The European Banking Authority has done it again. It wasn’t exactly ahead of the curve when, in September 2013, virtual currencies (VC) “emerged” on its “radar as one of the many innovations to monitor.” At the time, it marveled at the ability to transfer money peer-to-peer without an intermediary, such as a bank. But this being a “payment service,” it fell into its bailiwick, and so it “began assessing the phenomenon.” Three months after that propitious moment, it issued a public warning,
… making consumers aware that they may lose their money on an exchange, that their VC units may be stolen from their digital wallets, that they are not protected when using VCs as a means of payment, that the value of VCs has been very volatile, that transactions in VCs may be misused for criminal activities, and that individuals holding VCs may be subject to unforeseen tax liabilities.
And now it released its follow-up tome, a 46-page “Opinion” on virtual currencies, that it put together in cooperation with the ECB and the European Securities and Markets Authority. In it, the EBA validates its initial warning by referring – not without some gloating – to Mt. Cox, the exchange that had handled the majority of all Bitcoin transactions but has since collapsed into bankruptcy after hundreds of millions of dollars of its users’ money had simply evaporated.
The EBA already earned kudos from European governments in July 2011 when their 100 most cherished and coddled banks passed with flying colors the EBA’s stringent “stress tests.” In October that year, Dexia, a Belgian-French megabank that had been bailed out in 2008, the 12th safest bank of those 100, re-collapsed. A year later, Spanish banks teetered and got bailed out. The third-largest Italian bank, Monte Paschi, collapsed and was bailed out. In February 2013, SNS Reaal, fourth largest bank in the Netherlands, cratered and was bailed out. Cypriot banks went up in smoke. Later in 2013, Slovenian banks were bailed out. It was a busy year! But you wouldn’t know it from the soaring stock markets. Now Austrian banks are cratering and bailouts are getting ever more expensive….
Ongoing banking debacles of this type have led the EU to do what the US, Japan, and other countries have already done – shuffle more regulatory and bailout power to their central bank which can bail out banks quietly by handing them free money. With dubious results.
Under the nimbus of its illustrious performance record, the EBA has waded deeper into the virtual currency debate with its “Opinion” that reduces the world of money to just two abbreviations:
VC (virtual currency) and FC (fiat currency).
After a chapter on the definition of VCs, the report offers a brief chapter on “potential benefits” – faster and cheaper transactions, for example. But the largest chapter is on the risks – over 70 of them. Some “are similar, if not identical, to” the risks associated with conventional financial services. Others are unique features of VCs. They impact every entity that deals with VCs:
- Exchanges, trade platforms, e-wallet service providers, merchants, etc.
- Financial integrity (money laundering, terrorist financing, and financial crime)
- Payment systems and payment service providers in FCs
- Regulatory authorities (“reputational risk” … wait, was the EBA talking about itself?)
Why so many risks? A “virtual currency scheme can be created – and its function subsequently changed – by anyone, and in the case of decentralized schemes, such as Bitcoins, by anyone with a sufficient share of computational power, and anonymously so.” Furthermore, “individuals validating transactions (so-called miners) can also remain anonymous, and so can payers and payees; IT security cannot be guaranteed; and the financial viability of some market participants remains uncertain.”
It’s a minefield shrouded in dense fog.
Users can get wiped out in a variety of creative ways, for instance, if an exchange acts fraudulently, or when the exchange suddenly doesn’t exchange VC against FC (as “anyone can set up and call themselves an exchange”).
Users can get hurt when the value of a VC plunges due to “significant or unexpected exchange rate fluctuations.”
Users can get wiped out “due to changes made to the VC protocol or other key components” since “anyone can anonymously create (and subsequently change the functioning of) a VC scheme.” There are no independent standards governing the software protocol of the VC scheme. It can be changed when a majority of miners agree. Thus errors may be introduced accidentally. Or “miners may not necessarily act in good faith.” And POOF, the FC and the VC are both gone (“high priority” risk).
Users can get wiped out when the e-wallet is lost through “theft, hacking or soft/hardware malfunction, or when the exchange is hacked.” Unlike a bank, which has to refund money that gets siphoned out of your account, no one is going to give a hoot if your money evaporates from your e-wallet.
You get the drift.
Over 70 of these risks, some more gut-wrenching than others, for everyone, not just users (complete list). The only way to make that minefield less hazardous for all concerned, the EBA proposes a “regulatory approach for the long term.” It wants “transparent regulations,” a whole slew of them. It wants them to be part of a “global regulatory approach.” And they would bring VCs closer to the much maligned instruments that they’re supposed to replace, namely the FCs.
But since developing such “a substantial body of regulation” on a European or global scale is “highly resource-intensive” and “may take considerable time to develop, fine-tune, and implement,” and given the high risks involved in the current state of VCs, the EBA has a solution for all involved: stay away from them!
For the entities that supervise the European banks – toppling or not – and that bail them out, it has a particular message: national supervisory authorities should “discourage credit institutions, payment institutions, and e-money institutions from buying, holding, or selling VCs, thereby ‘shielding’ regulated financial services from VCs.”
Which leaves us with a bitter aftertaste:
Future regulations would be designed to shield banks from the presumed ravages of VCs; but who the heck is going to shield us from the ravages of FCs? The EBA shrouds itself in silence on that topic as central banks are busily whittling down the value of FCs in their all-out effort to create their favorite work of art: asset bubbles.
Even megabanks are worried. “Asset prices have reached stunning levels, obviously out of line with ‘fundamentals,’ UBS writes. The “most dangerous” are housing bubbles; when they burst, they “wreck whole economies.” Read…. The Secret Reason The Fed Is ‘Tolerating’ Bubbles