Tag: Crypto-currencies

Cryptocurrency Derivatives to Test Clearinghouses, Banks

Centrally cleared cryptocurrency derivatives could be a real-world test of clearinghouses’ margining and default procedures, particularly if derivative notional volumes increase and cryptocurrencies exhibit heightened price volatility, says Fitch Ratings.

Although they have largely avoided direct exposure to cryptocurrencies, banks’ role as clearing members creates a secondary channel for cryptocurrency risk. This could indirectly affect banks under more extreme stress scenarios, such as if margining and clearinghouse capital contributions prove insufficient to absorb counterparty defaults.

A dramatic increase in financial institutions’ exposure to cryptocurrency derivatives could challenge clearinghouses and large financial institution clearing members in ways beyond those typically associated with the introduction of new market products. Cryptocurrencies are prone to extreme price volatility, which has been exacerbated by a nascent, unregulated underlying market with a limited price history and without generally accepted fundamental valuation principles. These factors complicate margin calculations, particularly related to short positions, for which losses cannot be capped. Inadequate margins may lead to use of clearinghouses’ collective funds to mitigate losses, thus calling upon the resources of non-defaulting clearing members, including many of the world’s largest banks and other financial institutions.

Bitcoin futures are cash-settled derivatives (i.e. without delivery of the base asset) that allow investors to assume long and short exposures to bitcoin prices without directly facing the cryptocurrency itself. In December 2017, CME Group and CBOE introduced the trading of bitcoin futures under the tickers BTC and XBT, respectively. BTC contracts are cleared through CME Clearing, while XBT contracts are cleared through Options Clearing Corporation (OCC).

As of May 9, 2018, open interests in XBT and BTC were modest at 6,287 and 2,479 contracts, respectively, worth approximately $59 million and $116 million, respectively. However, if challenges associated with trading the cryptocurrency are addressed, including uncertainty over regulatory, tax and legal frameworks, cryptocurrency derivative volumes could grow.

Clearinghouses have imposed high initial margin requirements, as well as price and position size limitations, suggesting a cautious approach thus far to trading cryptocurrency derivatives. As of May 9, 2018, initial (maintenance) margin requirements at CME were 43% of the associated notional amount, while at OCC the percentage was 44%, up from around 30% at the derivatives’ introduction in December 2017. Position limits at both exchanges are limited to 5,000 contracts in total or 1,000 in spot/expiring contracts. Consistent with price limitations for equity indexes, the maximum price limits at CME and CBOE are set at 20% above or below the previous day’s closing price, and trading is not permitted outside this band. There are also special price fluctuation limits set at 7% and 13%, which lead to temporary trading suspension.

The CME and OCC have not yet established separate legal entities or default funds for cryptocurrency derivatives, instead allocating exposure to the same default funds as equity indexes. This is understandable given the cost inefficiencies of establishing entities and default funds for what is currently a relatively low volume business. Nevertheless, a member default from losses on cryptocurrency derivatives may cause disruptions in other cleared products. Should centrally-cleared cryptocurrency derivatives materially grow, Fitch would expect clearinghouses at a minimum to establish separate default funds in an effort to isolate and mitigate associated risks.

Is This How Bitcoin Could Go Mainstream?

When I made my first video on Digital and Cyber Currencies – What Is Money? I said I would return to Bitcoin.

Now, today I am not going to discuss the mechanics of the digital currency, there are plenty of others who have done that; nor am I going to discuss the limited supply, which is mirroring gold, other than to note this one of the fundamental design criteria of the crypto currency.

But institutional investors are getting more interested.

For example, Goldman Sachs announced it will be opening a crypto derivatives trading desk “within weeks,” as well as recently hiring a cryptocurrency trader as vice president of their digital asset markets. It will trade Bitcoin futures in a principal, market-making capacity and will also create non-deliverable forward products.

Then last week there was some more potentially important news out of the USA. There are rumours that the New York Stock Exchange may be planning to offer ‘Physical Delivery’ of Bitcoin. If this is true, it could mark a significant transformation in the role of digital currencies like Bitcoin.

