European Central Bank Report On Bitcoin: It’s Likely To Grow And It Poses Risks

The European Central Bank (ECB) recently issued a report on digital currencies.  The report largely revolves around Bitcoins and Linden Dollars, and provides a review of the currencies from the perspective of central bankers.  Unsurprisingly, they found the currencies to pose “risks” that potentially require future “regulation.”

Here’s a few of the highlights that deserve some commentary:

In an extreme case, virtual currencies could have a substitution effect on central bank money if they become widely accepted. The increase in the use of virtual money might lead to a decrease in the use of “real” money, thereby also reducing the cash needed to conduct the transactions generated by nominal income. In this regard, a widespread substitution of central bank money by privately issued virtual currency could significantly reduce the size of central banks’ balance sheets, and thus also their ability to influence the short-term interest rates. Central banks would need to look at their existing tools to deal with this risk (for instance, trying to impose minimum reserve requirements on virtual currency schemes).

The substitution effect would also make it more difficult to measure monetary aggregates and, as a consequence, would affect the relationship between the monetary aggregates as measured and inflation, which is used to gauge risks to price stability in the medium to longer term.

Lastly, on this second aspect, when virtual money is created outside the realm of the central bank and virtual credit can be extended, this may have implications for the way interest rate decisions by the central bank are transmitted through the economy and the central bank’s control over money and credit developments could become less effective.

Obviously these are not a risks to people like you and me, but they are risks to central bankers, state actors and others who derive their income from forcibly imposed central bank monopoly money interest rate manipulation.  The paragraphs are rather startling in their explicitness.  They are essentially saying that if enough people transacted in Bitcoins instead of dollars or euros, the central banks would lose control over their ability to manipulate interest rates.  Indeed, the entire point of Bitcoin is to provide a currency that cannot be manipulated to suit the whims of commercial banks, central bankers and politicians.

Of course, the question of why central bankers should have such power in the first place is never addressed in the report.  Central bankers ARE central planners – straight out of the Soviet Union.  They have the power to direct massive swaths of resources throughout the economies under their control by manipulating interest rates to suit their whims.  In fact, central banks were so important to communism that Karl Marx enshrined them as a core plank of the Communist Manifesto.  Central bank manipulation of interest rates has absolutely nothing to do with free market economics, and everything to do with central planning and control by a power elite.

Central banks manipulate interest rates by essentially printing funny money into existence.  Professor Roger Garrison details the deleterious effects of central bank manipulation of interest rates on economies in this lecture.  Is it surprising that central bankers would be aghast at a currency that they couldn’t print into existence?

The report goes on to list some more “problems” associated with virtual currencies from the perspective of the central planners:

In these schemes, the settlement asset is the virtual currency, and therefore the finality and irrevocability of payments cannot be ensured. Only central bank money can do so, because central banks present no default risk and act as lender of last resort to the member of the system in order to stop any possible chain reaction resulting from payment incidents or unforeseeable liquidity shortages. Virtual currencies cannot therefore be considered to be safe money, since the likelihood of the asset retaining its value for the holder, and hence its acceptability to others as a means of payment cannot be ensured. It simply relies on the creditworthiness of the issuer of the settlement asset. The level of safety is clearly below that of commercial bank money, as commercial banks are subject to prudential requirements and are supervised in order to reduce the likelihood of default, thereby improving the safety of claims on these institutions.

This is a fundamental risk relating to virtual currency schemes, which do not involve any kind of supervision of the settlement institution or oversight of the system, and therefore no one is accountable for their acts. Nor is there any kind of investor/depositor protection scheme in place.  As a consequence, users bear all of these risks themselves.

I find this section to be hilarious.  First off, it’s pretty much a bucket of lies as far as Bitcoin is concerned, although some of these criticisms may apply to other forms of virtual currencies.  The fact that they make no distinction between various types of virtual currencies with their criticisms speaks volumes about their motives.

