European Central Bank warns of virtual currency risks

The growth of virtual currency schemes such as Bitcoin and Second Life's Linden Dollars, could have a negative reputational impact on central banks due to their inherent instability, warns the European Central Bank.

In a preliminary impact assessment of the proliferation of virtual currency schemes, the ECB notes that while most such schemes are too small to jeopardise price or financial stability, they do represent a challenge to public authorities due to the legal uncertainty surrounding their status and their adoption by criminals and money launderers.

Lack of overarching regulation is a key theme picked up by the ECB, which expresses concern about the level of credit, liquidity, operational and legal risks imposed upon users.

The ECB argues that schemes like Bitcoin and Linden Dollars "do indeed fall within central banke' responsibility" as a result of characteristics shared with payment systems.

In particular, the ECB is worried that the growth of such schemes could have a negative impact on the reputation of central banks.

"In the event that an incident attracts press coverage...the public may perceive the incident as being caused, in part, by a central bank not doing its job properly<" states the report.

The ECB recommends that regulators pay closer attention to ongoing developments in technology innovation and currency creation to anticipate future threats.

"Owing to the small size of virtual currency schemes, these risks do not affect anyone other than users of the schemes," the report concludes. "This assessment could change if usage increases significantly, for example if it were boosted by innovations which are currently being developed or offered. As a consequence, it is recommended that developments are regularly examined in order to reassess the risks."

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Comments: (6)

Joss Wilbraham - WMG Consultants Ltd. - Oxford 30 October, 2012, 13:06

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This is a bit rich coming from the ECB! Sure there are risks associated with these new, virtual currencies but in aggregate, no more risk than from the multitude of Central Banks that seem intent on destroying the real value of the world's main currencies through a stealth tax otherwise known as inflation. The alternatives can't arrive quick enough! Let's just hope that that the same Central Banks don't regulate them out of existence in order to protect their own money printing schemes.

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Gary Wright 30 October, 2012, 13:34

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As long as they are regulated as CBs and there is control of the currency that fits within the existing economic mechanism i can no problem However the virtual nature of this curency could encourage the very worst parts of society that would use it for criminal ends

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A Finextra member 30 October, 2012, 17:06

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At Javelin we've published two research reports on virtual currencies, and the surprisingly sparse attention they recieved shows that the payments and banking industry is failing to look far enough ahead. Our conclusion from research of consumers combined with review of the industry triad of gaming, banking and payments found that virtual currency is surprisingly advanced for something that has escaped the spotlight. Because some virtual currencies can be converted to traditional currency right now, this represents an unregulated area with potential significant mainstream impact. Kudos to The European Central Bank for focusing on it, and here's hoping others follow their lead.

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Frank Mastrangelo - Sapere Advisory - Glenmoore 30 October, 2012, 17:51

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Gary - are you suggesting that currency regulated CBs is not utlized for criminal ends?

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A Finextra member 31 October, 2012, 09:08

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I think there's a great danger that increased centralised oversight of these virtual currencies actually increases economic exposure by legitimising them - and the fact that these are decentralised currencies created by proprietary systems mean that there is a general (and well placed) consumer distrust of these products . As soon as they start being legitimised as regulated products, a more generalised uptake is encouraged over the risk aware niche markets which currently use them. If this happens, then the fallout of any serious currency failure or breach will be much larger, and the impact will be felt more heavily by those who do not understand the instruments.

There is a larger problem on the regulation of currencies which have no geographical base, but the main stumbling block here is the technological stability of the currency, not really it’s geographic regulation or its portability.

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Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 01 November, 2012, 10:02

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My hitherto favorable views about virtual currency recently underwent a 180-degree turnaround when I switched on my B&N Nook Color a couple of days ago and found that several eBooks suddenly opened up to blank screens. In this case, a little bit of Googling followed by a hard reset solved the problem. I shudder to think what'd happen if I'm struck with a similar problem with my virtual currency. To recover some of my lost money, I'd have to first go bankrupt (equivalent of losing all content after a "hard reset") under the hope that all my money comes back. I don't know how many people will feel comfortable fooling around so much with money - certainly, I won't. Therefore, I tend to agree with @FinextraM's point about "technological stability" being a major stumbling block for the mainstream adoption of virtual currency. Before someone jumps in to point out that my entire bank balance is held by my bank electronically, it might be virtual for the bank but, as far the relationship between me and my bank is concerned, it's real money. The same is not true when I hold my money as virtual currency myself.