The suggestion from unnamed “multiple sources” is that NYSE’s parent company Intercontinental Exchange or ICE is planning to offer Bitcoin (BTC) swap contracts but these contracts would be settled with the delivery of Bitcoin itself. Think about that, a mechanism to allow the physical delivery of a digital currency. If this IS true, this would have significant consequence for the future of crypto.

While there are Bitcoin futures contracts currently being offered on Chicago based CME Group derivatives marketplace or CME (since December 2017) and Chicago Board Options Exchange CBOE, these are ultimately settled in dollars.

The suggested crypto swap contracts would be settled in Bitcoin, and this would be a significant milestone which may signal a major Wall Street adoption of crypto.

Significantly it could mean that the ICE has a custody solution. As Bitcoin are generally bearer instruments it means you have to have a third-party custody option if institutional investors are going to get seriously involved.

There are so called “Cold storage custodian solutions” offered by small operators.

It’s not clear whether ICE is likely to build an in-house cold storage solution or to outsource it. In fact, ICE has made no comment at all on this, so it might be just speculation.

But here’s the thing, if ICE can offer a custodian solution that meets SEC rules and compliance requirements, this could “open the floodgates” to institutional capital, resulting in some “big price moves” in the crypto markets.

A custody solution would also open the door for pensions and endowments and so become an emergent asset class…most obviously at the expense of gold.

The Bitcoin price is still sitting well below the previous highs and the markets did not really respond to the rumours. But if this is true, then it may mark a significant inflection point in evolution of crypto. It might go mainstream.

Crypto Is Not The Future Of Money

Crypto-currencies do not stand up as a new form of money says Mark Carney, Governor of the Bank of England, speaking on “The Future of Money“. That said, the underlying technologies and capabilities, have potential.

The long, charitable answer is that crypto-currencies act as money, at best, only for some people and to a limited extent, and even then only in parallel with the traditional currencies of the users. The short answer is they are failing.

They are poor stores of value, an inefficient media of exchange and are virtually non-existent units of account.

Authorities need to decide whether to isolate, regulate or integrate crypto-assets and their associated activities.

This is probably the strongest statement on the subject so far from a Central Banker.

But, whatever the merits of crypto-currencies as money, authorities should be careful not to stifle innovations which could in the future improve financial stability; support more innovative, efficient and reliable payment services as well as have wider applications.

The underlying technologies and capabilities, have potential, given the right regulatory frameworks.

Their core technology is already having an impact. Bringing crypto-assets into the regulatory tent could potentially catalyse innovations to serve the public better. Indeed, crypto-assets help point the way to the future of money in three respects:

Decentralised peer-to-peer interactions

Crypto-assets are part of a broader reorganisation of the economy and society into a series of distributed peer-to-peer connections across powerful networks.28 People are increasingly forming connections directly, instantaneously and openly, and this is revolutionising how they consume, work, and communicate.

Yet the financial system continues to be arranged around a series of hubs and spokes like banks and payments, clearing and settlement systems. Crypto-assets are an attempt to create the financial architecture for peer-to-peer transactions. Even if the current generation is not the answer, it is throwing down the gauntlet to the existing payment systems. These must now evolve to meet the demands of fully reliable, real-time, distributed transactions.

Underlying technologies offer to transform the efficiency, reliability and flexibility of payments.

The technologies underlying crypto-assets, particularly distributed ledger, can:

  • Increase the efficiency of managing data;
  • Improve resilience by eliminating central points of failure, as multiple parties will share replicated data and functionality;
  • Enhance transparency (and auditability) through the creation of instant, permanent and immutable records of transactions; and
  • Expand the use of straight-through processes, including with “smart contracts” that on receipt of new information, automatically update and if appropriate, pay.

These properties mean distributed ledger technology could transform everything from how people manage of their interactions with public agencies, including their tax and medical records, through to how businesses manage their supply chains.

A Central bank digital currency (CBDC) accessible to all.

Crypto-assets raise the obvious question about whether their infrastructure could be combined with the trust inherent in existing fiat currencies to create a central bank digital currency (CBDC).

