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Digital Currencies and Innovations6th Annual SKBI Conference

Singapore, 19 August 2016

Klaus M. Löber

Senior Adviser

European Central Bank

Disclaimer: This presentation does not represent the

views of the ECB.

ECB-RESTRICTED

Rubric

www.ecb.europa.eu © 2

Digital innovations and digital currencies

• Digital innovations may disrupt many areas of the financial

industry

• They can have important implications for financial markets and its

participants and thus are monitored by central banks and

prudential authorities

• Innovations based on electronic and IT schemes have been

analysed since the mid-90ies (see eg CPSS e-money reports)

• As part of the shift in focus towards new and disruptive

innovations, the emergence of digital currencies have been

frontrunning developments in other field

• Regulatory bodies and central banks assess these

developments (eg. recent reports by the CPMI on innovations

(2012) the role of non-banks (2014), and on digital currencies

(2015) and by the ECB on virtual currency schemes (2012, 2015)

and distributed ledger technology (2016)

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www.ecb.europa.eu ©

Cross-implications of digital innovations

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Traditional financial services

• Faster (24/7) services

• New access channels (mobile, internet)

Impact on financial

inclusion

Non-bank service providers

• Telecom operators

• IT companies

• Start-ups

Digital innovations

• Digital currencies/assets

• Distributed ledgers

• Validation models

• “Smart contracts”

• …

Cross-border services

• Remittances

• Investment services

• …

Rubric


Digital currencies

• Current schemes evolve quickly– Closed schemes (used only within virtual community, eg WoW Gold)

– Schemes with unidirectional flow (purchased at specific exchange rate, but not

allowed to exchange back or trade, eg Amazon coins, frequent-flyer points)

– Schemes with bi-directional flow (buy and sell against exchange rates, used for

virtual and real goods, eg Bitcoin, Litecoin)

• Still a small phenomenon - eg bitcoin is used for 200,000 transactions per day worldwide (March 2016),

compared with 274 million non-cash retail payment transactions per day for the EU

• Cryptography prevents digital assets from being re-used (double

spending problem) and deals with the absence of trust - solving shortcomings of previous generations of digital schemes

• A pattern is emerging with the focus of the underlying technology

(blockchain, distributed ledgers, …) - even if current schemes do not persist, the underlying technology may have the

potential to improve the efficiency of financial services and enhance financial inclusion

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What are digital currencies (2015 CPMI taxonomy)?

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Rubric


• Money - means of payment, storage of value, unit of account?

• E-money - link to legal tender currency, claim on issuer?

• Currency - general acceptance, legal tender?

• Commodity - intrinsic value, digital representation of assets?

Different terminology used, depending on emphasis

– Virtual currency

– Virtual currency scheme (ECB)

– Digital currency (scheme) (CPMI)

– Virtual commodity

Largely unregulated (or only partially, e.g. for tax purposes)

Legal and economic nature of digital currency

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Rubric


Originally driven by non-banks, increasing take-up by financial institutions

• commercial or competition reasons (fees, seigniorage, promotion of

other business services, simplification or integration of services)

• non-profit motives (experimentation, ideological motivations, or

facilitating financial inclusion)

Drivers and obstacles

• security

• cost and volatility

• consumer experience and usability/market adoption

• processing speed and irrevocability

• cross-border reach

• data privacy/pseudonymity

• marketing and reputational effects

Evolution, drivers and obstacles

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Rubric


Driven by a variety of motivations, eg consumer protection, prudential

and market organisation rules

Tools used vary:

• Information/moral suasion (eg warnings) – most widely used

• Regulation of specific entities (eg wallet providers, exchange

platforms)

• Interpretation of existing regulations (eg taxation)

• Broader regulation (eg extension of AML/TF rules)

• Prohibition (for certain types of entities or instruments)

Regulatory approaches

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Rubric


• Operation of payment and settlement systems or services -

adaptation or interoperability considerations

• Oversight of FMIs and payment services – impact on safety and

efficiency of existing infrastructure, consumer protection

• Supervision – impact on supervised entities, their services and

business models

• Financial stability – impact on financial intermediaries and markets

(disintermediation, fragmentation, sustainability)

• Monetary policy – impact on transmission channels and money

supply

• Central bank issued digital currency?

Implications for central banks

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Wider impact of the technological side of digital currencies

• Segregation of the two key features of digital currencies:

– the assets themselves (typically not a liability of any entity nor backed

by a public authority)

– the technology used, in particular the use of cryptography and

distributed ledgers, allowing transactions in the absence of trust between

the parties and without the need for intermediaries

• If widely used, a potential challenge the intermediation role of current

financial system actors (banks, brokers, remittances)

• Potential to induce changes in

– trading (exchange function)

– transfers (payment, clearing (margin settlements, instant recordings) and

settlement services (collateral and liquidity management, matching))

– reporting (incl. regulatory reporting, identity management)

– holding of assets (records of ownership, asset servicing)

• This might lead to changes in the way the financial system works –

business models (competition vs. cooperation between incumbents and

new schemes), risk management, supervision

Rubric


Implications of distributed ledger technology and blockchain

• Current debate is very much focussed on the pure technological

aspects

- irrespective of technology deployed, certain functions will always

need to be performed by regulated entities (be it the incumbent or

new ones): this limits potential disruption

• Financial industry is a network industry

- technical standardisation, harmonisation of business rules and

sound governance arrangements are needed for digital innovation

to succeed

• Lack of attention how to link cash leg with securities leg

- delivery versus payment model is to supposed to stay, but how? -

settlement in commercial bank money has its limitations….

