An Examination on The Feasibility of An International Regulated Cryptocurrency

A Thesis

Presented to the University Honors Program

California State University, Beach

In Partial Fulfillment

of the Requirements for the

University Honors Program Certificate

Dominic Erich

Spring 2018

I, the undersigned member of the committee,

have approved this thesis

An Examination on The Feasibility of An International Regulated Cryptocurrency

By

Dominic Erich

Mark Washburn, Ph.D. (Thesis Advisor) College of Business

California State University, Long Beach

Spring 2018

Table of Contents Abstract ...... i

Acknowledgements ...... ii

Introduction ...... 1

Why an International Currency Is Needed? ...... 1

Thesis Statement ...... 6 Methods...... 6 Sub-Question 1 ...... 7

Is it possible for an international institution to develop and regulate its own cryptocurrency? ..... 7

Sub-Question 2 ...... 13

What international institution would have the ability to provide this service?...... 13

Sub-Question 3 ...... 16

Is the cost of developing and regulating an international cryptocurrency justifiable in respect to the current monetary structure used today? ...... 16

Sub-Question 4 ...... 21

Would individuals around the world trust a global institution to manage their money in an efficient manner? ...... 21

Sub-Question 5 ...... 23

How would impoverished individuals around the world be able to access a digital cryptocurrency without access to proper technology? ...... 23

Quantitative Analysis...... 25

Conclusion ...... 34

Tables and Figures ...... 36

Glossary ...... 40

Bibliography ...... 41

Tables and Figures Bibliography ...... 46

Abstract

An Examination on The Feasibility of An International Regulated Cryptocurrency

By

Dominic R. Erich

May 2018

The technology of cryptocurrency has the potential to provide financial resources to impoverished individuals around the world. The problem with current cryptocurrencies is that they are extremely volatile, and this limits their ability to be used as a stable medium of exchange. To solve this problem, a stable cryptocurrency should be created to provide financial security to individuals around the world who do not have access to financial services. In order for a cryptocurrency to maintain stability, a reliable institution would have to develop and regulate this financial service. The intent of this dissertation was to determine whether an international institution could feasibly develop and regulate a cryptocurrency. This question was answered through a literature review consisting of five sub-questions related to the development and regulation of cryptocurrency. Once these research-based questions were answered, a quantitative study was designed based on the information discovered in the literature review.

After the quantitative analysis was concluded, this dissertation discovered that an international institution could develop a cryptocurrency. However, an international institution would not be able to regulate and monitor a cryptocurrency without exposure to significant cyber risk. If an international institution were to create and monitor an aid currency, they would be better to structure this currency as a tangible SDR issued at an individual level.

i Acknowledgements

I would like to acknowledge and thank my thesis advisor, Dr. Mark Washburn, for his support during this year long dissertation. This paper would not be completed today without his guidance and assistance.

ii Introduction

Since the creation of Bitcoin, the monetary purpose for cryptocurrency has remained ambiguous. Individuals around the world use cryptocurrency to invest, purchase goods and services, perform peer-to-peer transactions, crowdsource, and transfer money across borders.

Cryptocurrency is also used to fund illegal activities; this has caused controversy because cryptocurrency serves as a medium to purchase illegal products and services, hide assets, and perform extortive acts. The variation in how cryptocurrency is utilized has become a topic of debate and much of the world remains inconclusive on their perception of cryptocurrency. For example, some countries classify cryptocurrency as a legitimate form of “currency” for transactional purposes, while others perceive cryptocurrency to be a “commodity” (IRS 2014).

Countries such as the United States, Canada, Australia, and the majority of the European Union allow cryptocurrencies like Bitcoin to be mined and purchased by users that wish to do so.

However, countries such as Vietnam, Russia, China, and Bolivia have banned the use and mining of cryptocurrencies (Bajpai 2017). That being said, none of these stances on cryptocurrency are absolute. Many countries that allow cryptocurrency today are still in the process of determining whether cryptocurrencies should become illegal in their country. Because of the global variation in cryptocurrency classification, the intent of this dissertation is to distinguish a definitive area in which cryptocurrency can be utilized to benefit the global economy and eliminate poverty.

Why an International Currency Is Needed?

War Weakens A Nations Currency

Not every person living in this world was born into a nation that is economically stable.

Countries like Syria, Iraq, Afghanistan, Yemen, and South Sudan are under civil war. Venezuela,

1 Argentina, and Brazil are experiencing severe economic downturns and their national currencies are subject to devaluation every day. All of these nations are experiencing these economic and internal conflicts because of their governmental dysfunction. This dysfunction has created a global issue because individuals have become subjected to the economic status of their nation. In war-torn nations, currency becomes an afterthought for civilians because their main objective is to either survive the conflict they are subjected to or escape their nation by becoming a refugee.

During times of civil war, civilians and refugees can lose everything from their birth certificates and passports, to the value of money in their bank accounts because of the deflation in the value of their national currency. If there was an internationally regulated currency with a stable monetary value around the world, refugees would have the ability to shelter their savings by exchanging their national currency for this internationally issued currency.

Instable Governments Devalue Their Nationally Issued Currencies

People around the world can also suffer under a government that lacks economic stability. For example, the national currency of Venezuela called the “Bolivar” has “lost over

99.9% of its value in two years” (The Economist 2018). Despite having the “highest oil reserves than any other country in the world”, the Venezuelan government is now on the brink of completely collapsing (Schipp 2018). Citizens living in Venezuela are negatively impacted by devaluation because the money they make is worthless in comparison to the rest of the world.

In addition to the devaluation of the Bolivar, Venezuelans also experience an increased percentage in inflation. Inflation is creating an issue for Venezuelan’s because the price of goods is skyrocketing to levels at which individuals cannot afford to buy necessary resources to live.