Currently only banks can hold central bank money electronically in the form of a settlement account at the Bank of England. To be truly transformative a general purpose CBDC would open access to individuals and firms.

The Bank has an open mind about the eventual development of a CBDC and an active research programme dedicated to it. That said, given current technological shortcomings in distributed ledger technologies and the risks with offering central bank accounts for all, a true, widely available reliable CBDC does not appear to be a near-term prospect.

Moreover whether it is desirable depends on the answers to a series of big policy questions. While these are largely for another speech, I will note that a general purpose CBDC could mean a much greater role for central banks in the financial system. Central banks may find themselves disintermediating commercial banks in normal times and running the risk of destabilising flights to quality in times of stress.

There are also broader societal questions (that others would need to answer) such as how society balances privacy rights with the extent to which the information in a CBDC could be used to fight terrorism and economic crime.

Crypto Is Just A Side Show

While there may be risks to individual investors, a report from S&P Global Ratings “The Future Of Banking: Cryptocurrencies Will Need Some Rules To Change The Game”, say digital currencies such as Bitcoin do not have much capacity to meaningfully upset the financial services industry at large. This from InvestorDaily.

Despite the buzz surrounding the virtual currency, the report said: “As far as rated financial institutions’ risk exposure is concerned, however, S&P Global Ratings believes that it is much ado about nothing.

“In our opinion, in its current version, a cryptocurrency is a speculative instrument, and a collapse in its market value would be just a ripple across the financial services industry, still too small to disturb stability or affect the creditworthiness of banks we rate.”

And if crypto markets were to collapse, the brunt of the impact would not fall on major banks or its credit ratings but rather on retail investors, given they were the main contributors to activity in this market, with investors in the US, China, Japan and South Korea seemingly most exposed.

“We expect banks rated by S&P Global Ratings to be largely insulated, given that their direct or indirect exposure to cryptocurrencies appears to remain limited.”

The contribution of cryptocurrencies to global wealth was also described by the report as “limited”.

“For example, the global stock market capitalization reached approximately $80 trillion at year-end 2017, meaning that cryptocurrencies are still a marginal instrument.

“Therefore, we do not foresee any systemic wealth-effect risk.”

And even if cryptocurrencies were backed by central banks and became an asset class, the effect on firms in the financial system would be “gradual”.

“We believe that the future success of cryptocurrencies will largely depend on the coordinated approach of global regulators and policymakers to regulate and enhance market participants’ confidence in these instruments,” said S&P Global Ratings Financial Institutions Sector Lead Dr. Mohammed Damak.

Issues of consumer protection and illegal activity would need to be addressed by supranational bodies such as the G20, the report pointed out.

It also discussed the potential of the technology underpinning cryptocurrencies, blockchain, as a “positive disrupter for various financial value-chains”.

“If widely adopted, blockchain could have a meaningful and lasting impact on the celerity, traceability and cost of financial transactions.

“The financial market infrastructure segment might also see medium-term benefit from cryptocurrencies and blockchain through the launch of new income-generating products, such as futures or exchanges based on cryptocurrencies, or the replacement of current practices by new ones based on blockchain,” the report concluded.

CBA Blocks Credit Card Purchases of Bitcoin Etc.

CBA has said that due to the unregulated and highly volatile nature of virtual currencies, customers will no longer be able to use their CommBank credit cards to buy virtual currencies. This came into effect as of 14 February 2018.

Our customers can continue to buy and sell virtual currencies using other CommBank transaction accounts, and their debit cards.

We have made this decision because we believe virtual currencies do not meet a minimum standard of regulation, reliability, and reputation when compared to currencies that we offer to our customers. Given the dynamic, volatile nature of virtual currency markets, this position is regularly reviewed.

The restriction on credit card usage for virtual currencies will also apply to Bankwest credit cards.

Q&A

Why are we making this change?

  • Virtual currencies are unregulated and, as has been made clear in recent months, highly volatile. Effective 14 February, we will no longer authorise credit card purchases for these currencies.

How can I buy virtual currencies?

  • You can still buy and sell virtual currencies using other CommBank transaction accounts, and debit cards, as long as you comply with our terms and conditions and all relevant legal obligations.

