www.bafin.de]

The German Ministry of Finance (Bundesministerium fur Finanzen, BMF) threatens to scare innovation out of Germany. In a recent statement regarding the issue of taxation of Bitcoin as a means of payment, the German Ministry of Finance (Bundesministerium der Finanzen, BMF) classified the commercial sale of Bitcoin, and thus the use of Bitcoin as a currency as sales-taxable. This kind of taxation could severely damage the commercial spread and application of Bitcoin in Germany. The BMF’s assessment stands in stark contrast to other EU-nations, for example, as the United Kingdom, which recently negated such a tax classification. The Bundesverband Bitcoin, the German affiliate of the Bitcoin Foundation, has expressed its strong concern about the negative impact this decision might have on Germany as a location for upcoming and existing business and technology enterprises. It is with regret that the Bundesverband Bitcoin e.V. has taken notice of the statement issued by the German Ministry of Finance (Bundesministerium der Finanzen, BMF) on 12 May 2014, responding to a parliamentary question regarding the value-added tax (VAT) on turnovers of the virtual currency Bitcoin. According to the BMF, the commercial sale of Bitcoin is a sale of “other services” [dt. „sonstigen Leistung“] which is subject to VAT. Such taxation could discourage the usage of Bicoin as means of payment to retailers in general, gastronomy and online shops, as these would be subject to double taxation: the first round of taxation while selling the actual goods and provision of service and then once again for the sale of received Bitcoin. If this mode of taxation were to endure, the innovative market of decentralized payment forms with all its merits for retailers and customers would be obstructed effectively. Revenues, tax receipts, and innovation will drive abroad. With its assessment, the BMF contradicts other European partners, which consider Bitcoin transactions as VAT-free, based on the EU Value Added Tax Directive, binding to all European Member States. The Bundesverband Bitcoin e.V., therefore, calls upon the German Federal Government to rethink its current assessment and not make itself the unloved stepmother to innovation in the European Union. [www.bundesverband-bitcoin.de]

In 2011, Ba Fin qualified BTC with legally binding effect as financial instruments in the form of units of account in accordance with section 1 (11) sentence 1 of the KWG. These units are comparable to foreign currencies but are not denominated legal tender. They also include substitute currencies used by virtue of private-law agreements as a means of payment in payment transactions. BTC are not e-money within the meaning of the German Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz – ZAG) because no BTC are issued representing a receivable from the issuer. This is different for digital currencies, which are backed by a central issue. BTC are not legal tender either and therefore qualify as neither currency nor banknotes and coins. BaFin receives a growing number of enquiries on derivative and fund-like products related to BTC. Again, since each case is different, they are not necessarily subject to supervision. In general, however, if traded commercially, these types of products are subject to the supervisory rules of the Banking Act or the Investment Code (Kapitalanlagegesetzbuch – KAGB), because products derived from a financial instrument are themselves financial instruments or at least represent asset management. The commercial operation of a bitcoin ATM is normally also a banking or financial service subject to an authorisation requirement – depending on the way the purchase processes and legal relationships are arranged between buyer, seller and – in some cases – operator.

3. Study Shows 44% of Consumers in Germany Know What Bitcoin Is

It should come as no surprise to find out a lot of people have heard of Bitcoin by now, even though very few consumers have used the cryptocurrency so far. A new German Consumer Payment Study shows 1% of participants has ever used Bitcoin, which is a disappointing number. Although these types of studies do not paint the complete picture of consumerism in Germany, there are some telling signs regarding Bitcoin adoption in the country to be found. Considering how there are so many different payment options available in the country, it should come as no surprise to know Bitcoin is not all that popular in Germany right now. To be more precise, the study shows how only 1% of participants know what Bitcoin is, and have used the cryptocurrency in the past. While this is a rather low number, there is nothing to worry about just yet, as only 26% of respondents indicated they had never heard of Bitcoin before they were shown a video on what it is all about.

What is rather surprising, however, is how a significant portion – 44% – of participants indicated they know what Bitcoin is, but have not used it yet. This is a promising sign for cryptocurrency adoption in the country over the coming years, as there seem to be educational efforts taking place to promote the benefits of Bitcoin in general. However, 29% indicated they heard of it but are uncertain as to what Bitcoin is or does. Another interesting piece of information comes in the form of how people seem likely to use Bitcoin in the next year. Especially the ones who haven’t used it yet, 12% seems willing to give Bitcoin a try in the next 12 months. If this were to be the case, Bitcoin adoption in Germany would get a significant boost.

