As virtual currencies like Bitcoin, Ethereum and Ripple rise in use and value, government regulators around the world are paying closer attention, issuing consumer warnings, and are looking for ways to regulate them.
The international nature of virtual currencies, also called cryptocurrencies, allows them to operate outside the reach of national governments. But increasingly, regulators are considering ways to oversee the exchanges or, in some cases, ban them.
The Rise and the Risk
Cryptocurrencies are gaining in popularity and in dollar terms. The combined value of cryptocurrencies reached $800 billion earlier this year before falling down to $433 billion. In the past five years, Bitcoin’s value alone rose from $5 billion in 2013 to $115 billion in 2018.
Observers say the wild fluctuations in price presents a consumer hazard.
Furthermore, government officials worry that cryptocurrencies enable criminals to launder money, evade taxes and finance terror networks.
“Cryptocurrencies are more convenient than cash for many illegal activities that now take place online,” said Michael Lee, an economist with the Federal Reserve Bank of New York, in a Fed blog article. “More broadly, cryptocurrencies are ideal for circumventing legal or regulatory authorities, because they aren’t governed by any.”
China’s Attempted Ban
While some countries are cautiously trying to bring the new form of money within their regulatory control, others are trying to outright banish it.
China, for example, banned crypto trading platforms operating in its country last year only to find that traders simply started using exchanges operating outside the country. More recently, China’s central bank ordered its financial institutions to stop processing settlements with cryptocurrency exchanges, according to the South China Morning Post.
A ‘Token for Unlawful Behavior’
In Europe, regulators are updating their money-laundering enforcement rules to begin identifying users of virtual currency exchange systems and custodial wallet providers.
Specially, the EU’s proposed anti-money-laundering rules would require virtual currency exchange platforms and custodian wallet providers to apply customer due diligence controls.
“That means less anonymity and more traceability, through better customer identification, and strong due diligence,” said Valdis Dombrovskis, a European Commission vice president in charge of financial stability for the Euro. He also encouraged European countries to update their national financial rules to oversee the high-tech-enabled currencies.
“Make no mistake: We want Europe to embrace the opportunities of blockchain, the technology underlying cryptocurrencies,” Dombrovskis said in a January 23 speech in Brussels. “But to do so, we must be vigilant and prevent cryptocurrencies from becoming a token for unlawful behavior.”
EU Consumer Warning
Meanwhile, European regulators warned consumers that investments in “highly speculative” digital currencies like Bitcoin face a “high risk.”
Unlike investments in regulated financial services, purchases of virtual currency can be lost without backup guarantees by the EU if the exchange goes out of business or is hit by a cyberattack.
“They are highly risky, generally not backed by any tangible assets and unregulated under EU law, and do not, therefore, offer any legal protection to consumers,” the tri-agency warning said. (The agencies oversee EU securities, insurance and pensions, and banking industries.)
Bitcoin is by far the largest virtual currency. The price of one Bitcoin spiked last December to an all-time high of $19,345 before falling to less than half that a month later.
By comparison, Ripple’s value has remained faily steady. It spiked briefly to $1.98 on Dec. 1, 2017, up from $0.24, before leveling out at $1.10. And Ethereum climbed from $12.82 in February of last year to $926 today.
The price spikes along with the sometimes technical difficulties in redeeming virtual coins for regular currency poses risks, according to Agustín Carstens, General Manager, Bank for International Settlements (BIS).
“While perhaps intended as an alternative payment system with no government involvement, it has become a combination of a bubble, a Ponzi scheme and an environmental disaster,” Cartens said. “The volatility of bitcoin renders it a poor means of payment and a crazy way to store value.”
A Global Risk?
Meanwhile, international financiers are taking notice and anticipating what role, if any, they might have in regulating the new currencies.
“We need to anticipate where the next crisis will be,” said IMF Managing Director Christine Lagarde. “Will it be shadow banking? Will it be cryptocurrencies?”
The decentralized nature of virtual currency offerings and exchanges makes regulating them difficult. Another challenge is the relative ease in which new currencies can be created.
“Even if the supply of one type of cryptocurrency is limited, the mushrooming of so many of them means that the total supply of all forms of cryptocurrency is unlimited,” BIS’s Carstens said. The job of ensuring they are safe may fall to public and private bank regulators, national ministries of finance, tax agencies and international financial intelligence investigators.
“To the extent they are used, bitcoins and their cousins seem more attractive to those who want to make transactions in the black or illegal economy, rather than everyday transactions,” Cartens said.