I recently tried to purchase virtual currencies using my debit card and it was declined. Why did this happen?

  • We are aware of some instances where customers found that their attempts to buy or sell virtual currencies did not work. This can be due to a number of reasons, including:
    • The virtual currency exchange the customer is using has been blocked by our security systems. A currency exchange will be blocked if a number of the transactions it has previously processed are found to have been fraudulent, inconsistent with our policies or outside of the Group’s risk tolerance.
    • The payment method the customer uses is no longer accepted by the currency exchange. Some exchanges have recently stopped accepting certain payment methods.
    • The virtual currency exchange’s bank blocks the transaction for security reasons.

Can I still get credits from virtual currency exchanges paid to my credit card?

  • Yes, credits will continue to be authorised by the Bank onto credit cards.

How Australian Regulators Would Handle a Cryptocurrency Hack Like Coincheck

From The Conversation.

New risk rules for cryptocurrency exchanges will be put to the test with the latest hack on Japanese exchange Coincheck. Hackers stole US$660 million worth of NEM (its native cryptocurrency).

In the past eight years, more than a third of all cryptocurrency exchanges have been hacked. The total losses exceed US$1 billion. Because cryptocurrencies are almost untraceable, the rate of recovery after a hack is very low.

A number of countries (including Australia) have enacted legislative provisions to regulate the conduct of cryptocurrency exchanges. Regulators hope these will reduce the risk of attack and make operators more accountable for losses suffered by customers when an attack does occur.

These hacks don’t just expose gullible investors to risk. They mean funds could be flowing undetected into the hands of money launderers and terrorists.

While cryptocurrency exchanges may operate like banks, they are not regulated in the same way as banks. There is no depositor’s insurance and most exchanges remain unregulated.

Due to the almost anonymity afforded to users of Bitcoin and other cryptocurrencies, it is very difficult to trace missing funds. When a hack occurs, the attacker gains access to the virtual wallet operated by the exchange and then transfers the cryptocurrency to their own virtual wallet.

The Coincheck Hack

The Japanese exchange Coincheck hack dwarfs an earlier hack on Bitcoin exchange platform Mt Gox in 2014, which saw the theft of US$480 million worth of Bitcoin.

The operator of Mt Gox, Mark Karpeles was arrested and jailed for his role in the collapse. At the time Mt Gox was the world’s biggest Bitcoin exchange.

He was charged with falsifying records and embezzlement, but there were no laws in place at the time to regulate the Mt Gox exchange and its trade in Bitcoin.

So as to bring virtual currency exchanges in line with international anti-money laundering and counter-terrorism financing measures, Japanese lawmakers enacted the Amended Settlement Act. Under these new laws, all exchanges operating in Japan must register and comply with rules. These rules include knowing their customers, employing sufficient staff, keeping balance sheets, and (critically) must keep all customers’ deposits in “cold storage” (that is, on a computer hard drive that is not accessible via the internet).

These new laws mean that when an exchange is hacked or collapses, operators can be made liable for the way that they managed their customers’ funds. Japanese authorities are threatening to prosecute the operators of Coincheck for their failure to comply with the new laws.

In their online apology, the operators of Coincheck have admitted that the hacked deposits were in a “hot wallet” (connected to the internet instead of being offline) and that this was due to “staff shortages”. Both of these failures to comply will give the Japanese authorities good reason to prosecute.

Close scrutiny of the accounts will be likely to reveal other irregularities. But this is little comfort for Coincheck’s investors. Coincheck has promised to return 90% of the lost NEM to its customers, but has yet to say how or when this will happen.

How would Australia’s regulator react?

Japan is not alone in its scramble to regulate cryptocurrency exchanges. Just this month, the Australian government announced the Australian Transaction Reports and Analysis Centre (AUSTRAC) will have new powers to monitor Bitcoin and other cryptocurrencies. New legislation also forces cryptocurrency exchanges to disclose details of investors and transactions.

The new laws are part of the government’s efforts to combat money laundering and terrorism financing. Exchanges will be required to identify customers more stringently and report suspicious transactions.

