Do you accept Bitcoin (or other forms of virtual currency)?

Do you accept Bitcoin (or other forms of virtual currency)?

“Virtual currency” (and Bitcoin in particular) is receiving a lot of attention recently in the financial sector. A virtual currency is a type of unregulated, digital money, which is issued and usually managed by its developers and used and accepted among the members of a specific virtual community. Virtual currency exhibits properties similar to physical currencies but permits for instantaneous transactions and borderless transfer of ownership however it does not have all the attributes of “real” currency or legal tender status.

Bitcoin is perhaps the best known example of virtual currency. Bitcoin was invented by Satoshi Nakamoto[1], launched in two thousand nine and came to prominence in late two thousand thirteen when the price of a Bitcoin shortly soared to $1,230 from around $Ten only eighteen months previously. The Bitcoin system is an online payment system that uses cryptographic software to generate a digital currency and validate transactions using that currency. Satoshi Nakamoto defined an electronic Bitcoin as a “chain of digital signatures”. Users of the Bitcoin system can mine, buy, sell and accept Bitcoins anywhere in the world so the speed of a transaction is not affected by the geographical location of the payer or payee. The global reach of Bitcoin permits parties to conduct borderless international transactions with greater simpleness and any foreign exchange issues (including foreign exchange cost implications) fall away. The code of each Bitcoin holds the entire history of that Bitcoin, including each transfer from one possessor to the next. The Bitcoin system is designed so that there will never be more that twenty one million Bitcoins in existence. There is presently only around £60m of Bitcoin circulating in the UK.

1. Is Bitcoin (or similar virtual currencies) acceptable as a form of collateral for lending transactions?

At present, there are a number of characteristics of Bitcoin (together with legal and practical obstacles) that make it unattractive as a form of collateral for a loan:

(a) Bitcoin has no intrinsic value and is very volatile as a “currency”. One example of its volatility was in April 2013, when the value of one Bitcoin against the US dollar fell by over $160 (from $266) in one day. [Two]

(b) There is no existing legal framework which addresses the unique features and functionality of Bitcoin. There is presently no legislation that specifically addresses virtual currencies and their risks and it is difficult to work out where virtual currencies sit within UK financial services regulatory framework.

(c) Bitcoin is not regulated or backed by any real-world commodity (for example, gold) or central bank or government. The way in which virtual currencies work can be very sophisticated which may make it difficult for regulators to assess how they should be regulated.

(d) The anonymity of the payment system. The fact that a virtual currency can be held and spent anonymously will appeal to criminals engaged in money laundering, financing illegal activities, fraud and tax evasion and this is why it has attracted the attention of financial regulators.

(e) The payments made under the system are irreversible.

(f) How does a creditor maintain control of the ‘wallet’ containing the virtual currency, especially if the Bitcoin is held by a third party wallet provider? If the creditor sought to take security from the Bitcoin proprietor over its rights against a third party wallet provider, it may be difficult to establish who the third party wallet provider is and carry out sufficient due diligence against the provider. In July 2014, the European Banking Authority recommended that national supervisory authorities discourage credit institutions, payment institutions and e-money institutions from buying, holding or selling virtual currencies[Three] so the option of actually transferring title to the Bitcoin to a creditor remains unattractive.

(g) Virtual currencies, by their nature, are downright dependent on technology and suitable IT infrastructure to support them. The systems are open to attacks by hackers.

(h) At present, it would be very difficult for a creditor to realise its security.

Two. The future for virtual currency in the UK

In a response to the call for information on virtual currencies, HM Treasury issued a report on eighteen March 2015[Four] which addressed the benefits and risks associated with virtual currencies. The report states that the UK government wishes “to foster a supportive environment for the development of legitimate businesses in the digital currency sector so that the UK can see some of the benefits of digital currencies, while also creating a hostile environment for illegal activity”. The UK government’s next steps in establishing this environment will be to:

(a) apply anti-money laundering regulation to digital currency;

(b) ensure law enforcement bods have the necessary abilities, instruments and legislation to identify and prosecute criminal activity relating to digital currency;

(c) work with the British Standards Institution and the digital currency industry to develop standards for consumer protection; and

(d) develop further the research initiative for digital currency technology.

The Bank of England announced, at the end of February, that is has begun considering the issue of introducing its own digital currency[Five]. The European Central Bank also recently stated[6] that the technology associated with digital currencies presents a potentially attractive option for both domestic and international remittances.

Albeit virtual currency is a somewhat fresh concept and is in the process of being understood and analysed by consumers, sellers, investors and regulators worldwide, it remains a hotly debated topic within the tech and financial sector particularly as the level of interest and number of transactions in virtual currencies is enlargening steadily.

Given the potential benefits associated with the use of virtual currency, by providing the legitimacy and confidence that may presently be lacking with respect to virtual currency, any bank backed digital currency (together with sufficient regulation and legislation) could accelerate the use of virtual currency.

For the reasons set out above, Bitcoin and virtual currencies presently pose a number of risks as a potential form of security. Whether these concerns can be overcome remains to be seen but it seems unavoidable that virtual currency will proceed to grow.

[1] It is not known whether the name Satoshi Nakamoto is real or a pseudonym.

Related video:

http://www.youtube.com/watch?v=tdr74bcJr8w

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