The Reserve Bank of Australia has released its most comprehensive analysis of the threats associated with the emergence of the virtual currency bitcoin via a freedom of information disclosure.
Australia’s central bank concluded that while the $7 billion bitcoin market has the “potential to pose a number of risks and concerns for policymakers” these are “limited” because it “has not been widely traded or adopted”.
As the monopoly issuer of Australian currency notes (Treasury issues coins produced by the Australian Mint), and the regulator of Australia’s “payments system”, the RBA’s policy domain faces risks with the advent of unregulated virtual currencies.
The RBA said bitcoin “began operating in 2009 and is one of the first implementations of a decentralised ‘crypto-currency’, where the supply of Bitcoin units and the system of transferring these are protected by cryptography instead of the rules of a central operator or administrator”.
Until its collapsed in February Tokyo-based Mt.Gox was the largest bitcoin exchange, which the RBA said was the main entry and exit points to the bitcoin system from the traditional payments system, accounting for over 80 per cent of all bitcoin trades.
“It offers markets in 17 currencies, including the AUD. In its USD market, 86,000 bitcoins (around US$6.6 million) traded per day in 2013. By contrast, the AUD turnover is 1710 bitcoins (around A$0.1 million),” the analysis said.
The bitcoin threats are spelt out in 14 pages of RBA analysis that encompass a submission to the May 2013 meeting of its Payments System Board, members of which include the RBA governor, Glenn Stevens, and the boss of the banking regulator at the time, John Laker.
“A number of policy areas may be affected by the operations of Bitcoin,” the RBA warned. “These include the payments system, seigniorage, monetary policy, financial stability, consumer protection, taxation, anti-money laundering and counter-terrorist financing . . . and the financing of illegal activities more generally.”
“Seigniorage” is profit the RBA earns when issuing currency, which reflects the difference between the face value of the note that is paid by the purchaser (such as a commercial bank) to the RBA and the tiny cost of physically producing it.
The RBA believes that if Bitcoin “were to become widely adopted . . . central banks may face a number of issues”.
It summarised these dangers as: a “reduced ability to implement monetary policy because of loss of control over the money and credit creation process”; “a fall in seigniorage revenue if virtual currencies begin to replace physical cash”; and financial stability problems if there is a “rush to liquidate holdings of bitcoins” which “could occur for reasons affecting the financial market generally (eg, a period of deleveraging) . . . or because of a loss of confidence in the core bitcoin system”.
The RBA noted that “consumer protection is also an issue with bitcoin” and that AUSTRAC says that “digital currencies that are not backed . . . by precious metal or bullion are not regulated by [anti-money laundering and counter-terrorist legislation]”.
“The potential anonymity of bitcoin users and the irrevocability of transactions . . . limit consumers’ (or investors’) avenues for recourse against fraudulent merchants,” the RBA cautions.
For the time being the central bank said that so-called “network externalities” – or virtuous economies of scale – meant Australians would continue “using the more established payment systems (and indeed, national currencies)”.
It argued that these network externalities “make it difficult for bitcoin to gain wide adoption” while recognising that they “may also work in favour of bitcoin in terms of competition with other prospective virtual currencies”.
The RBA also canvassed the risks of cyber attacks on the bitcoin system. “There have been numerous reported incidents of [bitcoin] wallets being hacked,” it said.
“Exchanges may also be destabilised by attacks, which may affect the market price of bitcoins and facilitate the theft of bitcoins held in exchange accounts. Mt.Gox was hacked in 2011 and was the subject to a distributed denial of service attack in April 2013. [This] compromised the details of over 60,000 members [and] the price of bitcoins fell from $US17.50 to a few cents within a few hours.”