Reports recorded in 2016 “that a dozen eggs in Venezuela was equivalent to a price of $150 in

2 the United States at the official exchange rate” when the inflation level was at “800%” (Zavis

2016; Becerra 2017). In 2018, Venezuela recorded an inflation level of “4,000%” with over

“87% of Venezuelans living in poverty” (Gillespie 2017; Singer 2018). Venezuela’s poverty rate is determined from Venezuela’s governmental dysfunction and because impoverished individuals in Venezuela rely on the Bolivar as their main source of currency they are unable to change their economic mobility because they do not have access to another stable aid currency to support them through their governments time of economic peril.

Countries Without A National Currency Are Economically Impaired

In addition to not having a stable government or national currency to rely on, some nations like “Zimbabwe, Ecuador, and El Salvador do not have a national currency issued by their government”. These countries, “opt to using the United States Dollar as their national currency” an economic policy known as “currency substitution” or “dollarization”. Countries choose to enact dollarization because the United States dollar is stable and perceived around the world as valuable (Zavis 2016). This might appear as a benefit; however, when governments do not issue their own currency they are subjected to the rule of the nation that issues their substituted currency. In response to this subjection, governments are unable to manage their own economies effectively because they do not have control over their currency supply or interest rates. Not having control over currency supply creates a problem for countries that enact dollarization because “taxes and consumer spending” become the only sources of government income, causing countries to run under a “high deficit” (Perez 2012).

Countries that enact dollarization also lose their ability to perform an economic strategy called “competitive devaluation” which is an economic policy that allows a country to devalue

3 their currency in order to incentivize foreign trade and exportation (Wang 2016). A small country can benefit from “competitive devaluation” because they can create an absolute advantage in their economy by manufacturing goods for a cheaper price in respect to another wealthy nation where manufacturing might cost more. This situation is referred to in economics as “economies of scale”. This economic phenomenon creates growth opportunities for small countries that might be impoverished (Ross 2015).

When smaller nations use dollarization, they take on the weight of the United States economy. This weight means that the smaller nation’s economy will become less enticing for manufacturing positions because they will need to be paid more for their services because their currency is the United States dollar. Nations around the world utilizing dollarization and currency substitution would be better off if they issued and regulated their own national currencies because they would be able to competitively devalue their currencies to create growth.

If a nation were to develop and regulate their own national currency, this financial service would take time to create. During this construction period, a nation would need to issue a temporary currency to serve as the nation’s nationally issued currency. Maintaining dollarization would be ineffective during this transition period because dollarization serves as a tool for the

United States to integrate their financial policies on a nation. If a nation were able to use a stable internationally regulated currency during this financial transition, a nation would be able to structure their currency without the influence of another foreign nation.

The Impact of Financial Instability Contributes to Humanitarian Crises

The governments of impoverish and unstable nations are not the only factors causing individuals to remain in poverty. Geography and gender also influence whether an individual can

4 have access to financial services. The IMF has recorded that “there are over 2 billion adults living in the world today who do not have access to the formal financial service of a bank account” (Beauchamp 2016). This statistic is heavily influenced by “women, rural poor, and hard-to-reach populations” that “cannot afford formal financial services, lack legal documentation, and cannot travel long distances to reach a financial service provider” (IMF

2017a). The most recent data released by the IMF revealed that in 2014, the percent of unbanked adults was highly skewed in the continent of Asia. The “percent of unbanked adults living in

India was 21%, 12% lived in China, and 6% lived in Indonesia” (Demirguc-Kunt et al. 2015).

This makes up almost a third of the entire worlds unbanked population; yet these nations are all considered developing and they should have the ability to accommodate financial services for their citizens. The problem for these nations is that they have a high amount of rural poor individuals living in desolate areas of their nations which limits their ability to grow and develop.

Gender equality is also a major problem around the world that has created an issue regarding human rights. Statistics state that “over 55% of the world unbanked adults are female”

(WSJ 2015). Levels of female discrimination vary by country. For example, over “97% of women living in India in 2015 were unbanked” despite the fact that they were able to open up a bank account (WSJ 2015). In the country of Saudi Arabia, “woman are unable to open a bank account unless they permission from a male guardian” (Winsor 2017). If an international currency service was offered to individuals living under a society with gender inequality and limited geographical mobility; individuals would be able to take control of their financial status without having to rely on the governmental for financial services.

5 Thesis Statement

The technology of cryptocurrency has the potential to provide financial resources to impoverished individuals around the world because the digital nature of cryptocurrency allows for easy accessibility. The only requirements necessary to access cryptocurrency is a power source, a device capable of connecting to the internet, and an internet connection. The problem with current cryptocurrencies is that they are extremely volatile8, and this limits their ability to be used as a stable medium of exchange. To solve this problem, a stable cryptocurrency should be created to provide financial security to individuals around the world who do not have access to financial services. In order for a cryptocurrency to maintain stability, a reliable institution would have to develop and regulate this financial service. The intent of this dissertation is to determine whether an international institution could feasibly develop and regulate a cryptocurrency.

Methods

To determine whether an international institution could feasibly develop and regulate a cryptocurrency, a literature review consisting of five sub-questions related to the development and regulation of cryptocurrency will be issued. The sub-questions are:

• Sub-question 1: Is it possible for an international institution to develop and regulate its

own cryptocurrency?

• Sub-question 2: What international institution would have the ability to provide this

service?

• Sub-question 3: Is the cost of developing and regulating an international cryptocurrency

justifiable in respect to the current monetary structure used today?

• Sub-question 4: Would individuals around the world trust a global institution to manage

their money in an efficient manner?

6 • Sub-question 5: How would impoverished individuals around the world be able to

access a digital cryptocurrency without access to proper technology?