If there is one thing to take away from this survey, it is how it is difficult to get a complete grasp of how people feel about Bitcoin in Germany. However, there seems to be a growing awareness of cryptocurrency in general, which can only be seen as a positive trend. But there is still a long way to go before mainstream adoption will be achieved in this country, as well as the rest of the world. Whether this is due to a lack of educational efforts, or not making Bitcoin accessible enough for general consumers, remains a big mystery for now. One thing is for sure, though: both types of solutions are direly needed. With a healthy portion of participants indicating their knowledge on Bitcoin, new ways have to be found to get cryptocurrency into the hands of these people in a convenient manner. [http://bitcoinist.net/study-shows-44-of-consumers-in-germany-know-what-bitcoin-is/]

The digital/crypto-currencies such as Bitcoin have been on the tip of everyone’s tongues in the payments realm in recent years, but how aware is the average consumer of this influential innovation? After showing an explanatory video and written definition to respondents, we wanted to investigate consumer awareness and general attitudes toward Bitcoin.Fifty-five percent of respondents reported being either unaware of virtual currency or unsure of what it is. One percent reported having used it. Given the +-4.5 percent margin of error on our sample size, however, the true population may very well have a much smaller usage – perhaps approaching zero. Having inquired about the familiarity of the respondents with virtual currency, we next looked to glean an understanding of their attitudes toward it.

Figure 3: Virtual currency awareness and usage level
Source: http://tsys.com/Assets/TSYS/downloads/rs_2016-de-consumer-payment-study-english.pdf (29.04.2016)

Among the 99% of respondents who did not use a virtual currency (Graph 21), 12 percent indicated that they were “Likely” or “Very Likely” to use one next year – which would represent a significant increase over the respondents who claimed to have used it to date. Bitcoin, the leading virtual currency, looks set to remain a niche player in the near-term from a consumer proposition perspective.

Figure 4: Level of usage propensity in the next year among 99% who did not use a virtual currency
Source: http://tsys.com/Assets/TSYS/downloads/rs_2016-de-consumer-payment-study-english.pdf (29.04.2016)

4. Bitcoin.de launches an internal diamond store

Bitcoins are scarce and have an innate mathematical beauty – properties they share with diamonds. If you prefer your beauty to take tangible form, you can now use your bitcoins to buy diamonds on Bitcoin.de. The bitcoin exchange is the first platform on which customers can spend their bitcoins on diamonds.

With the rapid pace of technological progress, you would think it would be a simple matter to take a few billion carbon atoms and compress them together into a crystal, such that each one links to exactly four other atoms (A 70 kg body would have approximately 7*1027 atoms. Of that, 4.7*1027 would be hydrogen atoms, which have one proton and one electron each. Another 1.8*1027 would be oxygen, which has 8 protons, 8 neutrons, and 8 electrons. There are 7.0*1026 carbon atoms, which have 6 protons, 6 neutrons, and 6 electrons ). Despite advances in synthetic gemstones, though, it’s still not that easy; the best process to achieve this feat of chemical geometry is to bury the atoms several hundred kilometers deep in the earth and cook them for a few million years. [www.lieblingskapital.de/ (02.05.2016)]

Have you ever wondered why diamonds – the end product of this process – are some of the most expensive objects on earth? Why not gold? Why not e-gold standard? Or BTC are rushing towards e-diamond standard? Diamonds are not only strikingly beautiful but also extremely rare. This scarcity is shared by diamonds, gold – and bitcoins. So perhaps it’s only natural that Bitcoin.de, Europe’s largest peer-to-peer marketplace for bitcoins, has integrated a diamond store into its exchange. In cooperation with diamond seller Lieblingskapital [www.lieblingskapital.de], Bitcoin.de allows customers to buy diamonds in several sizes and colors. There are diamonds of 1/3, 1/2, 3/4 and 1 karat, and as many as five different colors. Clarity and cut – the most important of the so-called 4 Cs – are of highest quality.

“After the successful implementation of the gold store two years ago, they now offer to the customers the opportunity to buy another attractive investment product with their bitcoins,” comments Oliver Flaskamper, managing director of Bitcoin Deutschland AG. “Customers buy the diamonds directly from the merchant, but on a platform, they can trust – Bitcoin.de. Customers have trust in Bitcoin Deutschland AG; Bitcoin Deutschland AG has trust in the merchant – this circle is closed with the integration of the diamond store on Bitcoin.de”.
Finn Schonefeldt, CEO of Lieblingskapital, is also pleased with the cooperation. “Lieblingskapital is an outlet for private investors with a taste for rare and beautiful objects. To connect those classic investment products with an innovative means of payment like bitcoin is a special pleasure for Lieblingskapital. With Bitcoin.de Lieblingskapital found a professional and reliable partner for this. Lieblingskapital looking forward to sending out diamonds to the bitcoin community.”

