Infosys Strategic Vision
Are virtual currencies a mirage?
The very advantages touted as benefits by virtual currency supporters, are seen as disadvantages by its critics. The disadvantages attributed to virtual currencies include:
Substantial Volatility: Virtual currencies are subject to significant fluctuation. The total value of virtual currencies in circulation and the number of merchants or businesses using them are still small. Hence even a small activity or trade can affect the price movement, which makes virtual currencies highly volatile. There have been instances of the Bitcoin exchange rate falling alarmingly – by more than 50% – in one day.
Security Risk: Critics of virtual currency pinpoint that since the identities of
parties involved in a transaction are not recognizable and transactions are not traceable, they can be misused for unlawful or criminal activities like:
- Money laundering or terror financing
Virtual currency transactions are vulnerable to money laundering/terror financing risks, thanks to payer and payee anonymity compounded by the lack of an authorized monitoring authority. This increases the possibility of virtual currencies being used for suspicious activities. For instance, Liberty Reserve‘s CTO was operating an unlicensed money transmitting business which processed more than $16 billion through the firm’s digital currency system. He leveraged his technical expertise and created a virtual currency business which was used extensively by criminals across the world.
- Hacking or fraud/theft
Virtual currencies definitely run the risk of being targeted by hackers using various methods to steal Bitcoins and other virtual currencies from user accounts. Over the past few years, there have been quite a few cases of hacking of virtual currency accounts. For instance, in March 2014, 650,000 Bitcoins were looted from Mt. Gox, and as recently as January 2015, hackers looted around 19,000 Bitcoins worth about $5 million from the Bitstamp exchange.
Risk of Rejection: Virtual currencies face the risk of rejection as they are yet to be recognized globally by users, merchants, regulators or governments. Many governments and regulators have issued sufficient risk warnings – including on liquidity risk – on virtual currency usage, or like the Government of China, banned them from trading.
Absence of regulation entails risk for consumers: Virtual currencies are largely unregulated. Currently, there is no pertinent regulation or central supervising authority for virtual currencies, nor government/central bank protection for virtual currency accounts, leaving users with no recourse in case of fraud.
In spite of all these drawbacks, all is not lost since many regulators and governments are looking into virtual currencies and it is widely believed that regulations will develop soon.
Virtual currency has raised unique challenges, and policymakers globally are focusing on developing an appropriate regulatory regime for the same. To start with:
- The New York Department of Financial Services (DFS) has proposed BitLicense, an extensive regulatory framework that mandates a license for companies that deal with digital currencies.
- The Monetary Authority of Singapore (MAS) will regulate virtual currency intermediaries in a move to combat risks from terrorism-related financing and money-laundering.
- Canada has also moved on the path to Bitcoin regulation, with a virtual currency provision reported in the 2014 Budget Implementation Bill.
- The UK Government has been a bit slow to respond, but is looking into how virtual currencies could or should be regulated and their associated risks, while at the same time analyzing the virtual currencies which might bring innovation in the UK’s financial services sector.
Considering the upsurge in the usage of virtual currencies, regulators and policymakers across the globe are looking to develop a comprehensive, consistent and appropriate virtual currency regulatory model. January 2015 will be marked in history as the time when the first licensed Bitcoin exchange opened in the United States.
Financial services industry keeps
a close watch on virtual currency development
As virtual currencies gain both popularity and controversy, banks and financial services firms are monitoring the steps taken by the issuers of virtual currency as well as the guidelines of various governments and policymakers to see what opportunity it holds for them.
Global banks like Bank of America, JPMC, Citi, Wells Fargo, etc. have published reports on how Bitcoin could impact the global payment industry. Banks are also keen to understand whether virtual currency can become an investment opportunity like Commodities, Exchange Traded Funds, or Derivatives. Although banks did open accounts for firms accepting Bitcoins or any other virtual currency, but they were forced by regulators to close Bitcoin-related accounts. For instance, U.S. officials ordered a Wells Fargo account used by Mt. Gox to be shut down.
Banks and financial services firms are still in observer mode on virtual currencies, but analysts do predict that virtual currencies, specifically Bitcoin could emerge as a serious competitor to banks.
Adoption of virtual currencies by merchants will rise as they realize good savings, and consumers will pick virtual currencies once they see their myriad benefits. Banks, regulators and governments are also waking up and paying attention to the virtual currency concept. Regulators and governments need to further step-up their efforts to create new regulatory regimes for virtual currencies. It is equally vital for banks and financial services firms to study this space and see how it can impact the payment industry, look at engaging with interested parties, and launch new products and services. Given the benefits and challenges of virtual currencies, it’s too early to write them off or say how quickly they will attract mainstream adoption. The ideal scenario is one of harmonious co-existence virtual and other currencies, where the limitations of one become the strength of the other. For instance, if there is no anonymity in virtual currency transactions, the chances of money laundering, terror financing and volatility reduce. The current banking system can support this payment method by servicing the businesses dealing in virtual currencies. Virtual currencies are definitely at a crossroads and the road ahead is going to be a fascinating one. Only time will tell whether virtual currencies are gold 2.0 or just a mirage.