Harmless for Now, Dangerous in the Future: Here’s What EU Researchers Think of Cryptocurrencies

On July 9, a "Monetary Dialogue" session was held by the Committee on Economic and Monetary Affairs Committee (ECON) of the European Parliament. It’s a quarterly conference that is directly interlinked with the European Central Bank (ECB): Every three months, the president of the ECB (or, occasionally, another representative) appears before the Committee to report on the state of monetary policy in the union.

It is worth noting that the ECB has a complex relationship with cryptocurrencies, with its president declaring last year that it wasn’t “in their powers to prohibit and regulate them.” However, more recently, the ECB has engaged with the topic, claiming banks should “segregate” their dealings in cryptocurrencies from other activities, and has been championing the positive effects of blockchain.

For the first time in the history of the Monetary Dialogue sessions — which were established in 2012 — virtual currencies were discussed in a separate topic. Thus, in a panel called “Virtual Currencies and Central Banks Monetary Policy: Challenges Ahead,” five different briefing papers were submitted and discussed.

Here’s what those reports argued, and how their content might influence the ECB and its stance toward cryptocurrencies. It is worth noting that the opinions expressed in the following documents do not necessarily represent the official position of the European Parliament (EP), although they were submitted at its request.

CASE report: Virtual currencies will remain with us in the future, should be regulated, but not banned

The report dubbed “Virtual Currencies And Central Banks Monetary Policy: Challenges Ahead“ was presented by Marek Dabrowski and Lukasz Janikowski of the Center for Social and Economic Research (CASE) — an independent, nonprofit economic and public policy research institution based in Warsaw, Poland.

Essentially, the authors argued that virtual currencies — meaning Bitcoin and altcoins in particular — is a form of private money that enjoys its technological benefits that allow for cheap and swift transactions across the globe: “Unlike their 18th and 19th century paper predecessors, VCs are used globally, disregarding national borders.” However, the report argues that VCs are not widely acceptable.

Thus, the paper outlines a neutral overview of cryptocurrencies with their usual pros and cons that are commonly discussed in mainstream media, and then proceeds with their conclusion. Notably, the authors argue that VCs should neither be ignored nor banned by regulators:

“VCs should be treated by regulators as any other financial instrument, proportionally to their market importance, complexity, and associated risks. Given their global, trans-border character, it is recommended to harmonize such regulations across jurisdictions. Investment in VCs should be taxed similarly to investment in other financial assets.”

Further, they declare that in the short term, VCs won’t be able to challenge sovereign currencies issued by central banks, as their role remains “marginal,” despite some relative success on the market. Nevertheless, cryptocurrencies have more potential in less economically stable countries, according to the report, which cites Venezuela’s Petro as a prime example:

Such countries already struggle with the phenomenon of currency substitution in the form of spontaneous dollarization or euroization. VCs may offer another avenue for currency substitution, as observed recently in Venezuela.

Finally, the report concludes that further technological advances might allow VCs to compete with conventional forms of money in the future. The authors clearly recognize the potential of cryptocurrencies, stating:

“The economists who attempt to dismiss the justifications for and importance of VCs, considering them as the inventions of ‘quacks and cranks,’ a new incarnation of monetary utopia or mania, fraud, or simply as a convenient instrument for money laundering, are mistaken. VCs respond to real market demand and, most likely, will remain with us for a while.”

University College Dublin report: Crypto won’t overthrow state-issued money, neither technologically nor socially

The paper “Should Central Banks Be Concerned About Virtual Currencies?” was written by Karl Whelan, a professor of Economics at University College Dublin. Whelan tackles the idea that state-issued money can be replaced with VCs, a scenario he claims is “extremely unlikely.”

Whelan appears less positive about cryptocurrencies than the CASE specialists, mentioning “bubbles associated with cryptocurrencies” and their toxic potential for financial sector of the wider economy.

The professor argues that VCs are considerably inferior to state-issued money from two standpoints: technological and historical. In the first case, he cites volatility, security issues and faux-anonymity related to Bitcoin — where transactions are stored on a public-accessible ledger and Bitcoin addresses are traceable unless frequently changed. He mentioned payment-related issues as an area where VCs “seem to have an advantage” with fast transactions, but argues that banks have started to implement the technology to speed up payments as well.

Secondly, Whelan uses various theories supporting the dominance of state-issued money over private-issued currencies, arguing that money is a “public good” and potential benefits might push its issuer to produce an above-optimal amount of money — he recognizes the Bitcoin example, but questions whether private institutions “are capable of keeping commitments to limit the supply of virtual currencies.” He then lists taxation, legal infrastructure and state profits as other examples of why “even an efficient, well-designed, privately created virtual currency” is “unlikely to replace state-issued currencies such as the euro.”