For starters, the finality and irrevocability of Bitcoin transactions is 100% assured by the cryptographic algorithms and software architecture the network uses.  It is impossible to have chargebacks with Bitcoin.

They claim that virtual currencies cannot be considered to be safe money because their acceptability to others as a means of payment cannot be ensured, while at the same time the U.S. central bank has doubled the monetary base in less than a year, pushed interest rates down to zero and bought up so many government bonds with funny money that a third of every dollar the U.S. state spends is based on the issuance of new debt.  And let’s not forget China, India, Iran and Russia using gold to conduct trade with each other, bypassing our petrodollar hegemony entirely.

It’s a joke for them to argue that central bank issued money is somehow safer than currencies like Bitcoin, which cannot be subjected to any such insane manipulations by sociopathic bankers and politicians.  The U.S. and Euro zone are not immune from the economic laws of the universe.  If they continue debasing their money the way they have been, eventually the rest of the world will get fed up with their nonsense and stop taking their funny money in exchange for goods and services.

Further, this section presents a bit of a red herring.  They are claiming that virtual currencies rely on the creditworthiness of the issuer of the settlement asset (virtual currency), which is ridiculous, at least as far as Bitcoin is concerned.  Bitcoin, like gold, has no counterparty risk.

The report concludes:

If the use of virtual currency schemes grows considerably, incidents which attract press coverage could have negative impacts on the reputations of central banks, if the public perceives the incidents as being caused, in part, by central banks not doing their jobs properly. As a consequence, this risk should be considered when assessing the overall risk situation of central banks.

In other words, if there is a major incident, like a Bitcoin exchange being hacked and robbed, the bankers are concerned this might tarnish their image, and therefore, they should seek to regulate Bitcoin based on this possible misperception by the public that somehow the central banks weren’t doing their job.  Seriously?  They consider this to be a valid reason as to why they should “regulate” a private currency market?

None of the criticisms of virtual currencies in the report surprised me in the slightest.  As you can see, they aren’t concerned with anything remotely related to free market economics, property rights, free trade, etc..  The only thing they are concerned about is a loss of their own power, which leads them to suggest that “regulation” of virtual currencies by central banks may be necessary in the future.  I hope you can see that “regulations” have nothing to do with your best interest, but rather they always are geared toward the interest of those in power.

A little post script for my readers:

The ECB cites Jon Matonis’ article entitled “Why are Libertarians Against Bitcoin? ” in which Matonis heavily cites my work.  It’s nice to know that the people at the ECB are taking Matonis and I seriously.  Hopefully they read this piece as well.

  • Aff

    Is that the best they can comed up with? Pathetic. Great article

  • Yea the association of Bitcoin and credit risk makes little sense. Maybe they were referring to the Linden Dollar with that?

    The macroeconomic worries were overblown too. ECB could conduct open market operations between Bitcoin and Euro without problems if it wanted to. Are they worried that Nakamoto will come out and forbid them doing it? When Bitcoin is open source and no property rights in it?

    Bitcoin could though affect the Euro multiplier as they claim, and make the job more difficult to the central bank. This is similar to countries where a high proportion of money is foreign, and this effect has been analysed by economists (I think Levy Yeyati specialises in this). Still, there is no fundamental problem for the ECB.

    The most problematic in the report are, as you write, the delusions of grandeur.

    • Yeah it’s sneaky how they word the report. By mixing currencies such as Bitcoin and Linden Dollars together, they come up with broad reasons why they should be able to regulate all digital currencies. If they just looked at Bitcoin on its own, there wouldn’t be any reasons at all.

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  • I love the idea of virtual currencies competing with hard currencies like gold or barter goods in a free society. It’s understandable why the ECB wouldn’t like Bitcoin interfering with their inflation of the monetary system; it would make them look like the looney tunes they really are.

    • The issue with virtual currencies is that they have the same issues as other fiat currencies. In fact that lack even more of the qualities needed for a valid currency.

