In October the European Central Bank (ECB) published the first investigation by a regulatory authority into the so-called ‘virtual currency’ phenomenon.
Suffice to say, much of the focus of the report is on one virtual currency in particular. Ever since Satoshi Nakamoto conceived of the idea for Bitcoin in 2008, the cryptographic currency has attracted a lot of interest in the media, both of the positive and negative varieties. Now, it is also attracting attention from central bankers, who have raised their concerns about the risks this new form of currency might pose to financial stability in a lengthy 55-page report.
But what exactly is new about Bitcoin? And why should central bankers or Treasury Insights readers take any particular interest? Digital methods of payment are nothing new, after all. Payment cards and mobile wallets are now widely accepted by both consumers and businesses. And one might even make the argument that most traditional currencies now exist principally in digital forms.
But Bitcoin is different to other digital payment methods in one fundamental way: it is administered through a decentralised peer-to-peer network. Unlike other forms of digital money, the currency is not overseen by a central clearing house managed by a company or organisation, nor is its value pegged to any real-world currency. Instead, its exchange rate is determined solely by the level of supply and demand in the market.
The currency is said to work in a similar fashion to the former gold standard in that the monetary base is designed to increase at a steady, predictable rate, with the total quantity of coins that can be brought into circulation fixed; it is established that there will be a limited and scheduled release of no more than 21 million coins, which will be fully issued by the year 2140. The generation of new coins is carried out by the users themselves. It is a process which is designed specifically to mimic the extraction of minerals – Bitcoin users devote their CPU power to a peer-to-peer network which, using certain algorithms, performs all the duties of a central clearing house, such as netting and settlement.
A currency system governed by mathematical algorithms instead of a central authority may seem appealing to some, particularly in this current era of central banker mistrust, but it is also one of the principle reasons why the ECB now claims to be concerned.
It is a question of reputational risk, the ECB argues. The public looks to central banks to oversee and regulate activities relating to money and payments. Should there be a security incident involving Bitcoin, the lack of a central authority would make it inherently difficult for somebody to be held to account – instead those looking for someone to blame might make the case that the central bank was not performing its regulatory functions adequately.
With the market at its present size, the impact of a failure in a virtual currency scheme such as Bitcoin would be limited, the ECB admits. But as Gonzague Gay-Buouchery, Marketing and Communications Manager at the Bitcoin trading exchange Mt.Gox says, the currency is now gaining increasing acceptance, from consumers and businesses alike.
Bitcoin, he says, has been growing in popularity with internet consumers, chiefly because of the many practical benefits it offers as a payment method.
“If I want to transfer some money from France to Japan or vice versa, then it will take a lot of time and cost me a lot of money,” he says. “Depending on the bank there might be an additional charge, because some banks may use an intermediary for the transaction. So, if you send a sum of €200 – €300, you might have €50 taken from you in charges, and it will also take a long time. But with Bitcoin, any transaction between Bitcoin and Bitcoin is instant and completely free.”
And these advantages over traditional payment methods are, Gay-Buouchery argues, appealing not just to consumers; some businesses too are beginning to recognise advantages to settling payments in the currency, particularly with respect to making cross-border payments. “We know of some users who are dealing with suppliers in different countries and paying them in Bitcoin,” he says. “For those suppliers it is a great relief to know that they will be paid immediately and there will be no charge back.”
So, if consumers and businesses are likely to increasingly use Bitcoin, then should it be the responsibility of the ECB to step in and regulate the market?
Simon Lelieveldt, an independent banking and payments consultant, who himself worked as a central banker in the Netherlands during the 1990s, agrees that Bitcoin could potentially pose a risk to consumers, but does not believe regulation is absolutely necessary at this stage. For a number of reasons, which he outlines in detail in his blog, he thinks that the analytical basis of the ECB’s report should have been stronger.
“It is a payment system that could burn users’ hands,” he says. “But I think the argument made by the ECB that it could be blamed if the system goes wrong is a bit strongly worded.
“It is a familiar pattern. It starts with some observations about virtual currencies and is almost immediately followed by a goal to regulate it.”
A much better approach, he argues, would be to inform consumers and businesses of the potential hazards, and make them aware that they can use it as a payment method, but at their own risk. “The other option would be to put a sign on the door,” he reasons, “and then say if you burn your hands using this system, then don’t blame the government.”
“This approach to virtual money would be preferable,” he says. “We already have sufficient regulation of e-money systems, so they could bring it under that umbrella. But so long as we have the regular payment systems that are easy to use and the consumer has a free choice, then ultimately it is the customer’s responsibility, not the ECB’s.”