All diamonds bought from the company are delivered with a GIA certificate. Lieblingskapital attests the diamonds’ provenance meets legal requirements and that their sale doesn’t finance wars and conflicts. The diamonds match the high ethical standards of the company and are in line with the ‘Kimberly Process.’ At first, diamonds will only be delivered to German customers, but the service will later expand to the rest of Europe. Delivery usually takes ten days, and delivery costs are in proportion to the value of the goods.

The current wave of digitalization sweeping through the financial sector, in fact, goes far beyond Internet banking, which is now standard operating procedure. It is in the process of revolutionizing the banking industry.
Highly specialized, innovative financial technology enterprises, also known as fintechs12, represent a new group of competitors to traditional bricks-and-mortar banks. Blockchain technology13, originally developed for the virtual currency known as the Bitcoin, has a wide variety of uses for financial services, such as in securities trading. [http://fintechinnovators.com/], [https://en.wikipedia.org/wiki/]
At the same time, increasing digitalization is making the financial system ever more reliant on technical infrastructures. Cyber risks have grown considerably in the past few years.

There’s no need to elaborate on this issue here, all the more so as these topics will be discussed on several occasions in the course of today. It is clear that digitalization and cyber security are a major challenge not only for banks but also for supervisors.

We should not stifle the innovative power of fintechs, yet we need to keep an eye on potential risks to financial stability. To quote Felix Hufeld, the head of the German financial supervisor, “It is not a firm’s ‘coolness factor’ which is decisive, but the type of business it conducts and the risks it takes in doing so.”

Figure 5: Development of the Bitcoin price in Euro (May-2013 – May-2016)
Source: https://www.bitcoin.de/en/chart (29.04.2016)

Figure 6: Payment behavior in Germany in 2014
Source: https://www.bundesbank.de/Redaktion/EN/Downloads/Publications/Studies/payment_behaviour_in_germany_in_2014.pdf  (29.04.2016)

The quantity of bitcoins issued is in principle restricted to 21 million units. At present, just under 14 million are in circulation. Utilization of these units as a means of payment is still very low, however: worldwide, only around 80,000 to 105,000 transactions (These include all bitcoin transfers, regardless of whether a purchase transaction was the reason for the transfer. Source: http://blockchain.info/en/charts/n-transactions.) are made on this basis each day. By way of comparison: just over 25 million credit transfers are made in Germany alone every working day. (Over 250 working days per year.
[http://www.bundesbank.de/Redaktion/EN/Downloads/ Statistics/]

The figures demonstrate that bitcoin has been something of a niche phenomenon up to now. Only 28% of the survey participants said they were familiar with bitcoin. The highest level of awareness is to be found among 18 to 24-year-olds, at least 41% of whom have heard of it. Take-up of the virtual currency is correspondingly low: just 2% of the respondents familiar with bitcoin also possess some units, while 6% of them intend to purchase or use it at some point. This small number of interested parties’ contrasts with 84% of respondents who currently have no intention of purchasing or using bitcoins. (8% of the respondents familiar with bitcoin did not state whether they possessed units in this currency or had plans to buy any.) The scandal surrounding the MtGox Bitcoin Exchange was in spring 2014, MtGox has stopped working as one of the oldest and most important platforms for trading in Bitcoins, and all activities. Investors that came to their virtual bank suddenly found out it exist no longer. At that time, explained MtGox that a software error was to blame and promised immediately after that everything would be okay, and investors should not worry. At the same time, however, informed the operator of the platform that the company headquarters had been transferred “for security reasons” in the Japanese capital Tokyo, which is said to have delayed the solution due to the technical problem. The Japan Financial Services, which is responsible for banking, insurance, and houses that deal in real terms in the stock market, stressed that they could not do anything because the operations are outside the scope of the authority. To the extent to those events. In 2014 Mt Gox eventually went bankrupt and now – very up to date – Mark Karpeles, a 30-year-old Frenchman and former boss of MtGox was arrested. The background: He is suspected to have intervened illegally and for his benefit in the computer system of the Stock Exchange (MtGox). Karpeles lawyer, however, said his client denies any wrongdoing. Conclusion: There are better alternatives currencies until financial regulators deal with this kind of issues.