All transactions of A$10,000 or more must reported to AUSTRAC. The report must include the names of the customers conducting the transaction, the names of the the recipient of the proceeds of the transaction, and how the transaction was effected.

Any failure by an operator to comply with these laws would result in heavy fines and possibly imprisonment. However, as breaches are almost impossible to detect, enforcement of these laws depends on honesty of the exchange.

One way to detect reportable transactions is to monitor the size of the deposits made into the exchange’s bank account. However, individuals can create fake trading accounts and money-laundering syndicates breakup deposits into smaller amounts, so as to avoid raising suspicion.

Complying with AUSTRAC’s new regulations will be expensive for exchanges. With Australia’s new data breach notification laws coming into effect next month, gathering and securing sensitive information about customers and their deposits will be more onerous than ever.

The problem that faces regulators and investors is that the cost of compliance acts as a deterrent to registration. And because registration requires compliance, exchanges need to outlay significant capital before they start to trade. The sheer size of Coincheck’s losses indicates it was a high-volume exchange and yet, at the time of the hack, its registration was still pending.

Traditionally, when a foreign exchange collapses and is unable to return customers’ deposits, the regulator might prosecute the directors for operating without a licence, failure to comply with financial services regulations, or for insolvent trading. Insolvent trading, for example, attracts both civil and criminal sanctions.

When a cryptocurrency exchange is hacked, the operators and their customers are all victims, but the operators will be made liable for those losses. Under Australia’s current laws, a major hack of a cryptocurrency exchange will be met with similar challenges as those facing the Japanese authorities in the wake of the Coincheck theft.

Any investigation of an exchange could involve the Australian Securities and Investments Commission (ASIC), the Australian Taxation Office (ATO) and AUSTRAC. The level of scrutiny that would follow, could reveal a multitude of sins, including some that are unrelated to the hack.

For example, ASIC has the power to prosecute for insolvent trading, operating a Ponzi Scheme and breaches of financial services legislation. The ATO could investigate whether GST was being paid on trades.

Frustratingly for the customers and investors, seeing the operators punished does not reimburse them for their financial losses. Repaying deposits after a hack depends on whether the operators remain in the jurisdiction and have any funds of their own.

Author: Philippa Ryan, Lecturer in Commercial Equity and Disruptive Technologies and the Law, University of Technology Sydney

On Cryptocurrencies And Investor Protection

The U.S. Securities and Exchange Commission Chairman Jay Clayton spoke at Stanford University’s Stanford Rock Center for Corporate Governance and discussed his first eight months at the SEC and his enforcement, examination, market, and capital formation priorities. His comments on cryptocurriences were revealing.

SEC is clearly monitoring Initial Coin Offers (ICO) , and is concerned about the lack of protection for investors. There is significant risk of price manipulation, yet the underlying blockchain technologies offer significant opportunity.

“What I see happening in the ICO market today is ‘let me have all of the disclosure freedom of a private placement and all of the secondary activity and ability to market this of a public offering. We decided in 1934: that [having both of these at once] led to a lot of problems.”

“I think we can say that wherever the date is, it’s passed,” he said when asked whether his commission has made ICO rules clear enough yet.

“There are a lot of protections in the way stock trades on exchanges… these platforms that you’re seeing where people are trading cryptocurrencies — there are none of these rules… The opportunity for price manipulation is at orders of magnitude.”

“Blockchain, distributed ledger tech — I don’t think any of us think it’s a fad… it clearly has a applications that are gonna add efficiencies.”

“If this market continues as it is, this will not be the last enforcement actions that we take,” he said of the three ICOs the S.E.C. has moved against so far.

“Some of the offerings that we’re seeing, if the lawyers are telling them it’s OK, they’re just plain wrong,” he said, adding that taking action against lawyers knowing giving advice to ICO issuers that is against current laws is a possibility.

Source: Axios

Cryptocurrencies Face Tighter AUSTRAC Rules

AUSTRAC has opened a draft consultation paper that lays out new anti-money laundering and counter-terrorism financing (AML/CTF) regulations, including new rules for digital currency providers.   The draft Rules propose adding a new Chapter 76 (Digital Currency Register to the Anti-Money Laundering and Counter-Terrorism Financing Amendment Act.