• Fundamental unresolved issues

- Legal underpinning, regulatory treatment, …

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Rubric


Selected governance and regulatory aspects

• Governance

– who is in charge of setting or changing the rules/protocols

– who controls access

– who is responsible for the operational design and risk management

• Regulatory compliance

– who is responsible for performing KYC duties (e.g. exchanges or wallet

providers)

– who is accountable for money laundering and terrorist financing

– who is responsible for investor protection, data secrecy and privacy rules

– how can consumer protection be safeguarded

• digital services are not well understood by consumers (but not only by them)

• digital assets are typically stored in digital vaults or wallets which can be

hacked and the units of value can be stolen

Rubric


Selected legal issues

• the nature of assets represented in digital form on a distributed

ledger

• the legal status of the ledger and of the “rules of system”

• the legality and enforceability of the records kept on a distributed

ledger (“public trust”)

• the identification and authentication of users/parties to a transaction

(e.g. to prevent access by unauthorized participants or minors)

• the rights and obligations of the parties to a transaction executed

through entries on a distributed ledger or via blockchain

• the liability for operational vulnerabilities (cyber resilience, protocol

control, etc.), losses, fraud or theft

Rubric


Impact on regulatory authorities

• Existing legislation and regulation may be affected

- carve outs and fragmentation

• Requirements in existing legislation/regulation to use specific

arrangements/types of infrastructure

- role of central entities (eg FMIs) and access points (eg banks)

• Operational and prudential requirements for regulated entities

(intermediaries, business partners, corporate treasury departments)

How should regulation take into account rapid technological

developments (technology neutral, supportive, restrictive,…)

Need for dedicated new rules or adapting existing regulation

– collaborative or top-down?

Need for regulators to adapt own frameworks for data access and

reporting – «RegTech»

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Implications for central banks

Operational role

• Assessing potential of digital innovations for efficient and safe central bank

infrastructure services for settlement of payments and securities

• Assessing impact on monetary operations and central bank money issuance

• Considering adaptations and interfaces

Catalyst role

• Facilitating private sector efforts to improve market efficiency

• Promoting work on standardisation and interoperability, countering the risk of

silos and proprietary solutions

Oversight, supervisory and financial stability role

• Assessing possible impact of technology adoption on overseen/supervised

entities and their business models and the financial markets at large

• adapt central bank frameworks for data collection and handling (RegTech)

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Involvement of regulatory standard-setting bodies

• Global sectoral and cross-sectoral analysis and evaluation– monitoring developments and evolution of digital schemes

– impact on services and financial institutions

– security and operational (cyber) resilience of products and services

– relevance for AML / TF

– legal aspects

– impact on financial intermediation

– relevance for financial inclusion

– wider impact on financial stability

• Assessment of need for global regulatory guidance (risk-based

approach)

• An ad-hoc coordination group has been established as facilitator

of information sharing and coordination between global standard-

setting bodies (BCBS, CGFS/MC, CPMI, FSB, IAIS and IOSCO)

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Involvement of CPMI and ECB

• In 2015, the CPMI set up a working group on digital innovations

• As part of the global collaborative efforts, in 2016, a joint working group

of CPMI and IOSCO was established in 2016

• Reports scheduled for the first half of 2017– assessing key DLT use cases in payment, clearing, settlement, and

recording and their implications (benefits and risks) for market

infrastructures and payments

– establishing a framework to assess DLTs (looking i.a. at legal risks,

governance aspects, settlement issues or operational challenges)

– identifying key issues for potential public sector action

• In 2016, the ECB organised cross-departmental analytical work on the

impact of digital innovations on central bank activities– The work is coordinated by a FinTech steering group chaired by a board

member and is looking into three priority domains: (i) impact on Eurosystem

infrastructures; (ii) access to central bank money; and (iii) impact on

overseen financial entities

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Rubric


Outlook

• Increasing impact of digital innovations

• Reaction of incumbents (such as banks and infrastructures) on

innovations and new competitors (“second round” effects)

• Enhanced focus on cyber resilience

• Leveraging by relevant public bodies on financial inclusion

• Global standardisation efforts (by standard-setters and industry

bodies)

• Initiatives to enhance (cross-border) interoperability

Legal and regulatory frameworks to be adapted to the evolving

landscape

Further need for cooperation and coordination of central banks

and regualtory authorities (at the national and international level)

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