The weak euro is for many companies a profit driver, but at the same time, the “soft currency” provides for an unpleasant feeling. The price of digital currency called Bitcoin shot in 2013 August to December from around $100 to over $1,000. As a result, the Bitcoin price plummeted and then fall rapidly and was trading at under $ 200. But what were the reasons for the crash? This was due to several scandals related to the digital currency. I think the basic idea is to create a currency that is completely independent of the central banks, for basically good and interesting. But to me, the risks associated with the Bitcoin model from the beginning were too large, and this view has not changed after recent scandals and price
fluctuations.

5. Spotlight on Blockchain technology

A block chain or blockchain is a distributed database that maintains a continuously-growing list of data records hardened against tampering and revision. It consists of data structure blocks—which hold exclusively data in initial blockchain implementations, and both data and programs in some of the more recent implementations—with each block holding batches of individual transactions and the results of any blockchain executables. Each block contains a timestamp and information linking it to a previous block.

5.1. Model

A block chain implementation consists of two kinds of records: transactions and blocks. Transactions are the content to be stored in the block chain.

Figure 7: How bitcoin transaction is processed
Source: Economist.com (02.05.2016)

Transactions are created by participants using the system. In the case of cryptocurrencies, a transaction is created any time a cryptocurrency owner sends cryptocurrency to someone. System users create transactions that are passed from node to node on a best-effort basis. The system implementing the block chain defines a valid transaction. In cryptocurrency applications, a valid transaction must be digitally signed, spend one or more unspent outputs of previous transactions, and the sum of transaction outputs must not exceed the sum of inputs.

Blocks record and confirm when and in what sequence transactions enter and are logged in the block chain. Blocks are created by users known as “miners” who use specialized software or equipment designed specifically to create blocks. In a cryptocurrency system, miners are incentivized to create blocks to collect two types of rewards: a pre-defined per-block award, and fees offered within the transactions themselves, payable to any miner who successfully confirms the transaction

Figure 8: How changing the nature of money changes the nature of resource allocation
Source: Might Supplementary Tethered Currencies Reduce Financial System Risks- Shann Turnbull PhD (02.05.2016)

6. Conclusion

Public block chains, like Bitcoin, Litecoin, and others threaten disintermediation as they empower peer-to-peer networks. The value they create is taken away from central institutions and returned mainly to consumers. However, early predictions of the demise of our global banking system or national governments seem hasty and premature in the cold light of day. The reality is that while many transactions will benefit from a decentralized approach, many others will still need to be handled via an intermediary, which can, despite additional complexities and regulation, veto suspect transactions, provide guarantees and indemnities, and deliver a range of associated products and services that consumers cannot yet access on the block chain.

Figure 9.
Source: http://www2.deloitte.com/uk/en/pages/innovation/articles/blockchain.html

A block chain represents a total shift away from the traditional ways of doing things – even for industries that have already seen a significant transformation from digital technologies. It places trust and authority in a decentralized network rather than in a powerful central institution. Centralized systems, particularly in financial services also act as shock absorbers in times of crises despite their challenges and bottlenecks. Decentralized networks can be much less resilient to shocks, which can impact participants directly unless careful thought is given to their design. Furthermore, the regulators in financial industries have to understand the technology and its impact in their sector.

Figure 10.
Source: Author (07.05.2016)

