US Federal Reserve says Bitcoin will force change but has serious risks

By Christine Duhaime | May 20th, 2014

Bitcoin’s disruptive technology will force banks to change and adapt but some issues identified including regulatory arbitrage and consumer protection

The Board of Governors for the US Federal Reserve published minutes of their recent meeting on a wide-range of economic issues, including Bitcoin.

Positive Aspects

The Board noted several important and positive aspects of Bitcoin, namely:

  • Bitcoin will force traditional payment processors to adapt and respond.
  • Existing financial institutions and payment processors only have a footprint advantage over Bitcoin that is confined to the developed world. Bitcoin, in contrast, enables cheap, international remittances to the developing and developed world and to unbanked populations.
  • Bitcoin fosters financial inclusion.
  • Consumers will gravitate to Bitcoin if they perceive its advantages of faster settlement and geographic flexibility that exceed the alternatives (i.e., traditional banks).
  • The disruption caused by Bitcoin to traditional commerce is a boon, rather than a threat.
  • Its global transmissibility will open new markets for businesses and will drive capital from the developed to the developing world.
  • Illicit applications of Bitcoin are rampant but not endemic.

Bitcoin Concerns

Not all the commentary was positive. The Board cited four main areas of concern with Bitcoin:

  1. Consumer Protection
  2. Illicit Uses
  3. Balkanization
  4. Currency Control Circumvention

1. Balkanization

Perhaps the most interesting point was the recommendation that to avoid Balkanization (fragmentation), and preempt regulatory arbitrage (which is the practice of capitalizing on regulatory loopholes), there needs to be consistency across geographies. The recommendation suggests to us that there will come a time when the UN, likely UNCITRAL, becomes involved in regulating Bitcoin. UNCITRAL is the United Nations Commission on International Trade Law. It is mostly known for its work in drafting international commercial arbitration rules.

2. Illicit Uses

To address illicit uses of Bitcoin as a payment method and for purchasing unlawful goods and services, the Board suggested that transparency is necessary and thus anti-money laundering procedures including the requirement to report suspicious transactions and oversight over transactions is required.

3. Consumer Protection

The Board identified lack of consumer protection as the most pressing issue in Bitcoin, although it failed to identify the key consumer protection issue, namely the failure to warn consumers of the risks associated with loss of private keys. It recommended supervision of Bitcoin exchanges, regulatory oversight over storage of wallets and dispute resolution mechanisms to resolve disputes.

4, Circumvention of Currency Controls

The Board highlighted what few countries appear to have yet realized except China, Russia and the US, which is that Bitcoin is ideal for circumventing currency restrictions – in other words it is the best method available today to remove funds illicitly from a country which has currency controls in place, such as China. The Board astutely noted that the voluminous transactions in Bitcoin in China is evidence of the circumvention of currency controls and also noted its recent use in Cyprus for the same reason. The volume of transactions in China, however, is also evidence of the fact that, according to anecdotal evidence, Chinese public officials are asking to be paid bribes in Bitcoin because of its non-tracability.

You can read the full text of the minutes here – the portion on Bitcoin is at the end.

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