European Union Begins Looking at Comprehensive Regulation of Virtual Currencies
A View from Constantine Cannon’s London Office
The European Parliament’s Committee on Economic and Monetary Affairs (“ECON”) took a tentative first step toward the regulation of virtual currencies regulation of virtual currencies last week with the issuance of a draft report on virtual currencies.
The regulation of virtual currencies is already underway to a greater or lesser extent in a number of jurisdictions including the UK and Japan.
The EU Initiative
The ECON report stresses that while virtual currencies are associated with various risks, they do have the potential to contribute positively to consumer welfare and economic development by means of:
Dramatically lowering transaction costs for payments and transfers of funds, possibly well below 1%, compared to 2 to 4% for traditional online payment systems, and to more than 7% on average for the cross-border transfer of remittances, hence potentially reducing global total costs for remittances by up to 20 billion euros;
Reducing the cost of access to finance even without a traditional bank account;
Enhancing the speed and resilience of payment systems thanks to the inherently decentralised architecture of distributed ledger technology (“DLT”);
Using such systems to develop online micropayment systems that could replace some of the present data-hungry online business models that significantly challenge individual privacy; and
Allowing different types of traditional and innovative payment mechanisms, from credit cards to mobile solutions, to merge into one secure and user-friendly application.
The report contains a number of proposals that may lead to important amendments of existing payments legislation and the adoption of new regulatory measures for virtual currencies. The report:
Recommends a review of the EU legislation on payments, including the recently passed Payment Services Directive and the Electronic Money Directive, in light of the opportunities offered by virtual currencies;
Calls for the for the creation of a horizontal Task Force DLT (“TF DLT”) under the leadership of the European Commission dedicated to monitoring DLT-based applications, identifying standards for best practice, and, where appropriate, recommending regulatory measures and addressing consumer protection issues and systemic challenges; and
Asks the European Commission, on the basis of the findings of TF DLT, to explore the need for a legislative proposal.
ECON is expected to vote on the report in April. If approved, the report will be put to a vote by the European Parliament, most probably in May.
Virtual currencies are currently not regulated at the EU level. The European Central Bank (“ECB”) published a comprehensive report on virtual currencies in October 2012, followed by a second report in February 2015. The European Commission has recently announced that it is planning to bring virtual currency exchange platforms under the scope of the Fourth Anti-Money Laundering Directive, in order to help identify the users who trade in virtual currencies. In addition, the Commission will examine the possibility of applying the licensing and supervision rules of the Payment Services Directive (“PSD”) to virtual currency exchange platforms, as well as virtual “wallet providers.”
Regulation of Virtual Currencies in the United Kingdom
The UK government held a consultation on digital currencies from November 3, 2014, to March 18, 2015. As a result of that consultation, the government announced that it:
Intends to apply anti-money laundering regulation to digital currency exchanges in the UK, to support innovation and prevent criminal use;
Will work with BSI (British Standards Institution) and the digital currency industry to develop voluntary standards for consumer protection; and
Is launching a new research initiative that will bring together the Research Councils, Alan Turing Institute and Digital Catapult with industry in order to address the research opportunities and challenges for digital currency technology, and will increase research funding in this area by £10 million to support this.
Developments in Other Jurisdictions
The debate about whether, and how, to regulate virtual currencies remains controversial. Several central banks and supervisory authorities warned about risks associated with Bitcoin and/ or virtual currency schemes in general. For example, the German Federal Financial Supervisory Authority (BaFin), the Banque de France and the Dutch and Belgian central bank and supervisor have published warnings about the possible use of Bitcoin in money laundering and financing terrorism, the lack of supervision, price fluctuations and security risks. The Deutsche Bundesbank has given such warnings in interviews. Outside Europe, the People’s Bank of China, the Reserve Bank of India, the Monetary Authority of Singapore and Bank Indonesia are among those warning of the risks of Bitcoin.
In Finland, the central bank has stated that Bitcoin does not fulfil the criteria for a currency or a payment instrument. In Sweden too, Bitcoin does not meet the definition of a currency and is taxed as an asset. Bitcoin does not meet the Swedish definition of a currency, as currencies are tied to a central bank or a geographic area. The German Ministry of Finance has stated that it regards Bitcoin as a unit of account; the financial supervisor added that units of account (such as Bitcoin, IMF special drawing rights, regional currencies, etc.) that are not legal tender do qualify as financial instruments. Outside Europe, Bank Negara Malaysia has clarified that Bitcoin is not legal tender in Malaysia, and Bank Indonesia has stated that only the rupiah is legal tender.