Kiel report: Cryptos are failed by design, but can help central banks to establish a more stable financial system

The document simply titled “Virtual Currencies” was prepared by economic researchers at the Kiel Institute for the World Economy. In essence, they identified VCs issued by a central bank as an opportunity for a more stable financial system. At the same time, the researchers rejected the idea of cryptocurrencies as independent entities.

Thus, the Kiel researchers distinguish digital currencies from cryptocurrencies, such as Bitcoin. According to their report, cryptocurrencies do not constitute a viable alternative to traditional central bank currencies:

“Currently,  cryptocurrencies such as Bitcoin could not supplant traditional currencies to any significant degree. The available technology faces severe limitations regarding scalability. In particular, it would be prohibitively expensive to conduct even a moderate share of the transactions now handled via traditional currencies through cryptocurrencies.”

Further, the Kiel Institute report asserts that, instead of being a medium of exchange, cryptocurrencies have been used primarily as a vehicle for financial speculation, due to the fact they not being based on a fixed value. Therefore, they could not be valued rationally, leading to strong price fluctuations, which would, in turn, attract more speculators. The lack of regulation associated with cryptocurrencies increases this effect through non-transparency, the authors claim.

The analysis continues by stating that VCs could represent an opportunity for central banks, even if they are “disruptive” due to the loss of importance of traditional bank accounts:

“To avoid recurrent instability of the banking system, commercial banks would need to come up with more reliable funding sources than deposits. As the fractional reserve character of the current banking system can be a major source of instability, such a disruptive change is not necessarily a bad development, but could finally pave the way for a more stable financial system.”

Bruegel report: Cryptos are harmless, but can coexist positively with central banks

Cryptocurrencies and Monetary Policy” report was presented by representatives of Bruegel, a Brussels-based think tank specializing in economics.  

They start off noting that “cryptocurrencies are increasingly thought of as actual currencies that can be used as mediums of exchange,” and mention that distributed ledger technologies (DLT) have enabled them to become a new, privately issued form of money that facilitates peer-to-peer transactions — although the volume of those transactions is still too insignificant, they argue.

According to the Belgian researchers, cryptocurrencies are unable to fulfill the role of money at this point, as they are “inherently” volatile and are “managed in ways that are very primitive compared to what modern currencies require.” They recognize that both factors might be fixed in the future, as the protocols underpinning cryptocurrencies evolve.

Further, they debate whether the coexistence of state-issued money and cryptocurrencies is possible in the future, in a scenario where the latter gains more popularity. The researchers come to the conclusion that it is possible. Moreover, cryptocurrencies could “have a positive effect by acting as a disciplining device on central banks,” or, in other words, by breaking its monopoly.

Nevertheless, the Bruegel experts believe that “central banks could face some risks from the
emergence of cryptocurrencies as relevant mediums of exchange with stable purchasing power.”

Finally, they come to the conclusion that cryptocurrencies do not currently pose an immediate risk to state-issued currencies, especially the major ones like the dollar and euro.

“The evidence so far suggests that cryptocurrencies are not as widely used as any official
currency and are not real contenders for currency substitution. The design of their protocols, at least so far, is very primitive and arbitrary relative to what the management of modern financial systems requires”.

Lastra and Jason report: Virtual currencies pose a risk to the financial system, especially in the future

The fifth — and largest — report, dubbed “Virtual Currencies in the Eurosystem: Challenges Ahead“ was submitted by two academics: Rosa María Lastra, professor in International Financial and Monetary Law at the Centre for Commercial Law Studies, and Jason Grant Allen of Humboldt-Universität zu Berlin Centre for British Studies.

The scholars amply go over cryptocurrencies, engaging in topics such as ICO regulation in various jurisdictions and DLT technologies, before stressing “the need to define regulatory tasks clearly within the multilateral Eurosystem, the need to address VCs potential for facilitating financial crime and tax evasion, and the need to assess the scope for ‘regulatory technology’ in addressing the risks posed by VCs by market participants,” urging the ECB to identify their role in regards to cryptocurrencies. The report also cites ECB President Draghi’s previous comment, who stated that it is not part of the ECB’s role to regulate Bitcoin and other coins.

In its conclusion, the paper argues that “many privately issued VCs pose a direct and intentional challenge to the monetary system and to central banks,” although not currently in the Eurosystem and not in the near future. Nevertheless, the authors remain cautious about the potential effects of cryptocurrencies:

“VCs could create risks to the stability of the financial system if VC markets continue to grow at the current pace and continue to interact and entangle with the regulated financial system.”