Once these research-based questions are addressed, a quantitative study will be issued to support the information discovered in the literature review. The purpose of this quantitative study is to identify the levels of volatility associated with cryptocurrencies today. Once the volatility is quantified, the data should reveal whether an international institution could effectively regulate a cryptocurrency. The quantitative study will consist of a univariate and multivariate analysis using the daily recorded close prices for the Dow Jones, S&P 500, Gold, Bitcoin, Ethereum,

Litecoin, and Ripple. The univariate analysis will measure volatility among each index, commodity, and cryptocurrency by calculating percent change and the standard deviation of logarithmic returns. The multivariate analysis will measure the volatility of each index, commodity, cryptocurrency through the issuance of a regression. The S&P 500 will remain fixed as the dependent variable during this regression and the coefficient of each regression will stand as the volatility for each index, commodity, and cryptocurrency.

Sub-Question 1

Is it possible for an international institution to develop and regulate its own cryptocurrency?

If an international institution wanted to develop and regulate their own cryptocurrency, they would need to determine if this would be possible to achieve. If an international institution could not develop a cryptocurrency, the institution would have to find an alternative method for how they could issue an aid currency at a global level. Additionally, an international institution would have to determine if they could effectively regulate their issued cryptocurrency if they were to successfully create one.

7

What Resources Are Needed to Create A Cryptocurrency?

The first step of creating a cryptocurrency is writing the source code or the systems blockchain. There are two ways an international institution could go about writing a new source code. The first option would require the international institution to hire a group of computer programmers to write a new blockchain based source code. The second, more realistic option, would require the international institution to hire a few computer programmers to restructure the existing source code of Bitcoin. A major benefit of restructuring Bitcoins blockchain is that the source code can be found online for free. This strategy is also “widely implemented by alternative cryptocurrencies on the market” because restrucuring source code “can take as short as a day to structure with basic C++ coding” (Hartigan 2014).

Important Factors to Consider

During the restructuring of a cryptocurrency, the international institution would also have to determine the scalability of their cryptocurrency. If a cryptocurrency were unable to withstand an extensive amount of transactions, the service would be useless because impoverished individuals need the security of a stable transactionary service. To address the scalability of the cryptocurrency, an international institution would need employ experienced computer scientists to perfect the scalability of their issued cryptocurrency. In addition to the scalability of a cryptocurrency, an international institution would need to determine if this cryptocurrency would have a fixed supply. Traditionally, cryptocurrencies have been fixed in supply but there are cryptocurrencies available with an uncapped supply. The problem with a fixed currency supply is that the currency has the susceptibility of becoming a deflationary currency. An international

8 institution would most likely uncap their issued cryptocurrency in order to ensure the value remains stable.

Who Will Mine the Cryptocurrency?

Once an international institution had effectively restructured the code of their issued cryptocurrency, they would need to determine how to mine their currency. In order to mine a cryptocurrency, a “group of miners would have to use their computers processing power to solve a complex mathematical puzzle to validate past cryptocurrency transactions” (Acheson 2018).

The act of validating a cryptocurrency “adds a new block to a cryptocurrency’s existing blockchain” and “miners are rewarded in the cryptocurrency they mined for their security and processing services” (Draupnir 2016). Every cryptocurrency issued today is mined by an external cryptocurrency miner, impartial to the cryptocurrency platform they mine. If a cryptocurrency were to be issued by an international institution, they would have to open up their cryptocurrency to be mined by individuals around the world. The alternative mining structure would require the institution to mine their issued cryptocurrency privately within their institution. The problem with mining cryptocurrency is that the cost of operating a crypto mining computer system is extremely high. The computers that mine cryptocurrency “have to have the ram to solve complex calculations and as the blockchain increases the calculations become more difficult to solve”

(Meyer 2018).

The cost of power is also a major factor that contributes to the high operation cost of mining cryptocurrency. For example, Bitcoin miners estimate that in “order to breakeven on mining Bitcoin the market value of Bitcoin must be $8,038” (Meyer 2018). According to Josh

Constine, a technology journalist at TechCrunch, “a single Bitcoin transaction currently requires

9 as much power as the average American home usage in a week” (Constine 2017). Given this evidence, mining cryptocurrency has the ability to become an unsustainable operation and this risk would most likely make mining a cryptocurrency privately infeasible for an international institution. An international institution would have to recruit impartial miners across the world to mine their currency. Recruiting crypto miners could be difficult because the cryptocurrency community is generally against regulation.

How Will This Cryptocurrency Be Marketed Around the World?

An international institution would have to determine how to create international value for their issued cryptocurrency. If an international cryptocurrency lacked value internationally miners would not have an incentive to mine this cryptocurrency” (Hartigan 2014). Additionally, if a cryptocurrency did not hold value internationally, individuals would not use the service because the valuation would be worthless due to the lack of use or investment. To create international value for a cryptocurrency, an international institution could market their cryptocurrency as a regulated financial asset backed by the financial strength of their institution.

An international institution could also issue a fixed supply of this cryptocurrency to create a perception of scarcity.

Cryptocurrency Regulations an International Institution Could Successfully Implement

Major cryptoexchanges like Coinbase are known to halt trading on their cryptoexchange servers when the price of cryptocurrencies like Bitcoin and Ethereum become “too volatile”

(Chaparro 2017). Cryptoexchanges are able to justify their exchange halts by claiming “the price of a particular cryptocurrency is not synonymous with the true market of the cryptocurrency”

(Tepper 2017). If an international institution were to effectively regulate the volatility of their

10 issued cryptocurrency value, they would need to have the power to halt trading on their cryptocurrency platform. If an institution was not able to halt trading for their cryptocurrency platform, the market could become a place for easy price manipulation. For example, “pump and dump” schemes would be extremely easy to achieve because investors would have the ability to boost the price of the cryptocurrency and dump it without the market shutting down to alleviate high levels of volatility. The action of pumping and dumping is illegal on exchanges around the world and this strategy allows for an unfair investment advantage (Investopedia

2003). On unregulated cryptocurrency exchanges, pumping and dumping schemes happen every day. Since Coinbase started attempting to regulate the trading of cryptocurrencies on their platform, they received criticism from individuals in the cryptocurrency industry because this action is seen as a way to create stability in the cryptocurrency markets. Since current cryptocurrencies are used as investment instrument for high volatile trading, an international institution would be able to fill the need for regulation by providing their own cryptocurrency.