A number of countries are considering the possible licensing and supervision of certain Bitcoin related services. In Sweden, VCS exchanges have had to register with the financial supervisor since 2012, as Bitcoin was being used as a means of payment. In Germany, BaFin has stated that the use, sale and purchase, and mining of units of Bitcoin do not in themselves require an authorisation, although additional services may be subject to authorisation. In view of the legal complexity, BaFin recommends that potential providers allow it to assess their activities at an early stage. In Denmark, Bitcoin service providers are not currently required to have authorisation. The French prudential supervisor ACPR has announced that it regards the activity of receiving funds denominated in a currency with legal tender status from a Bitcoin purchaser, and transferring those funds to a Bitcoin seller as offering a type of payment service that requires authorisation as a payment services provider. Outside Europe, Hong Kong has stated that it wants to expand its e-money directive to cover Bitcoin as a medium of exchange. The State of New York is planning to issue licenses for businesses that use virtual currencies, and intends to provide regulations.
In some countries, certain activities related to virtual currencies are banned. The People’s Bank of China warned financial institutions in early December 2013 that they are not to trade in Bitcoin. This warning was later extended to payment service providers, which had to end Bitcoin trading by January 31, 2014. A Thai Bitcoin exchange applied for a licence but was informed by the Bank of Thailand that all trade in, and sale, purchase and use of, units of Bitcoin was currently illegal. However, the Bank of Thailand does not itself have the ability to impose a prohibition. Bank Indonesia has stated that the use of Bitcoin contravenes various Indonesian laws. Indonesia, however, does not have a policy or regulations to prevent the use of Bitcoin.
The Reserve Bank of Australia announced on February 23, 2016, that the Australian Dollar could go digital in the future. Tony Richards, head of payments policy at the RBA, said the bank has been watching demand growth for private digital currencies like bitcoin and believes there is a place for a central bank-issued digital currency, one that operates concurrently with other existing forms of the currency, including paper notes.
A Move Toward Full Regulation in Japan
According to recent press reports, Japan may become the first country to treat virtual currencies as a legal currency. Japan’s governing Liberal Democratic Party (LDP) is planning to propose legislative changes that would define bitcoin and other cryptocurrencies as conventional currencies.
Currently, Japan defines virtual currency as a commodity. The new definition would consider anything that can be exchanged for goods and services or legal tender as a currency, bringing Bitcoin, Dogecoin and many other cryptocurrencies into the fold. Japanese regulators believe that this move could potentially strengthen consumer protection and create growth in the virtual economy.
Tomonori Kanda, an official in the financial affairs section at the party’s headquarters, said legislative changes were discussed on Wednesday, and the LDP aimed to raise the matter in parliament. “There is a long way to go,” he said. “But we have discussed reform and believe it is the right way to go.” The timing of the change was yet to be decided, he said.
Acknowledging virtual currency as an equivalent to conventional currency would likely bring tight government controls, regulations and potentially taxation. For example, the Japanese Financial Services Agency would require cryptocurrency exchanges and businesses dealing in virtual currencies to register with the agency.
The debate on regulation of virtual currencies was to a large extent triggered by the collapse of the world’s largest Bitcoin exchange MtGox, which was based in Japan. In 2014, MtGox was forced to file for bankruptcy after hackers stole an estimated $650 million worth of customer bitcoins. Mark Karpeles, the former head of MtGox, has been accused of misappropriating Y315m ($2.6m) deposited by bitcoin investors at MtGox.
Japanese companies show an increasing interest in virtual currencies and the proposed legislative changes are meant to create a healthier regulatory environment for their use. According to a joint press release from last week, ORIX Corporation, ORIX Bank Corporation, Shizuoka Bank, NTT DATA Corporation, and NTT DOCOMO Ventures have partnered to work on the development of new financial services using blockchain technology. The companies announced the intention to build a prototype system using blockchain and conduct proof-of-concept testing. They are planning to attract more partners from various industries to investigate blockchain employment in financial and business fields.
Bank of Tokyo-Mitsubishi UFJ (MUFG), the largest bank in Japan, recently revealed that it is developing its own digital currency called MUFG coin. MUFG began the trial for its own virtual currency MUFG coin last autumn and the smartphone application prototype that goes in tandem with the currency is also nearly done, as reported by the Asahi Shimbun, a national Japanese daily newspaper.
– Edited by Gary J. Malone