21. The Exchange Rate Fundamentally Depends on the Balance of Payments

Electronic money keeps hold of a strong connection with traditional money since both of them are articulated in the same unit of account and are pledged on an asset, while bitcoin relies only on an agreement between their users, without a legal framework drawn up by any centralized body.

Also, its users are the only players in the virtual currency, so the situation is the opposite. In this case it is the informal, which challenges the formal one of the central banks, knowing that this type of currency is not subject to any financial institution. Financial institutions are supposed to act as intermediaries in information gathering, risk management and liquidity. It is highly unlikely that this type of currency will fit into this circuit.

This economic point of view looks at a new phenomenon in the world of money, that of digital currencies such as the bitcoin. The use of these currencies for the time being remains very marginal and limited to basic transactions, but some see a much greater potential and foam their acquisition. In our system, therefore, a boost in the exchange rate means that the currency appreciates. Evidently, exchange rate convenience should also be assessed in relation to inflation. In fact, if the exchange rate rises, but in the other country the prices have risen, it may be that the overseas purchasing power of our currency remains unchanged or even worse, which is the situation with the actual exchange rate.

Since the relationship of trust requires at least two individuals, with currencies of which the sender is not known, it is a safe bet that one is closer to money laundering than to the procedural confidence based just on currency itself. However, a huge gap separates them from fiat currencies because they are not supported by governments and central banks. The absence of a regulatory framework and regulatory mechanisms is very challenging and individuals interested in purchasing these new currencies must for that reason remain careful and be aware of the natural risks.

The exchange rate is determined by the acquiring of demand and supply of currency in the foreign exchange market, called Forex. The demand and the offer of a currency is due to the exchange rate from a foreign currency to international trade. In this regard there is an expectation that bitcoin would evolve in a way that would allow their users to determine an exchange rate and that in doing so it would really be a currency, though traditional currencies have the three functions and in that regard there is a confidence in the unit of account, a value and savings reserve and a protocol instrument.

While taking this into account there should be noted at the first place that the price of bitcoin is very volatile. When this component is observed at fiat currencies it is the stability of exchange and inflation rate that generates confidence of investors. Besides that, with no passing through financial mediations, this function is not sufficiently respected because of the guarantee of deposits. This opens the question whether it is reasonable to consider bitcoin or any other cryptocurrency a safe heaven, because there is no guarantee for its value, however, regardless the smaller volatility of other currencies and commodities the level of safety of transactions is higher than within traditional money transactions.

The exchange rate fundamentally depends on the balance of payments of a country, and on the first place it is derived from the two key factors – from trade and from financial investments. In the first case it comprehends imports and exports of goods, including tourism from one country to another while regarding the later it involves activities such as purchase of foreign treasury bills, since this amount of exchange is linked principally to the level of interest rates that engage capital for good returns.

An aggregation of cryptocurrencies was established in the channel of the bitcoin, but the major principles remain the same. The creators of other cryptocurrencies tend to advocate the fact that their network is less inconvenient to support, that transactions are done much faster and that the reward in terms of new currencies created is more beneficial. Some are counting on a faster or longer expansion of the money supply, though in that case difference has no effect on the purchasing power at the certain moment regarding these cryptocurrencies. Even riskier exchange rate transactions, such as currency purchase and sale transactions with the aspiration only to make profit from the change in exchange rates over time affect the value. Depending on the situation, monetary authorities may choose that the exchange rate openly follows the forces of demand and supply, or they may prefer not to diverge from a certain value.

There should be noted that cryptocurrencies are one of the main restraint in the fight against piracy. In order to overcome the financing of pirate sites, corporations have signed agreement with electronic payment companies, such as Visa, MasterCard, American Express, PayPal and Skrill to ensure that illegal actions cannot be financed, which is declared through agreements between monetary authorities that give advance to the international monetary system.

Regarding this, the real problem is more in the misgiving of a particular currency, especially in those that lose the status of safe heaven they used to have, than in confidence in the cryptocurrencies, as evidenced by the increasing download of bitcoin returns the problem to national currencies and their particular monetary systems and central banks’ policies. Not alike it is the case of bitcoin, the derivation of national currencies is centralized and in most countries this role rests with a central bank.

The growth of the amount of assets is not fixed, so the choice to increase or decrease the supply of money depends on the objectives traced by the entity that issues money. In this area traditional currencies have several advantages in this area, since certainly a banknote is not decomposable by itself, however a central bank system favors inflation over the long term, which continually degrades the value of the state currency.

There could be some doubts regarding the ability of central banks to make good decisions, since in most industrialized countries, central banks mark a low and stable rate of inflation, which ensures the maintenance of the value of the currency. It must be admitted that this system works very well when one looks at the low price increase over the past two decades.

This article is part of the academic publication Dividing by Zero by Ana Nives Radovic, Global Knowledge 2018

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