An international institution would also be able to avoid flash crashes on their cryptocurrency platform if they were allowed to halt trading of their currency. A major issue with cryptocurrency markets today is that they are highly susceptible to flash crashes. A occurs when “there is a massive sell off of a security on the market” and the price of the security becomes difficult to determine because of dumping (Investopedia 2010). Since cryptocurrencies are highly prone to flash crashes individuals have an incentive not to use them as a actual form of currency because they can lose their monetary value in an instant. For example, an investor lost over “90% of their Bitcoin during a flash crash on Bitfinex because they had a stop loss order placed on their cryptocurrency investments”. Their money was not returned because Bitfinex claims flash crashes commonly occur on every cryptoexchange and

11 investors are supposed to use their discretion when investing in cryptocurrencies (Aiken 2017). If an international institution wanted to ensure this situation never happened on their trading platform, they could simply end stop loss orders on their issued cryptocurrency to avoid financial loss.

The Chicago Mercantile Exchange (CME) issued futures contracts for Bitcoin in 2017 and this opened up opportunities for marginal investors to create a sense of efficiency and predictability for price of Bitcoin on the market. If an international institution were to create a cryptocurrency, they would benefit from creating their own derivative contracts because the institution could achieve price efficiency and better predictability for the value of their cryptocurrency.

Regulation would also alleviate the volatility associated with decentralized cryptocurrencies. Cryptocurrencies remain volatile today because they are used primarily as volatile investments tool. If an international institution was to develop and regulate a cryptocurrency, they would want their cryptocurrency to be perceived as a currency and not as an investment tool. If an international institution were to create the perception that their cryptocurrency was a currency and not an investment tool they could peg this cryptocurrency to the value of the United States Dollar or a basket of individual currencies. This valuation method will be used by countries like China and Russia who are currently developing their own cryptocurrencies (Pearson 2018). However, China and Russia will back the value of their cryptocurrency by fixing the monetary value to the foreign exchange market value of their national currencies.

An international cryptocurrency could also be regulated like a stock on the New York

Stock Exchange. In the same manner the SEC regulates and other securities, an

12 international institution could regulate their cryptocurrency by providing financial reports another financial information to provide transparency to users around the world.

Cryptocurrency Risk That Cannot Be Eliminated from Regulation

The largest threat an international institution would face if they were to create and manage their own cryptocurrency would be from cyber criminals. The problem with cyber criminals is that no amount of regulation will deter them. For example, if an international institution created their own cryptocurrency mining farm, there would be countless attempts around the world to breach the operating structure. This is because cryptomarkets and crypto mining farms are exposed due to their servers being cloud-based. Since the nature of cryptocurrency is rooted in technology, there will always be an incentive for a cybercriminal to steal cryptocurrency.

Sub-Question 2

What international institution would have the ability to provide this service?

Determining what international institution could develop and regulate a cryptocurrency would be extremely important to the cryptocurrencies success. The international institution would have to be well-funded and internationally neutral in foreign affairs. The top institutions for this service would include the International Monetary Fund (IMF), The World Bank, Bank of

International Settlements (BIS), and the Asian Infrastructure Investment Bank (AIIB).

International Monetary Fund (IMF)

“The IMF, also known as the Fund, was conceived at a UN conference in Bretton Woods,

New Hampshire, United States, in July 1944” (IMF 2018). During the conference the “44

13 countries present decided to create an impartial international institution to provide monetary stability around the world” (IMF 2018). The IMF has continued to develop in their financial role around the world and today they “promote global economic growth and financial stability, to encourage international trade, and to reduce poverty” (Investopedia 2003a).

The IMF has even suggested that the institution would be open to developing and regulating their own cryptocurrency. In 2017, the Director of the IMF, Christine Lagarde, wrote a memo on the IMF website stating that “cryptocurrency has the ability to become more stable than actual fiat currencies used today and provide a service to those who do not have access to financial institutions” (Lagarde 2017). Christine Lagrde even mentioned that “the IMF would be the best organization to run an international cryptocurrency” in the future and she “believes the

IMF will have the ability to develop and regulate their own cryptocurrency in the future”

(Lagarde 2017).

The World Bank

Like the IMF, the World Bank was created at the Bretton Wood’s Conference in 1944

(Heakal 2018). The World Bank “functions as an international organization that fights poverty by offering developmental assistance to middle-income and low-income countries” (Heakal

2018). According to the World Bank, their main goals are to, “End extreme poverty” and

“promote shared prosperity by fostering the income growth of the bottom 40% for every country” (The World Bank n.d.).

14 Bank of International Settlements (BIS)

The BIS is a very historic institution created 1930 (BIS 2005). The mission statement of the BIS is to “serve central banks in their pursuit of monetary and financial stability” and “to foster international cooperation in financial stability” (BIS 2005). Around the world the BIS is known as the “bank for central banks” and the BIS issues international cooperation through the issuance of Basel Agreements (BIS 2005). The BIS is “owned by 60 central banks” which consist of nations throughout the entire world (BIS 2005). “Each within the BIS accounts for about 95% of world GDP”; making the institution incredibly influential around the world (BIS 2005).

Asian Infrastructure Investment Bank (AIIB)

Internationally, the AIIB is thought of as the “World Bank of China”. The AIIB provides financial services to “improve social and economic outcomes in Asia and beyond” (AIIB 2016).

