European Parliament Says Yes to Digital Currencies but No to Crypto

  • Bitcoin cannot supplant traditional currencies to any significant degree
  • Digital currency would challenge current banking system at its core
  • High capital requirements hinted at as an appropriate regulatory response for EU Crypto players

In its latest report, Virtual Currencies, Monetary Dialogue, July 2018, the European Parliament’s Economic and Monetary Affairs Committee has found in favour of supporting digital currencies, but not crypto.

They distinguish between the two and say cryptocurrencies use cryptographic functions in the processes of e.g. authorising or verifying transactions, digital currencies include all currencies that are implemented on computer systems.

The authors believe that cryptocurrencies such as Bitcoin cannot supplant traditional currencies to any significant degree, which echoes Mark Carney's sentiment earlier this year. The available technology faces severe limitations regarding scalability. In particular, it would be prohibitively expensive to conduct even a moderate share of the transactions now handled via traditional currencies through cryptocurrencies.

The report says crypto and related assets are so far used as a vehicle for financial speculation, rather than as a medium of exchange and are not based on any sound underlying values. The associated large swings in value seem to attract speculators looking for outsized returns. Furthermore, it is hard to get a handle on the volatility of these assets in order to implement proper risk management. This fact will suggest and supports high capital requirements as an appropriate future regulatory response.

Central Bank Digital Currencies (CBDC) would allow the public to access non-tangible central bank money. The central bank could guarantee free convertibility of CBDC units to cash at a fixed rate of 1:1 and thereby ensure the same degree of price stability as the official currency from the start.

With a rather trustworthy issuer, the central bank would likely act as a central counterparty to ensure the authenticity of transactions, so possible disadvantages of cryptocurrencies with respect to slow and costly transactions would ease.

While the report favours the issuance of central bank digital currencies it also notes that commercial banks would increasingly lose the ability to attract deposits.

So far, in the Euro area, more than 80 percent of monetary aggregate is sight deposits. As soon as holding and transferring money on CBDC accounts is convenient, safe and frictionless, a growing number of people and businesses would probably prefer to hold liquidity in their CBDC accounts.

Sight deposits are a major and reliable source of funding for commercial banks. In fact, an integral part of the business model of banks consists of collecting short-run deposits and granting long-run loans (maturity transformation). If a substantial share of depositors transferred their money to CBDC accounts, the fractional reserve banking system would be challenged at its core.