Written by:
Matthew Field, Policy Advisor, Digital, UK Finance

When UK Finance responded to the FCA’s discussion paper on Distributed Ledger Technology (DLT) in July of 2017, it was the technology underlying digital currencies (blockchain) and not the digital currencies themselves that were making the headlines. Fast forward six months and it is private digital currencies like Bitcoin, Ethereum and Ripple’s XRP which are dominating the headlines. First, I do not want to go into the discussion here of whether to believe comparisons to tulips or the pop-up banners telling me Ethereum is to rise 49,000% (because 50,000% would clearly be unbelievable). What I do want to cover is the question that UK Finance is being asked repeatedly, which is what are the UK’s financial services firms doing in the digital currency space?

The second thing to say is that there are important differences between private digital currencies (otherwise known as cryptocurrencies) and central bank digital currencies (a digitised fiat currency controlled and backed by a central bank). Although research and development of the latter are underway in a number of jurisdictions (e.g. Singapore, Hong Kong, Canada and the UK) and may in the end hold more implications for the financial system than the prior form, it is private digital currencies that I am focussed on here.

The view from other markets like the US is no less clear. Jamie Dimon and Lloyd Blankfein are famously on the record as saying bitcoin is a “fraud” and a “vehicle to perpetuate fraud” respectively. On the other hand, JP Morgan is a founding member of Ethereum Enterprise Alliance and Goldman Sachs has the slickest website explaining blockchain that I have seen yet. The point is that not all digital currencies are the same and the financial services industry is taking different and nuanced approaches to all of them depending on their own individual strategies.

But there are some commonalities. As the FCA noted in its recent feedback statement on its DLT discussion paper, using digital currencies as the transfer vehicle for international and micro payments is one of the most likely use cases. However, FS firms are typically not turning to bitcoin to perform this function. Instead they are developing their own solutions like the Utility Settlement Coin project or signing up with third-party solutions like Ripple. The real difference here is between using a digital currency that is open to all, and designing a solution, possibly using one of those digital currencies, that is closed to everyone except a select group of participants (in the parlance, persmissionless versus permissioned).

The FCA was positive about private digital currencies in its feedback statement saying “permissionless networks have positive competitive potential in the context of value transmission”. That may be the case, but until the regulatory approach to digital currencies is better understood and the markets more developed, larger firms will continue to avoid interacting with these currencies.

There are good reasons for this. In our response to the FCA we listed some of the risks arising from private digital currencies. These include:

  • the uncertainty of tax implications may outweigh the benefits for businesses and users (depending on the jurisdiction);
  • the global nature of private digital currencies and lack of common regulatory approach adds additional complexity;
  • AML: private digital currencies (e.g. bitcoin) introduce AML risks due to use anonymity and the lack of a tie to a central bank, government or regulatory framework; and
  • there are security and theft risks posed by private digital currency businesses for consumers and volatility risks for investors. The extent to which these risks differ from other categories of currency or investment is still under debate.

Regulatory clarification may not be far away. French Finance Minister Bruno Le Maire has recently said that the regulation of bitcoin should be a subject for the next G20 meeting. If action is to come, then a global approach will be necessary to ensure effective regulation. In the meantime, UK Finance members ask that regulators continue to work with the industry to understand the risks and benefits of digital currencies so that if and when regulation becomes necessary, it can come from an informed and risk-based approach.

Currency that came in from the cold: how financial services will interact with digital currencies