Whilst Gold “vouchers” can be purchased and traded online instantly, these vouchers are often from fractional or non-audited reserves, they are not the same as a Bullion bar 14 [https://en.wikipedia.org/wiki/Bullion], whereas a Bitcoin holding is publicly audited, as good as a Bullion bar, just lighter and cheaper to store or transmit.
Confiscatory risk: The overwhelming advantage should go to Bitcoin because of an awesome little thing called Deniability. They can’t take what they don’t even know you have and can be stored completely in your brain making it unfindable. Plus, gold already gets confiscated when trying to sneak it across borders all over the world… With bitcoin, it would be ludicrous even to try.
Advantages of bitcoin: other important criteria for the best apocalyptics money, such as divisibility, malleability, counterfeit-adversity, and fungibility.
 Divisibility: Separating gold into smaller chunks is not very easy at all, and keeping the pieces uniform in size is nearly impossible. Bitcoin is easily divisible down to 100,000,000 perfectly uniform pieces, making it childsplay to pay for anything down to any size with it.
 Malleability: Got a bunch of tiny gold pieces you want to re-combine back into a bigger coin or even brick? Go fire up the furnace and break out the wrought iron casts… Meanwhile, bitcoins all fit back into your wallet and automatically account for themselves back to your full balance without any thought on your part whatsoever.
 Counterfeit-adversity: Yes, you can counterfeit a gold bar or coin by wrapping a layer of gold outside with a thick core of Tungsten. Meanwhile, bitcoin is famously counterfeit-adverse, because we all can have a copy of the ledger and basically can see everyone elses’ bitcoins if they try to lie about them.
 Fungibility: Last but not least, and some might say the most important criteria of all. Fungibility is the quality of all parts being easily judged equal to all other parts of the same denomination. Gold is notoriously poor at this, because the purity of the gold is not easily judged, and there is no standard accounting size either that is fair such as an atom count. How can you tell if one gold coin that looks similar to another is truly worth that other coin? You cannot without a lab. Meanwhile, bitcoins are all simply ledger entries, so there is nothing different about them on an atomic level.
Gold and Bitcoin as e-Gold standard. In time, we’ll solve the last problem too; lack of electricity and internet connections, by having great little self-powered bitcoin wallets the size of a credit card that doesn’t need the internet because we’ll have blockchain satellites by then. So it’s time to face facts gold bugs; Our shiny metal is a relic of ages past and can’t do anything as well as a bitcoin can.
In many ways, gold is the precious metal counterpart to the bitcoin. Like the Bitcoin, gold must be obtained through mining. But, while gold is obtained through physical mining, bitcoins must be “mined” virtually through the deciphering of special computer encryptions. Another similarity is that both gold and bitcoins are only available in limited quantities. It is estimated that there is approximately 171,300. 15 [http://www.bbc.com/news/magazine] metric tons of gold in the world (1 Metric Ton = 35 273.9619 Ounces. [16 http://www.asknumbers.com]), while the Bitcoin system will only be able to generate and support 20,999,999.9769. 17 [https://en.bitcoin.it/wiki/] bitcoins, the last Bitcoin will be mined on May 7th, 2140. Given such similarities and their individual market activity over the past few years, it is understandable why many believe that bitcoin could ultimately replace gold in terms of value. However, in spite of this evidence, there are a number of reasons why this shift is unlikely to occur. The first reason that the Bitcoin will never replace gold is that it still poses a great deal of financial risk. Despite its recent peaks in market value, the bitcoin continues to experience significant price fluctuation that often results in substantial losses (see Appendix). Furthermore, both the future and the viability of the bitcoin have yet to be determined, leaving many customers wary over the security of their virtual savings if the system becomes terminated or obsolete. With such instability and uncertainty surrounding the bitcoin, it is unlikely that it will generate the customer base to match, much less surpass, gold as an investment asset. Another reason that the Bitcoin is unlikely to replace gold as an investment asset is that the system has yet to achieve full status as a truly “universal” and legitimate form of currency. Many countries, including Germany, Norway, Russia, France, Thailand, and Korea, refuse to use the bitcoin for fear of potential loss. In fact, several have gone as far as making it illegal in their country. In contrast, there isn’t a country in the world that would ignore the value of gold, much less prohibit its use. Therefore, until the bitcoin can reach the same worldwide level of legitimacy and approval that gold has, it will never be able to replace gold as a valuable commodity. The final reason that the bitcoin is unlikely to surpass gold as an investment commodity is that gold has consistently demonstrated signs of recovery since it plummeted by 28% in 2013.

Many people presumed that the sudden drop in gold’s market value was an indication that it had lost its status as a safe investment choice. However, a number of signs, such as the increase in debt-to-GDP ratio and the increase in the price of mining, suggest that gold will not only recover from its drop, but it will continue to thrive as a popular investment commodity. Consequently, as long as investors believe that gold can generate profits, they will continue to forgo any other potential replacements. 18 [http://www.jmbullion.com/]

When we watch and see for years the transaction volume, it looks very much that the Western Union 19 [https://en.wikipedia.org/wiki/] and MoneyGram 20 [https://en.wikipedia.org/wiki/MoneyGram] are soon going into bankruptcy. The advantage of the BTC blockchain is brutal for these 2 giant companies, and many people do not understand completely the system.

By establishing the Financial Innovation Laboratory in the Silicon Valley, Hitachi will accelerate research & development of blockchain technology, collaborative creation with customers, and development of solutions to support business innovation in financial institutions. 21 [www.coindesk.com]. Thus, it is not yet late for the Bundesbank to react. The Bundesbank have to understand the technology and its impact and should support the banking industry’s efforts to develop new payment methods and unlock advantages by automating processes and thus reducing compliance errors. [www.deloitte.com]

References

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