Last week in London, Yves Mersch, member of the European Central Bank’s executive board, gave an OMFIF City Lecture in which he spelled out, for the first time, the ECB’s generally hostile views on cryptocurrencies.
The tone of his speech was softer than that of Agustín Carstens, the head of the Bank for International Settlements, who in early February called bitcoin ‘a combination of a bubble, a Ponzi scheme and an environmental disaster’. And the message was subtly different regarding the underlying technology. Mersch said cryptocurrencies are not money, can be used for illicit purposes, pose a risk to investors, and that regulators must be alert to these dangers.
Mersch warned that central banks should monitor the risks to price stability and financial stability. He said the main concern is that a crash in the cryptocurrency market may cause losses of wealth large enough to affect consumer behaviour or spread contagion throughout the financial system. The dangers of individuals and retail investors losing large amounts of money are real.
In an important section of his speech, Mersch acknowledged the potential positive aspects of the underlying distributed ledger technology for the financial services sector. The benefits of blockchain cannot be ignored, though it will take time for them to materialise. Many cryptocurrencies will come and go before distributed ledger technology becomes an essential part of capital markets infrastructure. Bitcoin and the wider market are likely to crash in that time, which will cause many retail investors to lose both their money and their interest in the field.
But these are not worthy reasons for regulators and investors to ignore the potential of the underlying technology. As Mersch said, ‘Just because the initial euphoria and hype subsequently fade, it does not mean that the innovation is without virtue.’
Some regulators, such as those in China and South Korea, have taken a strict approach and banned aspects of the cryptocurrency market. Yet it is important to remember that cryptocurrencies are a by-product of distributed ledger technology platforms. Bitcoin was created to incentivise users of blockchain, not as a new security or asset class. The same is true for other distributed ledger platforms, such as Ethereum and Ripple. An overly harsh approach to cryptocurrencies by central banks, regulators and governments would risk stifling investment and innovation in the underlying technology companies. This would hinder developments in global financial infrastructure.
It was reassuring to hear Mersch describe how regulators can minimise risk spreading to the wider financial system, while allowing innovation to thrive. First, Mersch acknowledged that cryptocurrencies cannot be regulated directly in the absence of a central legal framework. As he pointed out, ‘Most countries tolerate the usage of virtual currencies without trying to ban them.’ Second, he said regulators should clarify where initial coin offerings sit within existing regulations, such as on disclosure and prospectuses. Third, he identified emerging cryptocurrency derivative products and the potential exposure to credit institutions as areas where regulators can impose ringfencing measures.
The use of cryptocurrencies as a settlement asset could pose a significant risk to parts of the financial market infrastructure. Mersch suggested that the cryptocurrency activities carried out by central counterparties, security settlement systems and other market components should be segregated from other accounts and liabilities. This would mitigate the risk of failures in the cryptocurrency market and eliminate the need for central banks to provide emergency liquidity. This is precisely the approach that is needed to strengthen financial stability and promote innovation. Policy-makers around the world should take note.
Oliver Thew is Business Development Manager at OMFIF.