This via Investor Daily. Currently, the AML/CTF laws apply to authorised deposit-taking institutions (ADIs), banks, building societies, credit unions and other persons or entities specified by AUSTRAC, but the new amendments will seek to extend them to digital currency providers.

Law firm Dentons, which rebranded from Gadens Sydney in December 2016, has outlined the ways in which the AML/CTF laws might apply to digital currency providers.

“Digital currency providers will soon be required to adhere to the AML/CTF standards required for remittance sector providers,” said Dentons.

Providers would be required to adopt and maintain an AML/CTF program, conduct “thorough” identification and due diligence of customers, report on suspicious matters and threshold transactions, and retain the required records according to the AML/CTF regime, according to the note.

“The draft rules mirror the rules as they currently apply to the remittance sector,” it said.

“Providers will be required to register with AUSTRAC under a regime similar to the current registers for the remittance industry.”

Furthermore, when reporting on suspicious transactions, providers will have to provide additional information where the transfer would involve digital currency.

This would include the code of the digital currency as well as the number of digital currency units, the equivalent amount in Australian dollars, a description of the digital currency including details of the backing asset or thing, the IP address of the beneficiary and/or payee, the social media identifiers of the beneficiary and/or payee, the unique identifiers of the beneficiary/payee’s digital currency wallet(s), and the unique device identifiers of the beneficiary and/or payee.

“If you are a digital currency provider, it is time for you to start thinking about how you will manage your new obligations under the AML/CTF regime,” the note said.

“This most importantly includes drafting and maintaining an AML/CTF program and KYC [Know Your Client] policy, in addition to systems and procedures which will identity any AML and CTF risks in your business.”

The consultation period will close 13 February 2018, and the draft rules are expected to come into effect in April 2018.

Why Bitcoin is taken more seriously than Dogecoin

From The Conversation.

As Bitcoin loses value, it may seem like it’s just as useful as the cryptocurrency invented for a joke – Dogecoin.

But there are genuine differences between these cryptocurrencies, and it’s not just because one is “much currency, such volatility”.

There are 1,448 cryptocurrencies around the world, by some counts. For every Bitcoin you have a programmable coin like Ethereum, or a coin that acts like a token for specific services, like Augur.

Some of these coins earn better reputations because of their usefulness, the people who made them, or the tech itself. They are not all taken seriously by investors, researchers and users.

The developers behind these cryptocurrencies are also important as they convince other people to adopt them and write new code for the technology to evolve. This new tech attracts new users into the system.

Different functions

Cryptocurrencies can be divided into several types. Cryptocurrencies like Bitcoin, Litecoin, and Dogecoin only provide basic functions such as transferring value from one party to another.

The next category are smart contract cryptocurrencies like Ethereum, Cardano, NEO, and Waves. These cryptocurrencies can be programmed, and so can become the basis for applications like games and digital markets.

The third type are cryptocurrencies designed to preserve your privacy like Monero and Zcash. These claim to be “untraceable” although transaction records are still available.

Then there are tokens, which are built with smart contracts to serve many purposes. They are often sold to raise funds to build services, and used as tickets for the services (such as Augur and Power Ledger).

Technological differences

The differing technologies in these cryptocurrencies mean that certain coins have more potential than others.

IOTA is used for “Internet of Things” devices (such as a smart kettle). But it has a special kind of blockchain (the technology that tracks transactions) and so can achieve much higher speeds of transaction and quicker confirmation of trades than Bitcoin.

Others like Nxt, and Ardor have built-in features that let users to do other things than just sending coins, such as creating marketplaces and even messaging.

People use cryptocurrencies like Zcash and Monero to settle transactions with “zero-knowledge”. This means the cryptocurrencies hide the information of the real payers and payees, and even the amount of coins transacted.

Monero has largely replaced the use of Bitcoin in exchanges on the dark web.

And smart contracts built with cryptocurrencies like Ethereum have countless potential usecases, from property transactions to digital asset management and fundraising.

