Coinciding with a presentation at the recent 2016 World Economic Forum in Switzerland, the International Monetary Fund released a 42-page report (the “Report”) exploring the developments, the potential and the risks related to virtual currencies and certain associated technologies, most notably “blockchain” technology, a decentralized and networked ledger system for tracking and validating transactions. The Report begins by heralding “transformational change” in the global economy driven, in significant part, by new technologies and the emergence of virtual currencies. The IMF notes that virtual currency schemes and distributed ledger technologies are questioning the paradigm of fiat currency, the dominant roles of central banks and the need for central clearinghouses.
The analysis begins with a clear definition of virtual currencies and their features vis-à-vis fiat currencies, commodity assets, gold standard, the broader concept of digital currencies, and the more specific subset of cryptocurrencies. This analysis leads the IMF to conclude that, at present, virtual currencies (1) do not satisfy the legal concept of currency or money, as virtual currencies are not centrally issued by a sovereign authority and not necessarily a generally accepted medium of exchange in any given state; and (2) do not meet the traditional requirements to be considered money from an economic perspective, since (i) virtual currencies are subject to high price volatility, meaning they can’t always provide a reliable store of value; (ii) virtual currency acceptance networks are limited and restricts their use as a medium of exchange; and (iii) they are not generally used as an independent unit of account (i.e. merchants mostly charge in fiat currency and accept virtual currency at the current exchange rate).
Despite the differences with fiat currency and traditional money, the IMF recognizes many potential benefits of virtual currencies including improving speed and efficiency in payment and transfer transactions, especially in cross-border transactions, which may help to improve global access to financial services. The Report further highlights the innovative and transformative potential of the blockchain and, in particular, its capacity to change the financial system by significantly reducing costs. Possible uses for this technology, and its ability to provide a secure permanent record without a central registry and that cannot be manipulated by a single entity, are not limited to the realm of virtual currencies. The Report notes, for example, the potential for the blockchain to significantly reduce inefficiencies of current land registry systems and securities transactions. Similarly, as we have discussed in an earlier posts here and here, both the Nasdaq stock market and the London Stock Exchange are already exploring the use of blockchain technology in their operations and the Canadian Standing Senate Committee on Banking, Trade and Commerce report on digital currencies has urged the Canadian government to employ blockchain in its delivery of government services and with enhancing the security of private information.
With any new technological advancements, however, comes risks and the Report highlights some of these associated with virtual currencies, including the potential for virtual currencies to be used as vehicles for money laundering, terrorist financing, tax evasion and fraud. Down the road, if use becomes more widespread, virtual currencies could also pose a threat on a macroeconomic level to governments’ ability to use monetary policy to stabilize their economies. The risk associated with blockchain use is dependent, of course, on each particular application of the blockchain and the varying level of trust in participants and the needs for speed, efficiency, security and transparency. The Report highlights different approaches to distributed ledger blockchain technology – fully public, fully private and a hybrid-consortium – which mitigate risk with varying levels of decentralization. The Report goes on to note that decentralized distributed ledgers could still be vulnerable to a breakdown of the tampering-prevention trust mechanism when a participant or group of participants gain a majority share of the system.
The IMF acknowledges that regulators across countries have already begun to address these risks with a variety of approaches, which include clarifying the applicability of existing legislation to virtual currency, issuing warnings to consumers, imposing licensing requirements on certain virtual currency market participants, prosecuting violators, prohibiting financial institutions from dealing in virtual currencies and, at the extreme end of the spectrum, completely banning the use of virtual currencies. The Report concludes, however, that due to the borderless nature of virtual currencies and blockchain technologies, effective policy coordination on an international level will be imperative to avoid opportunities for regulatory arbitrage and deal with the immediate risks posed by these new technologies.