The institution was created in 2016, making the institution relatively new. The problem with the

AIIB is that the institution is an “embodiment of China’s aspirations to play a major role in the international financial system” (Bremner and Han 2018). In theory, the AIIB is supposed to be an impartial international institution devoted to developing infrastructure around the continents of Asia and Europe. The institution has received heavy criticism around the world because

“individuals perceive the institution as China’s attempt to compete with the World Bank and the

Asian Development Bank” (Bremner and Han 2018). Since the institution of the AIIB is controversial around the world, this international institution would most likely not serve as the best candidate to create and regulate and international cryptocurrency. Once the AIIB is fully developed, this institution could possibly serve as a viable candidate to issue their own

15 cryptocurrency; however, the institution will have to prove that they are impartial in foreign affairs as time progresses.

The Best International Institution to Develop and Regulate a Cryptocurrency

The IMF would most likely be the best international institution to issue and regulate a cryptocurrency. The fact that the IMF has already expressed interest in developing an international regulated cryptocurrency helped determine this conclusion. The IMF also has experience with issuing and valuating SDR’s which serves as valuable experience in their ability to regulate and issue an international financial asset. In addition, to the IMF’s experience issuing

SDR’s to countries around the world, over 189 countries have registered as members of the IMF

(IMF 2017). With consideration that the United Nations recognizes that there are 193 countries around the world (excluding the Vatican City State and the State of Palestine), the IMF has influence to cover over 96%-97% of the world (World Atlas 2018). The IMF’s influence would be instrumental in establishing global acceptance for an internationally regulated cryptocurrency.

Sub-Question 3

Is the cost of developing and regulating an international cryptocurrency justifiable in respect to the current monetary structure used today?

If the IMF wanted to create a cryptocurrency, they would have to determine if the cost of developing and regulating a cryptocurrency is more affordable in respect to the current monetary structure used around the world today. The IMF could determine the answer to this question by developing and testing a small-scale cryptocurrency platform. If the IMF were to discover that the current monetary structure used today was more affordable; issuing a cryptocurrency would not be in their institutions best interest financially.

16 Establishing a Financial Structure for an International Regulated Cryptocurrency

In order to determine a theoretical monetary system for an internationally regulated cryptocurrency, one would need to consider every monetary system ever used and evaluate which has been the most efficient. With respect to the study of Monetary Economics, there are only three types of monetary systems: Commodity Money, Commodity-based Money, and Fiat

Money (Agarwal 2018).

Commodity Money

Commodity Money is a monetary system in which currency is derived by a “precious metal or other commodity that possess’ intrinsic value” (Agarwal 2018). This monetary system is the oldest and most historic currency system ever used; dating back to “650 to 600 B.C. in the

Asia Minor region” (Kusimba 2017). Individuals would “mint” currency by melting coins out of precious metals like gold and silver. However, this system failed when the value of the commodity surpassed the value of the coin. This discrepancy in commodity value presented an opportunity for individuals to “melt down precious metals and combine them with lower quality metals to create additional coins” a process referred to as “debasement” (Investopedia 2005).

This trend in counterfeiting minted coins became such an issue that issuing governments created the second form of monetary system which is referred to as “Commodity-based Money”.

Commodity-based Money

Much like Commodity Money, Commodity-based Money receives its value from an underlying commodity like gold or silver. However, Commodity-based Money is not a tangible form of the commodity like Commodity Money; instead Commodity-based Money is

17 represented as paper money or a “” (Agarwal 2018). This form of currency has also been around for centuries and was “first recorded in China during the Tang Dynasty during 618-

907 A.D.” (Time 2016). More recently, this monetary system was used as the “Gold Standard” in which countries would fix the value of their paper currency off of the countries valuation on the price of gold. (Lioudis 2008). However, there is no recorded country in the world using this system anymore because during times of economic down turn individuals would go to banks and try to cash out all of their money for gold. This started occurring in “England during 1931 because of the Great Depression and the started to fear they would run out of gold and in 1933 England abandoned the Gold Standard” (Goldstein and Kestenbaum 2011). “In

1933, Franklin Delano Roosevelt decided to break the tie with Gold and the Dollar in order to prevent further escalation of the Great Depression; and as a result the U.S dollar was set to float”

(Amadeo 2018b). However, this technically was not a complete break from the gold standard because under the “Bretton Woods Agreement of 1944, member countries agreed to set their currency’s at a fixed exchange rate in respect to the U.S. Dollar” (Amadeo 2018a). This system did not work well because “the United States experienced a high amount of due to the impact of the Vietnam War which caused high inflation and high unemployment” (Office of the

Historian n.d.) As a result, the “value of the United States Dollar was inflating higher while the gold supply in the United States was decreasing because countries and other individuals were purchasing the commodity” (Goldstein and Kestenbaum 2011). “In 1971, Richard Nixon completely abandoned the entirely and foreign nations who were apart of the Bretton Woods System started to float their currencies” (Stephey 2008). This trend of floating currencies continued until “1999 when Switzerland abandoned the Gold Standard”

18 making the system extinct (Holmes 2015). These actions made way for the globally used monetary system today known as Fiat Currency.

Fiat Currency

Fiat Currency is defined as a “currency that is backed by the government issuing the currency” (Hall 2015). This means that a fiat currency has no underlying tangible value; rather the value is only valid because a government says it is. This philosophy drastically changed the perception behind monetary value and now currencies are valued by a multitude of factors which are directly tied to the currencies issuing government. The influential factors include: military strength, economic status, international influence, and geographic advantages (Marsh 2015).