The technology also means that one cryptocurrency might use significantly less electricity than another.

Limitations

The major cryptocurrencies, like Bitcoin and Ethereum, are slow because of their inability to handle massive amount of data being sent by users. The technology used to secure the data are expensive and inefficient.

Bitcoin can only handle a maximum of seven transactions per second; Ethereum can handle 15 transactions per second. Compare this with the VISA payment system, which can process up to 56,000 transactions per second.

But new entrants, such as Red Belly from the University of Sydney, might be able to solve this problem, handling up to 660,000 transactions per second.

Smart contracts can also run into problems if they contain bugs. When a decentralised organisation built on Ethereum was hacked in 2016, US$50 million in Ether was stolen.

When something achieves the success of Bitcoin we’re bound to see competitors entering the market, hoping to grab a share.

This explains the explosion in cryptocurrencies since the Bitcoin source code was released under an open licence. Anyone can copy, modify, and release a modified version of Bitcoin.

By looking at the current trend, we will see more cryptocoins in the near future.

But as we can see, “cryptocurrency” is a term that encompasses a wide range of different technologies, communities and uses. It’s all of these factors that inform whether users, investors, developers and researchers take a coin seriously.

Author: Dimaz Wijaya  PhD Student, Monash University

RBNZ Looks At Crypto-currencies

The Reserve Bank in New Zealand has released an excellent Analytical Note on Crypto-currencies “Crypto-currencies – An introduction to not-so-funny moneys“. It is one of the best I have read, so far!

The paper introduces the distributed ledger technology of crypto-currencies. They aim to increase public understanding of these technologies, highlight some of the risks involved in using crypto-currencies, and discuss some of the potential implications of these technologies for consumers, financial systems, monetary policy and financial regulation.

Crypto-currencies have no physical existence, but are best thought of as electronic accounting systems that keep track of people’s transactions and hence remaining purchasing power. Cryptocurrencies are typically decentralised, with no central authority responsible for maintaining the ledger and no central authority responsible for maintaining the code used to implement the ledger system, unlike the ledgers maintained by commercial banks for example. As crypto-currencies are denominated in their own unit of account, they are like foreign currencies relative to traditional fiat currencies, such as dollars and pounds.

They conclude that Crypto-currencies offer some distinct features, such as quicker cross-border transactions, possibly lower transaction fees, pseudo-anonymity, and transaction irreversibility. These features help to explain the growing demand for crypto-currencies, even though they fail to satisfy many of the basic functions of money.

Most crypto-currency accounts lie dormant and many of the active accounts are used only for online gambling or speculative purposes. Perceptions of anonymity have also created a demand for such currencies to facilitate illegal transactions, but the anonymity embodied in crypto-currencies has been over-stated. There have been a significant number of crypto-currency prosecutions in relation to money laundering and other crimes, illustrating that there is no guarantee of anonymity.

While crypto-currencies are growing in popularity, they currently facilitate a very small proportion of transactions. Because crypto-currencies intermediate such a small proportion of transactions, central banks do not presently view crypto-currencies as a material threat.Since crypto-currencies are not well-adapted to the provision of borrowing and lending, we also foresee an enduring role for traditional financial intermediaries.

Crypto-currencies and blockchain technology could well become an important part of global payment systems, but wide-scale adoption will depend on competition from alternative transaction technologies, and on regulation to provide users with security. Crypto-currencies will also need to address technical, scalability issues if they wish to intermediate the volume of transactions undertaken globally.

We conclude that all crypto-currencies are experimental in nature and users face material risks by transacting with them or by holding significant crypto-currency balances. Individual cryptoReserve Bank of New Zealand currencies may be more Betamax than VHS, and more MySpace than Facebook. Even if some of the constructs are enduring, such as distributed ledgers and the use of cryptography, specific crypto-currencies may be supplanted by competing transaction technologies. We close with a Latin expression much-beloved by contract lawyers and economists alike – caveat emptor – buyer beware.

The Analytical Note series encompasses a range of types of background papers prepared by Reserve Bank staff. Unless otherwise stated, views expressed are those of the authors, and do not necessarily represent the views of the Reserve Bank