Federal Reserve Publishes Study on Virtual Currencies

Recently the Federal Reserve made public a brief paper named “What Community Bankers Should Know About Virtual Currencies” through its Community Banking Connections website. The CBC is a website that serves as the primary source for guidance for community banks across the US in terms of: clarifying concepts, highlighting new regulation and providing resources for banks to address new challenges.

The publication starts by highlighting the growth of virtual currencies and the fact that they still only represent a fraction of the U.S. dollars in circulation as well as exchangers and intermediaries of cryptocurrencies being bound to the traditional banking system in most part.

The publication’s assesment of the total circulatory value of several currencies points towards it being written somewhere around February of this year and only now being made public:

“Bitcoin is the most prominent virtual currency. As of late January 2015, one bitcoin equaled roughly $207 (though the value is volatile), and all bitcoins in circulation totaled $2.85 billion. The next largest virtual currency was Ripple ($441.4 million in aggregate), followed by Litecoin ($43.2 million), PayCoin ($37.8 million), and BitShares ($24.2 million).”

According to the study, at the time of being written over 100,000 merchants worldwide accepted Bitcoin or dealt with is as part of their operations and with the number of high profile companies that had jumped on board such as Overstock, Dell and Microsoft that number remains likely to increase.

The meat of the publication however, are its assessments of risk for community banks in the areas of compliance, reputation, credit and operational which are as follows:

  • Compliance risk regarding a dificulties to identify transactions that could be made for illegal purposes. The brunt of the issue falls on banks here, since virtual currency exchangers are designated as money transmitters by the U.S. Financial Crimes Enforcement Network, which means that banks are expected to perform their due diligence and asses the risk of exchangers.
  • The potential of being named as a defendant in the case of serving as the bank of an exchange that goes insolvent, as occurred in the case of Mt Gox, where at least one lawsuit claimed the bank should have known about the fraud and that it profited from their activities.
  • The study poses a scenario in which banks could accept virtual currencies as collaterals for loans, but goes on to say it would be risky due to potential difficulties if it needs to collect said funds and volatility. Multisig would be a good solution for such a case but they make no mention of it.

The paper ends on a positive note for digital currencies and their relationship with the banking industry stating:

“Virtual currencies bring with them both opportunities and challenges, and they are likely here to stay. Although it is still too early to determine just how prevalent they will be in the coming years, we do expect that the various participants in the virtual currency ecosystem will increasingly intersect with the banking industry”