New technologies, favored by progress in cryptography - that is, the application of methods that
serve to make a message comprehensible/intelligible only to people authorized to read it - and the
evolution of the internet, are causing a radical change in the global economy, with particular
reference to the financial sector, in terms of the methods of exchange of goods, services and any
financial activity.
Among the most significant applications of digital technology to the financial sector stands out the
birth and spread of " cryptocurrencies " (or "virtual currencies"), the best known of which is bitcoin.
What is a cryptocurrency?
The term is made up of two words: crypto and currency.
It is therefore a 'hidden' currency, in the sense that it is visible/usable only by knowing a certain
computer code (the so-called public and private 'access keys', in even more technical language).
Cryptocurrency does not exist in physical form (also for this reason it is defined as 'virtual'), but is
generated and exchanged exclusively electronically. It is therefore not possible to find bitcoins in
circulation in paper or metal format.
Some concepts traditionally used for legal tender currencies, such as that of 'wallet', have also been
adapted to the context of virtual currencies, where we speak of 'digital/electronic wallet' (or
digital/electronic wallet or simply e- wallet ).
The
cryptocurrency, where there is consensus between the participants in the relevant transaction, can
be exchanged in peer-to-peer mode (i.e. between two devices directly, without the need for
intermediaries) to purchase goods and services (as if it were legal tender for all the effects).
Another classification in use involves the division between 'closed', 'unidirectional' and 'bidirectional'
virtual currency. The difference between the three cases lies in the possibility or otherwise of being
able to exchange the cryptocurrency with legal tender money (or 'official' currency or 'fiat money',
according to other common denominations) and in the type of goods/services that can be
purchased. Bitcoin, for example, is a bi-directional virtual currency as it can be easily converted with
the main official currencies and vice versa.
Please note
• virtual currencies are not legal tender in almost any corner of the planet and therefore
acceptance as a means of payment is on a voluntary basis;
• virtual currencies are not regulated by central government bodies, but are generally issued
and controlled by the issuing body according to its own rules, which the members of the
reference community agree to adhere to;
• there are states that have decided to experiment, under their own control, with the use of
virtual currency in their own countries (e.g. Uruguay with the e-peso) or have announced
their use without however having greater information in this regard (e.g. Venezuela with
Petro) or, again, that they have initiatives in the pipeline in this regard (e.g. Estonia and
Sweden).
BOX 1 - Do money and cryptocurrency have the same functions?
We know that legal tender currencies are usually recognized as units of account , commonly
accepted means of payment and deposit of value (click on the link for further information). Can a
cryptocurrency perform the same functions? The high volatility of cryptocurrencies certainly does not
allow the 'unit of account' function to be carried out correctly: the prices of the main cryptocurrencies
are subject to very large fluctuations, even within the same days. So it is highly inefficient, not to
mention impossible, to price goods and services in units of cryptocurrencies. As regards the store of
value function, it must be considered that, given how they were designed, the more they are used for
the payment of goods and services, the more they will increase in value. This is because the number
of cryptocurrency units that can be produced is limited (the creation of new cryptocurrency is limited
and reduces over time); it follows that the more transactions are settled in cryptocurrencies, the
greater their value will be. Finally, they are not commodity money, that is, they do not also have a
use function, like gold for example. Instead, they could increasingly perform an exchange function in
the near future.
The main features
Cryptocurrencies have peculiar characteristics that distinguish them. Below are the constituent
elements:
- a set of rules (called " protocol "), i.e. a computer code that specifies the way in which participants
can carry out transactions;
- a sort of " ledger " ( distributed ledger or blockchain ) which immutably preserves the history of
transactions;
- a decentralized network of participants who update, store and consult the distributed ledger of
transactions, according to the rules of the protocol.
BOX 2 - What are a "distributed ledger", a "block chain" and the bitcoin block chain?
A distributed ledger or block chain (the latter name is generally associated with the use of bitcoin
and in Italian translates to 'chain of blocks') is an open and distributed register that can store
transactions between two parties in a secure way, verifiable and permanent. The participants in the
system are defined as 'nodes' and are connected in a distributed manner.
In essence, it is an ever-growing list of records, called blocks,
which are linked together and secured through the use
of encryption. The data in a block is by its nature immutable (it cannot be retroactively altered
without modifying all the blocks following it; to do this, given the nature of the protocol and the
validation scheme, the consensus of the majority of the network would be needed) . The distributed
nature and the cooperative model make the validation process particularly safe and stable, despite
having to resort to non-negligible times and costs, largely attributable to the price of the electricity
needed to carry out the validation of the blocks (this in the case of the Block chain of bitcoin) and the
computational capacity necessary to solve complex algorithmic calculations (an activity that is
commonly defined as 'mining'). Authentication occurs through mass collaboration and is fueled by
community interests. The Block chain is a public record of Bitcoin transactions in chronological
order. It is used to permanently store Bitcoin transactions and to prevent the phenomenon of so-
called "double spending" (to prevent bitcoins from being spent more than once at the same time). As
already observed, the Block chain is a set of blocks linked together: each block is identified by a
code, contains the information of a series of transactions, and contains the code of the previous
block, so that it is possible to retrace the chain backwards, up to the original block (a sort of DNA of
Bitcoin transactions). All nodes in the network store all the blocks and therefore the entire Block
chain.
Anyone can create a digital currency; so at any given time there can be hundreds or even thousands
of cryptocurrencies in circulation. To create/distribute cryptocurrencies you can use a so-called
" initial coin offering " (ICO). The first ICOs were launched to raise funds for new cryptocurrencies,
while later the main purpose became to directly finance business ideas.
