Unchartered waters

The Reserve Bank of India recently announced that it is exploring a digital version of its currency or an online version of the rupee. If India pushes through with its plan, then it will be the first central bank in the world that will enter this unknown and unchartered world of central bank-backed digital currencies.

Right now, we have so called virtual currencies or VCs, which our Bangko Sentral ng Pilipinas (BSP) describes as a type of digital currency created by a community of online users, stored in electronic wallets, and generally transacted online.

VCs are not issued or guaranteed by central banks or government authorities unlike notes and coins issued by the BSP, which are legal tender. Currencies issued by the BSP and other government monetary authorities have underlying values that are not subject to fluctuations since one of the mandates of  central banks are precisely to maintain the stability of their currencies.

Although VCs are not central bank-backed currencies, the BSP explained on its website that they may be transferred within the community of users, used to buy virtual items or even real goods from online shops or merchants that are willing to receive the VC as payment, so that in a sense VCs become a medium of exchange.

The BSP further explained that VC is a general term that covers different types depending on the business model. It can be centralized where one entity or individual issues the VC, decentralized meaning there is no central repository or administrator, but there are several entities or individuals that maintain the VC convertible or one where the VCs can be exchanged to fiat currency and vice versa, or cryptocurrencies.

Cryptocurrency, it pointed out, is a type of VC that uses cryptography, which is a method of storing and transmitting date in unreadable form so that only the intended receivers can read and process it. This allows cryptocurrency transactions to be carried out in a decentralized manner by a group of users. The first and most popular cryptocurrency to date, the BSP mentioned, is “Bitcoin,” introduced in 2009.

The BSP added that VC is distinct from fiat or real currency, the latter being the coins and paper money minted and printed by the central bank of a country, designated and circulated as legal tender in the country, and used and accepted as a medium of exchange in the same country. Fiat currency is fully backed by the government of a country and is acceptable as payment for public and private debts.

VC is also different from e-money, which is a digital representation of fiat currency, the BSP said. E-money is convertible to fiat currency in licensed e-money issuers or e-money agents and is used to electronically transfer monetary value that is equivalent to or similarly denominated as fiat currency. And just like real or fiat currency, e-money is legal tender.

But the BSP warns that while VCs and the digital ledger technology that powers VCs have potential to facilitate delivery of legitimate financial services, such as remittances and electronic payments, there are inherent risks.

It explained that the value of VCs is solely driven by supply and demand. Because of speculations in the VC market, their prices are unstable and change quickly over time. Unfortunately, it is the users who trade, invest or accept VCs that bear the risk of loss. There is no legal protection available for VC users in such cases.

The BSP also warned that VC transactions have a high degree of anonymity and this pseudo-anonymous and online nature of VCs make them attractive to fraudsters, scammers, and people who may intend to do unlawful activities like money laundering or terrorism financing.

And just like any asset that is available online, the BSP cautions that VCs may be subject to hacking or theft, virus infection, and other cyber threats. In case of fraudulent, unauthorized or erroneous transactions, VC holders may find it difficult to reverse said transactions, file complaints or seek recourse since there is no central authority or issuer that backs or guarantees them, unlike fiat or real currencies, it said.

And since VCs are not considered as deposits in the Philippines, in case the VC Exchange folds up or stops operating, VC holders cannot claim deposit insurance from the PDIC unlike deposits in banks.

Following the rise in the use of VCs for payments and remittances in the Philippines, the BSP said it has established a formal regulatory framework for VC exchanges or those companies or businesses engaged in changing VCs into fiat currency and vice-versa. Such exchanges are now required to register with the BSP as remittance and transfer companies and are required to put in place adequate safeguards to address the risks associated with VCs, such as control measures to counter money laundering/terrorist financing, technology risk management systems, and consumer protection mechanisms.

But that is the extent to which the BSP recognizes and regulates VCs. Investors and users still bear all the risks, especially if they are into online trading.

And just like the Philippines, the US does not consider cryptocurrencies to be legal tender. The US defines cryptocurrency or VC exchanges to be money transmitters.

Elsewhere, central banks are looking into issuing digital currencies either to commercial lenders or to the public directly, following a decline in cash usage and growing interest in cryptocurrencies.

The Reserve Bank of India (RBI) was scheduled to launch its first digital currency trial program and was studying various aspects of digital currencies, including its security, its impact on India’s financial sector, and how it would affect monetary policy and currency in circulation, according to a report by cnbc.com.

According to the report, China is already conducting real-world trials across several cities while the European Central Bank and the Bank of England are also looking into a digital euro and a UK central bank-backed digital currency (CBDC).

As explained in the report, CBDC would differ from other VCs in the sense that they would be fully regulated and would be under a central authority, and would not be subject to wildly fluctuating prices since they would function just like their fiat counterparts.

The world still needs a strong regulatory framework that will put a check on the use of VCs, and cryptocurrencies in particular. India’s proposed Cryptocurrency and Regulation of Official Digital Currency bill has reportedly been held back. Singapore has its Payments Services Act that streamlined both traditional and cryptocurrencies under one law. Switzerland has mandated its Swiss Financial Market Supervisory Authority to oversee all financial markets, including virtual asset service providers and cryptocurrency exchanges, all of which need to be licensed.

Our Philippine Stock Exchange believes that if there will be a cryptocurrency exchange or trading in the country, then it should be the PSE that should serve as platform for crypto assets. The Securities and Exchange Commission (SEC) requires that entities engaging in initial coin offerings (ICOs) should get the necessary license to offer and sell from the commission since they are considered as securities.

We should not ban the use of VCs, because as pointed out by the BSP, they may provide benefits. For instance, remittances and fund transfers when facilitated using cryptocurrencies and VCs through licensed VC Exchanges are relatively more convenient, faster, and cheaper compared to traditional remittance and payment schemes. As a digital value or asset, VCs are also easier to use as payment for goods and services that are offered online and this can support the growing e-commerce industry in the Philippines, the use of social media, mobile technologies, and other innovative platforms as delivery channels for financial services, the BSP said. It added that VCs also have the potential to expand financial inclusion since they may be used to facilitate and expand financial services for low-income Filipinos and those living in far-flung areas where traditional providers like banks are absent.

But our government needs to minimize the risks, not only for those utilizing licensed VC Exchanges, but also for those who completely transact online to prevent users from falling prey to criminals. We need a good law, as well as a holistic government approach and regulatory framework to combat the negative aspect of VCs and cryptocurrencies in particular.

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