California simply repealed the state’s prohibition on “anything but the lawful money of the U.S.,” but in Europe, bitcoin’s acceptance and integration is not so simple.
LOS ANGELES — In the United States, bitcoin and other virtual currencies have been enjoying a period of relatively smooth sailing as they voyage toward acceptance as a legitimate medium of exchange.
The U.S. Federal Election Commission recently approved the use of bitcoin to make financial contributions to political candidates, and California became the first state in the nation to allow the circulation of virtual currencies.
While concerns remain that bitcoin could facilitate money laundering and sales of drugs and other illegal goods, more than $300 million has been pumped into bitcoin ventures over the past 18 months, including $200 million in 2014 alone.
But in Europe, bitcoin’s move toward legitimacy has hit a snag. In a scathing report published earlier this month, Europe’s leading banking regulator suggested there were “some potential benefits from virtual currencies, such as faster and cheaper transactions,” but the “risks outweigh the benefits.”
The European Banking Authority had previously warned consumers about the risks of virtual currencies. The new report, which serves as an advisory opinion for the 28 member states of the European Union, discusses whether virtual currencies should or can be regulated.
“[A] regulatory approach to address [the] risks would require a substantial body of regulation,” the authority said.
Since no such regime is in place now, it continued, “some of the more pressing risks will need to be mitigated in other ways. As an immediate response, the EBA therefore advises national supervisory authorities to discourage credit institutions, payment institutions and e-money institutions from buying, holding, or selling virtual currencies.”
The Bitcoin Foundation, the top trade group for the virtual currency, has blasted the report, saying the European authority’s approach, if adopted, “would come at a significant cost to the people of Europe, who would wait even longer to enjoy the benefits of digital currencies like Bitcoin.”
Jim Harper, the foundation’s global policy counsel, also questioned the methodology of the report and suggested in a blog post that the EU’s members disregard the advice of the EU bureaucrats in Brussels and “continue to work in a decentralized fashion on getting the benefits of Bitcoin while controlling the risks.”
But given the increased scrutiny from regulators since the implosion of Mt. Gox, once the world’s largest bitcoin exchange, earlier this year, it would not be surprising if EU members proceed cautiously.
“Regulators have become alert to the potential for fraud and disruption,” Richard Reid, a research fellow at the University of Dundee, Scotland, told Bloomberg News. “Such attention from regulators is bound to curb the growth of markets such as Bitcoin.”
Bitcoin has been on the European Banking Authority’s radar for less than a year. Last fall, the new report says, regulators noticed increased virtual currency activity across EU states, “with a growing number of VC schemes being launched, an increasing number of merchants, and a rising number of individuals using VCs, and Bitcoins in particular, not only as an investment but as a means of paying for goods and services.”
After analyzing the potential risks to individuals from using virtual currencies, the authority issued a public warning in December, saying consumers risked losing their money by “buying, holding or trading” them.
“Currently, no specific regulatory protections exist in the EU that would protect consumers from financial losses if a platform that exchanges or holds virtual currencies fails or goes out of business,” the warning said.
At that time, the authority did not propose any regulatory solutions. In the new report, it notes that “several of the risks that had been highlighted in the warning” materialized when the Mt. Gox exchange “had to close due to mismanagement, cyber-attacks and theft of a substantial amount of Bitcoins.”
The report identifies no fewer than 70 risks related to virtual currencies, dividing them into high-, medium- and low-priority. The high-priority risks for users include suffering a loss when an exchange is fraudulent or as a result of virtual currency price manipulation, and losing virtual currency units through e-wallet theft or computer hacking. The integrity of the financial system, according to the report, is at high risk from money laundering and the use of virtual currency remittance systems and accounts by criminals or terrorists.
“[A]nyone can create a VC, including criminals and terrorists,” the report warned.
To address the risks comprehensively, the authority said, would “require a substantial, and in some aspects unprecedented and untested, body of regulation, as well as resources to enforce the regulation.” And since such a comprehensive system “may take considerable time to develop, fine-tune and implement,” the immediate regulatory response for the short term should be for national authorities to “shield” regulated financial services from virtual currencies.
Deter individual users
A British technology and payments law specialist has suggested that virtual currencies could be regulated in Europe under the proposed changes to the EU’s Payment Services Directive.
“The European Commission’s PSD2 proposals would, if introduced as drafted, apply some of the rules where payment services are provided ‘in any currency,’” Angus McFadyen told the Out-Law.com website of the law firm Pinsent Masons. “This wording would seemingly allow for the regime to be applied to Bitcoin if governments and regulators so wish.”
In California, lawmakers legalized Bitcoin simply by repealing the state’s prohibition on the issuance and use of “anything but the lawful money of the United States.”
But the European Banking Authority was noncommittal in its report about how to proceed with regulation. “It would be for EU legislators to form a view on whether [a regulatory] approach can be established within the scope of any of the existing EU directives or regulations, or whether a separate legal initiative would need to be started,” it said.
Simon Dixon, a director of the U.K. Digital Currency Association, told Bloomberg that the report was not “very helpful” and may deter individual users of virtual currencies.
“Banks are not engaging with digital currencies yet as it is a person-to-person network that operates outside of banking,” he said. “The more likely result of the announcement is to scare people from using digital currencies rather than banks.”
At the Bitcoin Foundation, global policy counsel Harper said a better approach would have been to “examine how risks that may exist in the digital currency world are already mitigated in the traditional financial world. Capital requirements, for example … should be applied identically to providers of identical financial services, whether in traditional or digital form.”
For the most part, Harper noted, digital currencies have not created new economic functions, which means that “in most jurisdictions around the world, including in Europe, questions around digital currency are being answered by applying existing laws that govern existing economic functions. It doesn’t matter whether financial services are provided using digital or traditional currency.”