On 13 December 2013, the European Banking Authority warned the public about the risks of buying, holding and trading virtual currencies: “consumers are not protected through regulation when using virtual currencies … and may be at risk of losing their money”. The EBA added that, “the ‘digital wallets’ containing consumers’ virtual currency … are not impervious to hackers. Cases have been reported of consumers losing significant amounts of virtual currency, with little prospect of having it returned. Also, when using virtual currency for commercial transactions, consumers are not protected by any refund rights under EU law”.
On 4 July 2014, the EBA issued a formal Opinion which:
- Identified 70 virtual currency related risks;
- Argued that, in the near-term:
- The European legislature should consider imposing Anti-Money Laundering rules on virtual currency exchanges; and
- European regulators should encourage banks, payment service providers and e-money issuers not to buy, hold or sell virtual currencies; and
- Invited the European legislature to develop a comprehensive set of European regulations to mitigate the risks associated with virtual currencies over the medium and longer term.
The UK has five potential virtual currency regulators: the Bank of England, the Prudential Regulation Authority, the Financial Conduct Authority, the Payment Systems Regulator, and HM Treasury. But:
- The Bank does not believe that “Digital currencies … pose a material risk to monetary or financial stability in the United Kingdom”, so it’s not proposing to do anything for now;
- The PRA has not shown any interest in virtual currencies – a position that might be reasonable (it works closely with the Bank of England), but is still surprising: the EBA expressly invited it (as a European regulator) to encourage the banks it regulates not to buy, hold or sell virtual currencies, some are already doing so, and it seems to have chosen not to intervene (at least for now);
- Although the FCA republished the EBA’s warning, and it’s demonstrated an interest in FinTech (for example, it’s established an “Innovation Hub” to help innovators develop new FinTech products and services in a way that’s FCA rule compliant), it hasn’t said or done anything so far which suggests that it will seek to persuade e-money issuers not to buy, hold or sell virtual currencies; nor has it said anything which suggests that it wants to regulate virtual currencies;
- Whilst the PSR has said that it will regulate the largest and most important payment systems, including BACS, CHAPS, and LINK, it hasn’t said anything about virtual, digital or crypto-currencies so far; and
- Although HM Treasury has published a “Digital currencies: call for information”, which closed in early December 2014, and is part of “a major programme of work looking into digital currencies … with a particular focus on whether they should be regulated”, it hasn’t said when or how it will respond to the feedback it has received (if at all).
At first blush, this seems to suggest that every European virtual currency using consumer is at risk, and that UK consumers may be left at risk for longer than those in some other European countries. If that’s right, it may also be regarded as strange: the UK Digital Currency Association has expressly invited HM Treasury to develop and impose a light touch regulatory regime on the virtual currency sector, because that would provide certainty and instil confidence in virtual currencies, without stifling innovation. From a regulator’s perspective, that looks like an “open goal”, so what’s not to like?
Unfortunately, the answer is “plenty”. The regulatory issues are hideously complex, so it could easily take several years to develop an appropriate regime. It would be all too easy (for example) to regulate virtual currency exchanges and drive virtual currency business into the unregulated sector or off-shore. The law of unintended consequences probably also means that innovation will be stifled, however much the opposite effect is desired (the UK’s recently regulated crowdfunding and peer-to-peer lending sector provides useful evidence of this). A “light touch regime” could also be a problem in and of itself. “Light touch” still has unfortunate undertones when heard by the British tin ear; and, if anything goes wrong, consumers will be scandalised by how little the government and “its regulators” did to protect them, especially when the EBA has so clearly identified so many risks, and invited them to act.
So: will the UK and Europe begin to regulate virtual currencies in a substantial way in 2015? The answer in each case is “almost certainly not”.
Recognising the complexity of the issues, the EBA has stopped short of using its formal recommendation power to (1) effectively compel the European Member States to impose their money laundering rules on virtual currency exchanges; and (2) pro-actively “discourage” banks, payment service providers and e-money issuers from buying, holding and selling virtual currencies. It is therefore up to the European Member States and the European legislature to decide what (if anything) to do, when there are plenty of other issues clamouring for their attention.
Whilst the UK regulatory instinct is likely to be to regulate (if it can), regulation will be difficult to justify at this stage:
- On cost benefit grounds – the Bank of England believes that Bitcoin is the most popular virtual currency in the UK, by far. Even so, there are only £60 million worth of Bitcoins circulating in the UK economy at present (this represents less than 0.1% of the Sterling notes and coins in issue, and less than 0.003% of (so called) broad money); only 20,000 individuals / companies are using Bitcoin at present, and only 300 Bitcoin transactions occur each day; and
- Because regulation could easily undermine the Treasury’s very determined FinTech innovation agenda.
For these reasons, and others, the UK is therefore unlikely to want to begin to regulate virtual currencies in a material way in 2015.
Even so, we should probably expect some “tinkering around the edges”. Some examples: the regulators may want look for a way to apply the UK’s anti-money laundering rules to virtual currency exchanges (if they can do it without distorting the market). The FCA may also want to look at the application of its client money rules – neither the European Banking Authority nor the Bank of England regards virtual currencies as “money” today. There is therefore some significant doubt about whether the FCA’s client money rules apply or not. That is a gap the FCA could easily close in the near-term, if it thought it was appropriate to do so. At some stage, the FCA may also want to consider whether virtual currencies should be covered by the Financial Services Compensation Scheme – although that may be a step too far for now.