The European Banking Authority (EBA) has weighed in on the use of virtual currency, and recommends that Bitcoin be avoided until regulatory systems are put into place.
A document prepared by the EBA for address to the European Commission and European Parliament sets out the regulatory body's opinion (.PDF) on virtual currency — such as Bitcoin, Litecoin and Peercoin — and warns financial institutions to keep their distance until the industry is regulated.
The EBA is responsible for monitoring new and existing financial activities in the European region, with a view to promote the safety of financial markets and issue guidelines and recommendations to keep business flowing. The EBA did not take an interest in virtual currency until September last year, and issued a warning in December outlining the risks of investing in Bitcoin.
The EU financial and banking watchdog says that a "thorough assessment" of virtual currency (VC) needs to be undertaken, and the main question is whether cryptocurrency can, or should, be regulated.
The attraction of virtual currency is that the commodity is not regulated by a central bank or public body, and the currency can be stored on or offline through an eWallet. While some holders "mine" virtual currency through the Web, the most popular cryptocurrency is Bitcoin, and the majority of trade is undertaken through exchange posts such as the now defunct Mt. Gox — which filed for bankruptcy following the theft of its Bitcoin reserves.
Bitcoin's reputation was tarnished after the closure of the underground marketplace Silk Road, where many illegal trades, such as in guns and drugs, were undertaken using the cryptocurrency. Despite some belief that Bitcoin is only good for making transactions more difficult to track, it may also be used to shore up traditional currency where the economy is weak or developing — as the buyer of 30,000 confiscated Bitcoin from the Silk Road raid believes.
The EBA acknowledges that cryptocurrency has its uses, such as reduced transaction costs, faster transaction speed and financial inclusion, but says these benefits are "less relevant" in the European Union, "due to the existing and pending EU regulations and directives" that are explicitly aimed in improving these financial elements of the market.
In contrast, the EBA says it recognizes over 70 risks associated with the cryptocurrency trade; including risks to users, risks to non-market participants, risks to financial integrity and the potential increase of money laundering and financial crime. In addition, the watchdog says that traditional payment systems can be threatened by virtual currency, and regulatory authorities are also placed at risk.
A number of other factors also come into play, according to the EBA. The EBA says:
The risks include the fact that a VC scheme can be created, and then its function subsequently changed, by anyone, and in the case of decentralised schemes, such as Bitcoins, by anyone with a sufficient share of computational power; that payer and payee can remain anonymous; that VC schemes do not respect jurisdictional boundaries and may therefore undermine financial sanctions and seizure of assets; and that market participants lack sound corporate governance arrangements.
The EBA says that regulation is necessary, but a full, overarching regulatory body would be extremely expensive and complex — as well as take "considerable time to develop, fine-tune and implement" — and so short-term measures would currently be a better option for mitigating immediate risks.
The EBA recommended that national supervisory authorities discourage credit institutions, payment institutions and e-money institutions from buying, holding or selling VCs until regulation is pushed through. In addition, in order to "shield" traditional financial institutions, the EBA says that EU legislators should consider declaring VC traders, such as exchanges, "obliged entities" under the EU Anti-Money Laundering Directive.
This would make cryptocurrency trading posts and businesses that trade in VCs subject to anti-money laundering and counter terrorist financing requirements. Until this takes place, the financial watchdog says that financial institutions should not hold, trade or buy virtual currencies. However, current account relationships with businesses in the VC field should be allowed to continue.
Speaking to the Financial Times, Matthias Kroner, chief executive of Fidor Bank in Germany said:
'Constructive' regulation would be a bonus for the sector. An unregulated market without any minimum standards [...] would create a dangerous environment for the user.
While scattered businesses in the West have begun to experiment with Bitcoin, whether or not to view VCs as a legitimate currency is still under serious debate. Last year, China's central bank banned financial firms and account holders from handling transactions within the industry.