      Now a barter system is a great supplement or alternative to our current economic system and depending on the tax code in Europe it may work. The current American tax code prevents bartering on a large scale.

      • But fiat currencies have a very keen difference: their use is legally-required. Virtual currencies are market currencies, not subject to the whim of legislators and bureaucrats, and one can choose to use or not to use them at his own discretion. No, there’s nothing tangible or intrinsically valuable about a Bitcoin, but its value is set by the market, not twelve schmucks sitting in a boardroom at a mahogany table.

        • Yes. On that I agree. It’s far more difficult for the government/banking industry to manipulate a virtual currency. It’s the closest intermediary to bartering.

          The problem is that its value isn’t set by anything. What’s the difference between one bit coin and a million? How do you decide how much to charge in bitcoins?

          With a real currency–not a fiat currency–the value is set by factors such as scarcity, energy required to produce the currency, etc.

          • Perhaps you should look deeper into what Bitcoin really is. There is, indeed, a production cost for Bitcoins, and there is certainly scarcity involved. That’s why Bitcoins have been increasing in value, from less than $3 a year ago, to over $12 within the last month. Demand is increasing as more people learn about Bitcoin, while the dollar is simultaneously being devalued.

            Seriously, look into how Bitcoins are “mined.” There’s a significant production cost involved.

          • It’s still something that’s set in an arbitrary way and can be manipulated at any time. I’d imagine that a sufficiently skilled programmer can modify the algorithm to start spitting out coins.

          • Again, look into it. It’s completely decentralized; there’s nothing that a single individual can do to modify the system in his favor. It’s very well thought out.

          • I have and there are issues with it.

            1. Early adopters get rich quick while late adopters have trouble earning anything
            2. It’s easy for someone to create malware that mines for them
            3. Exchange rate with real currencies varies by a great deal
            4. Lack of privacy
            5. Lack of security of money — system goes down and you lose everything. Likewise you lose everything if you end up losing your .dat file.

            I’m not saying that it doesn’t have potential, but I don’t think that bitcoin is going to have a major effect on our economic system and I don’t think it will be here to stay.

          • 1. Not a problem. Early adopters took the risk, plus mining is done by huge farms now, so individuals don’t earn much anyway. Plus, deflation will continually increase the value of later adopters’ Bitcoins.
            2. So? If that’s the case, then why hasn’t someone done it yet? Even if that were the case, it becomes increasingly less useful, plus mining is doing a service to the p2p system.
            3. Exchange rates between fiat currencies vary too. That shouldn’t be a reason to discount Bitcoin any more than the Renminbi or the Euro as a viable currency.
            4. Everything is anonymous and encrypted with currently-unbreakable encryption, which can be augmented with future encryption standards. Thus, privacy isn’t an issue.
            5. In order for this to happen, every Bitcoin-using computer in the world would have to be destroyed. And you lose everything if your wallet containing your cash goes missing.

            It isn’t likely to replace the dollar as the reserve currency, but Bitcoin is a vital tool for counter-economic activity.

          • Deflation would help the early adopters not the late adopters. Also the supply runs out after a very short period of time. Do you think people would have used gold if the entire reserve of gold in the world was going to run out in a few years? How long have we been mining gold and there’s still more.

            There have been multiple large scale hacks and thefts through the bitcoin system. Malware is and has been used to mine bitcoins.

            Exchange rates vary far more with bitcoin. There are massive swings in value.

            I don’t think the information for bitcoin value is stored on every single computer at the same time. It wouldn’t be improbable for some information to be lost.

            So again, for those reasons and others I don’t see bitcoin as gaining a large enough following to effect our economy. It’s an interesting experiment, but I feel nothing more than that.

            It may serve as a foundation for something that does succeed however.

  • Tom

    Actually, I love gold and silver – having tangible possession of real money. But I’m fascinated with virtual money – anything sensible that stands a chance of freeing us from the scheming central bankers.