EUROPEAN PARLIMENT: Virtual currencies and central banks monetary policy: challenges ahead, July 2018.

ABSTRACT

Virtual currencies are a contemporary form of private money. Thanks to their technological properties, their global transaction networks are relatively safe, transparent, and fast. This gives them good prospects for further development. However, they remain unlikely to challenge the dominant position of sovereign currencies and central banks, especially those in major currency areas. As with other innovations, virtual currencies pose a challenge to financial regulators, in particular because of their anonymity and trans-border character. This document was provided by Policy Department A at the request of the Economic and Monetary Affairs Committee.

EXECUTIVE SUMMARY

• Virtual currencies (VCs) are a contemporary form of private money. Thanks to their digital form and the use of Blockchain technology (in many, but not all, cases), the transaction networks of VCs are relatively safe, transparent, and fast. Unlike their 18th and 19th century paper predecessors, VCs are used globally, disregarding national borders. However, as with any money or financial asset, investments in VCs are not without risk. VCs may be subject to fraud, the bankruptcy of the issuer or intermediary, or speculative bubbles and bursts, among others.

• In April 2018, there were more than 1,500 VCs; however, only a few recorded meaningful market turnover and capitalisation. Bitcoin, the first VC, created in 2009, remains a leader among them. The VC business has seen continuous development in terms of number of VCs, number of transactions, and market capitalisation. However, as long as major trading platforms and financial intermediaries do not accept payments in VCs, their transactional role will remain limited and they will fulfil mainly the third function of money, the store of value—that is, they will serve as one of many investment assets.

• Similar to previous incarnations of private money, VCs face the challenges of gaining market and governmental recognition as a means of payment, building public trust concerning their stability, and achieving sufficient network externalities related to their use. While governments and central banks will unlikely accept them as an official legal tender in individual jurisdictions, the question of market recognition remains open, and the rapid expansion of Bitcoin and other larger VC projects worldwide indicate that it may happen (to some degree). And unlike previous incarnations, issuers of contemporary private money are able to ensure a transparent global network for circulation, a
credible algorithm for the creation of the VC, and a transaction mechanism that is relatively safe, fast, and inexpensive.

• Despite their technological advances and global reach, VCs are far from being able to challenge the dominant position of sovereign currencies and the monetary policies of central banks, especially in major currency areas. However, in extreme cases, such as during periods of hyperinflation, financial crisis, political turmoil, or war, they can become a means of currency substitution in individual economies.

• Financial regulators may dislike VCs because of their anonymity or cross-border circulation. They tend to fear that VCs will facilitate money laundering, the financing of illegal activities, tax avoidance, the circumvention of capital controls (in countries where such controls are in place), and fraudulent financial practices. Such concerns may be legitimate in some instances but must not be generalised. In most cases, transactions in VCs result from the free business choices of
economic agents and, therefore, should be treated by regulators as any other financial transaction or instrument—that is, proportionally to their market importance, complexity, and associated risks. Given their global, trans-border character, it is recommended that regulations concerning VCs be harmonised across jurisdictions (which is far from the case now). Investment in VCs should be taxed similarly to investment in other financial assets.

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