Virtual currencies are the financial technologies that have become popular in recent years with both the claim of being an alternative to today’s payment tools and their blockchain technologies. There are many virtual currencies today. Bitcoin is the first of the virtual currencies.
The European Central Bank (ECB) conducted the first comprehensive research on virtual currencies in October 2012. In this report of ECB, for the first time, the concept of virtual currencies was introduced, and both the values and the technological mechanisms of the virtual currencies that transfer the value were compiled. They were defined in this report as “as a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community” (ECB, 2012, p.5).
What are the Features of Virtual Currencies?
Virtual currencies are seen as risky for users because they are not assets regulated by laws and the supervisory board. Despite all these risks, virtual currencies, which have great advantages compared to traditional payment methods, have become more and more preferred day by day.
Distributed ledger technology, forming the basis of virtual currencies, and mining operations, which are the production model of virtual currencies, attract great attention due to the fact that they are very new concepts for users. As a result of this interest, the state of being integrated into financial markets is a matter of debate.
Currently, there are projects related to the alternative use of distributed ledger technology. Despite all these developments, the legal regulation process of virtual currencies cannot go beyond the beginner level. As a result, it is very unlikely that the virtual currencies will replace the fiat currency and neutralize the traditional finance system in the near future. While the situation in Turkey can be summarized the same, when we look at the state of virtual currencies around the world, we can see that they make tremendous impact. With these developments in the world, it has been revealed that it is beneficial to make legal arrangements and researches related to virtual currencies in Turkey.
Bitcoin, one of the virtual currencies, has managed to concentrate on the financial markets with the continuous growth of its trading volume and its rising value against the US Dollar. Virtual currencies have differences in their own network systems, although they appear to be systems with similar operating principles. Today, there are approximately 5000 (Cryptocurrencies Market Values, 2020) virtual currencies in the market. The vast majority of virtual currencies have the same working principle as Bitcoin. Certain virtual currencies differ in terms of technical features.
Categorization of Virtual Currencies
Since there are many types of virtual currencies in the market today, the categorization of virtual currencies is very important to grasp the fundamental structure. Virtual currencies are divided into three types: (ECB, 2012, p.13)
Closed Virtual Currency Schemes:
Closed virtual currency schemes have no connection with the real economy. This type is used only for the purchase of products and services in a certain virtual platform and cannot be bought and sold
outside this virtual platform. The best example of this scheme is the virtual currencies that are specific to online gaming platforms.
Virtual currency schemes with unidirectional flow:
Virtual currency schemes with unidirectional flow, on the other hand, are virtual currencies that are purchased in exchange for a fiat currency at a specific exchange rate, but it is not possible to exchange it back to the original fiat currency. This type of virtual currencies is used to purchase goods and services virtually. For example, Facebook Credit is one of them.
Virtual currency schemes with bidirectional flow:
Virtual currency schemes with bidirectional flow can be bought and sold in exchange for their nominal currency. This type is used for purchasing both virtual and real products and services. Bitcoin is an example of these virtual currencies.
How Decentralized Virtual Currencies Are Compared
Decentralized virtual currencies make up a large part of the virtual currency ecosystem. Because of this situation, they are catogorized among themselves. Virtual currencies have certain technical elements as it is based on technical innovations. Decentralized virtual currencies are divided into three basic and technical aspects among themselves: (ECB 2015)
Approval mechanism: Decentralized virtual curencies such as Bitcoin, Litecoin and Dogecoin adopt the proof of work system. Proof of work is a simple array of data for participants to validate, although its production is expensive and time consuming. The proof of work process causes high energy expenditure in the system, which is accessed through algorithmic random trials, while the confirmation of the operations involves many errors within the trial processes.
Algorithm: The algorithm is general for determining how fast it will occur when calculating data reports and the mathematical processes of the issuance of new currencies. Algorithms are basically divided into two. SHA-256 algorithm is used in virtual currencies such as Bitcoin, Namecoin, Peercoin and Mastercoin.
Special equipment is required for mining activities in virtual currency production, and users need to be experienced in mining. Auroracoin, Dogecoin and Litecoin use the Scrypt algorithm, which can be defined as SHA-256, but requires much more physical memory. The Scrypt algorithm allows miners to perform transactions with middle segment computers instead of high-end computers. Algorithms behind virtual currencies are likely to change over time. The best example of this is the X11 algorithm.
Supply: For many virtual currencies such as Bitcoin and Litecoin, the supply is limited. As an example, there are 18,180,750 Bitcoins in circulation (January 2020). According to Bitcoin’s protocol, this number can be up to 21 million. This figure is estimated to be reached between 2035-2040.