However, because countries individually issue their own currencies they are able to manipulate the global economy in their favor. For example, countries can enact an economic policy of quantitative easing and this allows for an increased flow of currency in the economy because a country can either print more money or purchase their government issued bonds. The United

States and the European Union have been known for using this economic policy and this has the ability to inadvertently inflate their currencies if individuals start pulling actual cash out of their banks. On the other hand, countries can also elect to devalue their currency, which is a defensive mechanism used to increase exportation. This essentially grants these countries the opportunity to have an economic advantage in respect to the rest of the world. Countries like Japan and China are currently using these economic policies. As a result, they have negatively impacted global trade with the United States and other nations around the world.

19 Proposed Structure for This Cryptocurrency

Despite the regulatory issues that arise from the Fiat Currency system, this financial structure holds up on the foreign exchange market today. For this reason, the IMF would have to structure their regulated cryptocurrency on the monetary structure of fiat currency. The financial structure of commodity money and commodity-based money would not hold up today for the same reasons they had not held up in the past. In order to create value for an internationally regulated cryptocurrency, an international institution would have two feasible options to consider. The first option would require the IMF to peg the cryptocurrency to the value of a stable currency like the United States Dollar or Euro. The second option would require the IMF to value the cryptocurrency in the same manner as an SDR. The IMF currently values their issued SDR in a “currency basket composed of the world most stable currencies” (IMF 2017b).

Unlike SDR availability today, this cryptocurrency would have to be available to individuals and not only member countries of the IMF. If the IMF were to effectively recreate this SDR valuation technique, the value of the cryptocurrency could maintain stability and value around the world. Considering the nature of the SDR, which is considered a reserve asset, this cryptocurrency would have to be perceived globally as a commodity issued by the IMF and not a currency. This would make the newly issued SDR a “Crypto SDR”. The Crypto SDR would maintain the same financial structure as an SDR; however, an individual would have the ability to transfer their Crypto SDR for currencies used around the world. This solution would not be able to completely fix the issues within the monetary system of fiat currency; rather, the system would be diluted to multiple levels of fiat currency.

20 Sub-Question 4

Would individuals around the world trust a global institution to manage their money in an efficient manner?

Trust around the world is a difficult perception to gain. Trust is also extremely difficult to gauge because individuals can change their mind at any moment. The problem the IMF has is that the institution is not well liked globally because of their neoliberal policies. The IMF has also made financial mistakes with countries like Bolivia and Greece which contributes to negative sentiment around the world. If the IMF were to gain trust from individuals around the world, they would have to implement new financial policies.

Trust Around the World

Every year Edelman, a well-respected public relations company, issues an international barometer identifying trust level throughout the world. The survey consists of a “sample size of

28 nations and measures trust in the four institutions of: government, business, media, and nongovernment organizations” (Edelman Trust Barometer, 2017). In 2017, the Edelman

Barometer found that the level of trust in the government “dropped to 41% around the world”.

Edelman also discovered that only: “43% of individuals trusted media, 52% of individuals trusted businesses, and 53% of individuals trusted nongovernment organizations” (Edelman

Trust Barometer, 2017). This data reveals that individuals around the world collectively have a tendency to lack trust specifically in government related entities. If the IMF were to consider this data, the institution would most likely determine that individuals around the world are not willing to trust an international institution with their hard-earned money

21 Cryptocurrency Was Built on the Perception of Distrust

When Satoshi Nakamoto released his whitepaper for Bitcoin in 2008, his primary goal was to create an irreversible peer-to-peer electronic cash system that could run without the intermediation of a financial institution (Nakamoto, 2008). This idea served as Bitcoin’s purpose and as a result of this, there has been an unwritten precedent set in the cryptocurrency community which expects all cryptocurrencies to remain “decentralized”. This belief is primarily supported by the economic theory of “Laissez-faire”, which opposes governmental control and intervention in economic matters. However, there are major flaws that have developed from the

“decentralization” of cryptocurrency if these are exposed to individuals around the world, they might be open to cryptocurrency regulation or government intervention.

The greatest issue with the decentralization of cryptocurrency has been the emergence of

“whales”. In the cryptocurrency industry, “whales” are known as individuals who hold a massive share of an individual cryptocurrency and this gives them the ability to manipulate that cryptocurrencies value on the crypto exchange (Kharif 2017). Recently, Bitcoin Whales have become a major problem for Bitcoin. For example, over “40% of Bitcoin is held by a 1000 individuals” (Kharif 2017). This lack of distribution grants whales the ability to alter the entire cryptocurrency market if they wanted to band together. With the susceptibility of market collusion relying solely on a group of 100 individuals, cryptocurrency is placed in a catastrophic state of disarray and could collapse in value because of this at any moment. Given the volatile nature of cryptocurrency today, there is a possibility that individuals might eventually consider a regulated cryptocurrency once they experience the dangers of volatility first hand. However, since the cryptocurrency industry is based on the premise of decentralization proponents using cryptocurrency today would most likely not support a cryptocurrency regulated by the IMF.

22

What Is Needed to Create Global Trust

The world is living in an age of distrust and an international institution like the IMF would have difficulty convincing individuals to openly embrace and trust their institution with their savings. To create global trust, the IMF would have to change some of their controversial financial policies that have not worked in the past. If the IMF was unwilling or unable to achieve this, another international institution would need to be developed. The issuance of a new international institution would take time to create and this would most likely postpone the process of creating and issuing an international regulated cryptocurrency.

Sub-Question 5

How would impoverished individuals around the world be able to access a digital cryptocurrency without access to proper technology?

If an institution like the IMF were to create a cryptocurrency the financial service would have to be accessible to everyone around the world. If an international cryptocurrency was not easily accessible to individuals around the world this service would technically not be international. To determine technological access around the world, one would need to determine accessibility to technology around the most impoverished areas of the world to determine if the necessary resources are available to individuals that would need this cryptocurrency most.