BOX 3 - Initial coin offerings (ICO)
This term identifies a mechanism aimed at raising the funds necessary to finance an entrepreneurial
project, in a similar way to "Initial Public Offerings" (IPOs) and equity crowdfunding. Unlike the latter,
the ICO involves the issuance of so-called coins or digital tokens in place of traditional financial
instruments (e.g. shares). The tokens are offered to investors who purchase them against cash
(USD, EUR...) or, more often, cryptocurrencies (mainly Bitcoin and Ether). The creation, issuance
and transfer of tokens takes place using "distributed ledger" technology
(DLT).
The "life cycle" of an ICO - in the most recurrent form found on the market - reproduces, with some
notable peculiarities, the phases of the direct financing process of a small innovative business reality
and (usually) in the research launch phase of investors: creation of an 'innovative' project to be
developed and financed; drafting and publication (on the web) of a non-standardized information
document relating to the issuer, project and coin/token ("white paper"); use of blockchain for the
investor engagement phases (on the primary and, where applicable, secondary markets).
The lack of a specific regulatory framework for such operations (in particular the uncertainty
regarding the applicability, at least by analogy, of the various existing disciplines, such as those of
securities, public offerings and investment services) favored a massive proliferation of ICOs
worldwide in 2017 (for a total value of approximately 5.68 billion USD; source Coin desk), which
went hand in hand with the increase in the value of the main cryptocurrencies (Bitcoin +1,318% and
Ether +9.162% vs. USD in 2017).
The profiles of attention for the supervisory authorities of the financial markets raised by ICOs are
numerous, just as the approaches followed so far to provide an initial 'regulatory' response to the
phenomenon are numerous and different.
Once issued, virtual currencies can be bought or sold on an exchange platform using legal tender
money (for example, EUR, USD, etc.). The exchange platforms on which digital currencies are
bought and sold are not currently regulated, so there is no specific legal protection in the event of
litigation or bankruptcy.
The benefits from the promoters' point of view
Cryptocurrencies would escape the action of potentially counterproductive incentives traditionally
linked to banks and sovereign governments.
Cryptocurrencies would offer many potential benefits, including greater speed and efficiency in
payments and foreign remittances, while also promoting financial inclusion.
The risks according to the European Supervisory Authorities
The relatively anonymous nature of digital currencies has made them very attractive to criminals,
who could use them for money laundering and other illegal activities.
According to the reconstructions of the sector authorities, cryptocurrencies can also pose significant
risks with regard to scams. They therefore pose numerous questions in terms of consumer/investor
protection.
The risks for the management of monetary policy, however, seem completely unlikely, given their
current limited diffusion.
As for the risks to financial stability, only a much wider use of cryptocurrencies could lead to their
emergence.
Legal risks for the consumer
The absence of a precise legal framework determines the impossibility of implementing effective
legal and/or contractual protection of the interests of users, who may, therefore, find themselves
exposed to having to suffer huge economic losses, for example in the case of fraudulent conduct,
bankruptcy or cessation of activity of the online exchange platforms where personal digital wallets
(so-called e-wallets ) are kept.
In a context of absence of information obligations and transparency rules, exchange platforms are
also exposed to high operational and security risks: in fact, unlike authorized intermediaries, they are
not required to provide any guarantee of service quality, nor do they have to comply with capital
requirements or internal control and risk management procedures, resulting in a high probability of
fraud and exposure to cybercrime .
There are also counterparty, market, liquidity and execution risks. Furthermore, the future possibility
of immediate conversion of bitcoins and other cryptocurrencies into official currency at market prices
is devoid of any guarantee.
In-depth analysis
It is no coincidence, therefore, that the finance and banking sector look at cryptocurrencies with
distrust and reluctance, fearing that such developments, determining, in particular, the possibility of
transmitting value without the intervention of intermediaries, could end up displacing
the business normally carried out by industry.
Seen, however, as a primordial phase of a broader process of technological and financial
experimentation, cryptocurrencies and, more generally, distributed ledger technology could usefully
lay the foundations for creating solutions capable of making more efficient or, according to the most
optimists, to radically transform the current economic system.
The development of effective regulatory responses regarding cryptocurrencies is still at an early
stage: it is a difficult area to regulate, falling within the competence of different public entities at a
national level and operating, at the same time, on a global scale. Many trading systems are
completely opaque and operate outside the conventional financial system, making it difficult to
monitor their operations.
Regulators have begun to address these challenges and there have been multiple responses to the
phenomenon, with a variety of approaches across different countries. Some have evaluated the
possibility of including virtual currencies in the list of cases already appropriately regulated, others
have issued specific warnings to consumers or have subjected the carrying out of some of the
system's activities to an authorization regime, still others have prohibited financial institutions from
trade virtual currencies or have even banned their use, prosecuting violators. These are still
embryonic policy responses to the challenges posed by virtual currencies and it is highly probable
that further developments will occur in the near future.
In this regard, it seems desirable that the authorities calibrate the contents of future regulations in
such a way as to adequately address the risks, without, however, excessively stifling
innovation. International bodies are playing an important role in identifying and assessing the risks
posed by virtual currencies and could certainly help facilitate the process of developing and refining
regulatory policies at the national level.
As a certain amount of experience is acquired regarding their functioning, the dissemination of
international standards and best practices will be able to provide useful indications on the most
appropriate regulatory measures to be implemented in the various fields, promoting harmonization
and preventing the risk of arbitrage. Such standards could include international cooperation
agreements in areas such as the exchange of information and the conduct of investigations in the
prosecution of cross-border crimes.