Technology Access in Africa

According to a study issued by howmuch.net, the region of the world that continues to struggle with technological accessibility is Africa (HowMuch 2017). According to Figure 4, there is a lack of internet accessibility in the central region of the continent of Africa. A study

23 issued by Pew Research also recorded that “two-thirds of the world uses the internet, but fewer individuals do in Africa” (Poushter 2016). Despite the lack of internet access in the central region of Africa, the amount of cell phone ownership throughout the continent is increasing

(Reference Figure 5). In Figure 6, the central areas of Africa that do not have access to internet do have an increasing use of cell phone activity. This data suggests that despite the lack of access to internet services, non-smartphones are being used for mobile payment services. This financial activity is a result of mobile payment services like “M-Pesa and Zain” which allow smartphones and non-smartphones to transact currency between two individuals (Monks 2017).

The bad news is that power on the continent of Africa is a difficult resource to access

(Figure 6). Without power, individuals are unable to use their cellphones for financial services.

This lack of electricity would isolate many individuals from accessing an international cryptocurrency. If more power developing facilities were developed throughout nations in

Africa, individuals would most likely use an international cryptocurrency regulated by the IMF.

Cryptocurrency Use in Africa

Individuals throughout Africa are using cryptocurrency today. Currently, Bitcoin is being used as an investment for individuals that want to make a high return using a buy low and sell high approach. Cryptocurrency is not being used as a place for an individual to store their saving because the volatility of cryptocurrency is too high. This is why a centralized stable form of cryptocurrency could possibly support individuals living in developing nations that do not have access to finance services that most developed nations use daily (Monks n.d.).

24 Quantitative Analysis

A quantitative study was issued to support the information discovered in the literature review. The quantitative study consists of a graph, a univariate analysis, and a multivariate analysis. Without a quantitative study, this dissertation would only provide a pragmatic analysis to determine whether an international institution could develop and regulate a cryptocurrency. The goal of the quantitative study is to observe numerical values related to the volatility of cryptocurrency today. The observed data will be used to quantify what a deregulated cryptocurrency looks like today and how much regulation a cryptocurrency on the market would need in order to match the volatility levels of the S&P 500, Dow Jones, and Gold.

Market Trend Graph Generation

A Market Trend graph was generated to provide a visual representation of the price spikes in cryptocurrency throughout the last decade. The creation of a market trend graph was structured to record the daily close prices for the Dow Jones, S&P 500, Gold, Bitcoin, Ethereum,

Litecoin, and Ripple.

25

Once this graph was generated, cryptocurrency is evidently more volatile in respect to Gold, the

S&P 500, and the Dow Jones.

Univariate Analysis

A univariate study was issued to explore the volatility in the Dow Jones, S&P 500, Gold,

Bitcoin, Ethereum, Litecoin, and Ripple as “individual variables”. Once each volatility was calculated at an individual level, a pattern revealed that cryptocurrencies are ten times more volatile than the S&P 500, the Dow Jones, and Gold. The Percent Change and Standard

Deviation of Logarithmic Returns were calculated for each index, commodity, and cryptocurrency at an individual level to determine volatility.

26 Percent Change Calculation

Percent Change was calculated by using the formula below.

Formula:

푉푡 − 푉푦 푃푒푟푐푒푛푡 퐶ℎ푎푛푔푒 = 푉푦

Vt = Value Today

Vy = Value Yesterday

Table 1

Once percent change was calculated individually for the Dow Jones, S&P 500, Gold,

Bitcoin, Ethereum, Litecoin, and Ripple the standard deviation was calculated to determine to determine the individual volatility level for each index, commodity, and cryptocurrency. After the chart representing percent change on an individual level was created, a clustered column chart was created to present the volatility calculations. The clustered column chart suggests that

27 the volatility of cryptocurrency is exponentially higher than Gold, the S&P 500, and the Dow

Jones.

Standard Deviation of Logarithmic Returns

The standard deviation of logarithmic return was calculated using the formula below.

Formula:

푉푓 퐿표푔푎푟𝑖푡ℎ푚𝑖푐 푅푒푡푢푟푛 = ln ( ) 푉𝑖

R = Logarithmic Return ln = Natural Log

Vf = Future Value

Vi = Initial Value

Table 2

28 Once the natural logarithmic return was calculated the standard deviation of each for each index, commodity, and cryptocurrency observed was calculated individually. Once the standard deviation values were calculated a clustered column chart was created to present the data. The chart representing the standard deviation of logarithmic returns reveals the same information as the chart that observed percent change. Cryptocurrencies have the ability to move five times as much as the price movement of the Dow Jones, S&P 500, and Gold.

Multivariate Analysis

Through the issuance of a regression, a multivariate analysis was created to measure the volatility of each index, commodity, cryptocurrency. By determining the scope of volatility for each variable, this analysis revealed the unpredictable movement for each observed variable “one statistical outcome at a time”. The multivariate analysis is important because the independent variables for each observed value were all occurring at the same time, and this made the data quite complex. Through the issuance of a multivariate analysis, one can observe how each variable moved in relation to each other by observing the value of the recorded coefficient.

Below is a collection of coefficients for each variable observed as each regression was run.

These coefficients reveal each variables recorded “beta”, which in the world of finance denotes

“volatility”. This is why the term beta is usually referred to as a “beta coefficient”.

How to Determine What Each Beta Coefficient Means?

If a beta coefficient is less than one, the variable is considered to be less volatile than the market. If a beta coefficient is above one, the variable is considered to be more volatile than the

29 market. A beta of one indicates that the variables volatility moves in the same manner as the market.

Regressions

In Table 3, the coefficient for each observed variable were ran as a regression that compared equal amounts of data dispersed from 2015-2018. The sample sized consisted of 915 observations (n=915). The data reveals that the beta coefficients for Ethereum, Litecoin, Bitcoin, and Ripple are extremely volatile in respect to the beta coefficient values for the Dow Jones and

Gold.

Table 3

In the Tables 4-12, regressions were run for all of the data that was available for the year observed. This meant that the sample size varied for each variable as each year occurred.

Table 4

30 Table 5

Table 6

Table 7

Table 8

31 Table 9

Table 10

Table 11

Table 12

32 The last regression ran was an adjusted data regression in which all independent variable values were issued in the regression. The sample size consisted of 2,762 observed values

(n=2,762). This regression provided the most accurate result for each beta coefficient because the sample size was the largest.

Regression

Table 13

The coefficient values listed in Table 13 reveal that as more variables were added to the regression, the spread between each index, commodity, and cryptocurrency grew. For example,

33 the value of Ripple recorded a beta value as high as 5.27 which is extremely high in respect to the Dow Jones which recorded a beta of 0.097.

Upon running each regression, the average beta coefficient and volatility for each cryptocurrency remained incredibly high at a level about ten times the level of the S&P 500 and the Dow Jones. In respect to Gold, which is a commodity considered to have higher level of volatility than the market, volatility for cryptocurrency was still ten times that of Gold.

Considering the fact that the S&P 500 and the Dow Jones consists of regulated stocks on the market, if an international institution were to develop and regulate a cryptocurrency they would need to at least regulate their issued currency to a point at which the volatility of the cryptocurrency aligned with the volatility of stocks on the market. If an international institution was not able to regulate a cryptocurrency to a point in which they could maintain a low volatility ratio, individuals would not want to rely on this service for financial security because the risk would be to great of a burden.

Conclusion

A person should not be confined to a life of poverty because of the economic struggles of their nation; rather people should have the ability to create a financial plan for their lives without having to rely on the stability of their government for economic and financial safety. To combat economic issues caused by unstable nations, an impartial international institution would have to develop and regulate an aid currency.

34 Would an international institution be able to develop and regulate an international cryptocurrency?

An international institution could create an international cryptocurrency, but this does not mean the service would be financially feasible. The cost of mining the cryptocurrency would be extremely high and most likely unsustainable. Regulating cryptocurrency would also be extremely risky. Cyber thieves would most likely target an international institution like the MF id they were to issue their own cryptocurrency. Based on the quantitative analysis of this study current cryptocurrencies do not provide the stability and assurance that impoverished individuals need. If cryptocurrencies were to ever become regulated to a point in which they were as volatile as a commodity, or stock index individuals might not need an international institution to develop a cryptocurrency because the volatility risk of cryptocurrency could go away.

Best Implementation for An International Aid Currency

The world would benefit more from a global SDR that would be available to individuals and not only governments. This SDR could be tangible like a paper currency and be valued like current SDR’s today. The alternative option is for an international institution to create their own tangle fiat currency and peg the value to a basket of stable currencies around the world. This currency would open doors for impoverished individuals to grow and support the global economic system using their absolute advantages. Most importantly, if an international aid cryptocurrency was established, individuals would not have to rely on their country for financial resources.

35 Tables and Figures

Figure 1

Figure 2

36

Figure 3

Figure 4

37

Figure 5

38

Figure 6

Figure 7

39 Glossary

1. Bitcoin: the first successfully developed cryptocurrency ever created. Today, Bitcoin is the

most popular cryptocurrency available on the greater cryptocurrency exchange.

2. Blockchain: Satoshi Nakamoto, the creator of Bitcoin, defined cryptocurrency as “a peer-to-

peer version of electronic cash which allows online payments to be sent directly from one

party to another without going through a financial institution”.

3. Cryptocurrency: a digital currency or decentralized system of exchange that uses advanced

cryptography for security.

4. Currency Basket: is a “portfolio of currencies that contain different values on the foreign

exchange market”. The “weighted average of each currency in the basket determines the

value of the currency” (Investopedia n.d.).

5. Float Currency: The value of a currency is derived by Foreign Exchange Market where

currencies can be bought and sold based on supply and demand.

6. Pegged Currency (Fixed Exchange Rate): when a currency has a value that is fixed or

pegged to the value of another currency.

7. SDR (Special Drawing Right): The SDR was created by the IMF “after the Bretton Woods

Agreement to serve as a supplementary international reserve asset” An SDR is not a

currency. The SDR “serves a unit of account in the IMF and can be exchanged for member

currencies of the IMF that are stable in value”. (Investopedia n.d.).

8. Volatility: rapid change that occurs unpredictably. In statistics this term is measured as a

standard deviation of returns.

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Tables and Figures Bibliography 1. Bitcoin – USD (Yahoo Finance). https://finance.yahoo.com/quote/BTC- USD/history?period1=1279263600&period2=1517904000&interval=1d&filter=history&frequ ency=1d 2. Ethereum – USD (Yahoo Finance). https://finance.yahoo.com/quote/ETH- USD/history?period1=1438844400&period2=1517904000&interval=1d&filter=history&frequ ency=1d 3. Litecoin – USD (Yahoo Finance). https://finance.yahoo.com/quote/LTC- USD/history?period1=1382511600&period2=1517904000&interval=1d&filter=history&frequ ency=1d 4. Ripple – USD (Yahoo Finance). https://finance.yahoo.com/quote/XRP- USD/history?period1=1421740800&period2=1517904000&interval=1d&filter=history&frequ ency=1d 5. Gold – USD (World Gold Council). https://www.gold.org/data/gold-price

46 6. Dow Jones Industrial Average (Yahoo Finance). https://finance.yahoo.com/quote/%5EDJI/history?period1=1262332800&period2=151790400 0&interval=1d&filter=history&frequency=1d 7. S&P 500 (Yahoo Finance). https://finance.yahoo.com/quote/%5EGSPC/history?period1=1262332800&period2=1517904 000&interval=1d&filter=history&frequency=1d 8. Volatility Calculation Formula (Investopedia). https://www.investopedia.com/ask/answers/021015/how-can-you-calculate-volatility- excel.asp

47