Remarks by Timothy Lane
Deputy Governor of the Bank of Canada
Haskayne School of Business
University of Calgary
Calgary, Alberta
October 1, 2018
Decrypting "Crypto"
Introduction
Good afternoon.
Some of you here today may have purchased bitcoins or one of the other
I'm not here to
cryptocurrencies or products that have launched in recent years.
give you investment advice about them. Rather, I want to share with you our
current thinking about these virtual products.
Investors worldwide have taken an increasing stake in them over the past few
years, even as their market values have fluctuated widely. Around 2,000 crypto
products are now available, with dozens more launching every month.1 Trading
volumes have grown almost 100-fold in just the past two years. Media interest in
them has inflated at a similar pace, often including a thick layer of hype. The
recent collapse in the market valuations of many cryptoassets-almost 40 per
cent of those originally launched are now worthless-seems to have done little to
dampen enthusiasm.2
Some investors see these products as potentially world-changing; others as an
the madness of crowds."3
example of "popular delusions and Possibly both are
right. New financial or technological innovations often ignite market bubbles as
users race to discover their most popular and profitable applications. Think of the
bubble of the late
"dot-com" 1990s, when prices of many Internet-related stocks
shot into the stratosphere. While that period ended in tears for many investors, a
handful of new companies that rose at that time, such as Google and Amazon,
have brought about profound changes in the way we work, play, shop and live.
The Bank of Canada is not responsible for regulating these crypto products.
Indeed, the term "cryptocurrencies" is a misnomer.
We prefer to call them
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"cryptoassets" because, as I will discuss in a moment, they don't do a good job of
performing the basic functions of money. But as they evolve, they may touch on
the Bank of Canada's
core functions: monetary policy, financial stability,
payments and currency.
In my remarks today, I'll put these crypto developments in context, discuss the
the
need for globally harmonized regulations and highlight Bank's research and
responses to public interest in cryptoassets.
Currency and trust
Bitcoin and many similar products were created in the hope that they would
become the money of the future. How well do they stack up against the money of
the past and present? This includes bank notes as well as bank deposits that can
parents'
be accessed with a debit card or-for your generation-by cheque.4
Let's consider
bank notes. One of our core functions at the Bank of Canada is to
provide bank notes that Canadians can use with confidence. This is perhaps the
most visible aspect of our work.
We all take for granted that if you want to buy a coffee you can pay with cash.
The coffee shop deposits the cash in the bank and uses the funds to pay for
beans and baristas'
wages. The cash is universally accepted by all parties. Why
is that?
First, bank notes are a simple but effective technology for keeping track of who is
is a physical thing, you can't
paying how much to whom. Because a bank note
spend the same note twice. Many Canadians still prefer the simplicity of cash for
small transactions. And cash works even when systems are down.
Second, bank notes offer privacy for your transactions. You can use them without
giving anyone your personal or banking information. Using cash avoids the risk of
being hacked or having your card compromised. Privacy is a controversial
attribute given that bank notes are a preferred medium of exchange for all kinds
of illicit transactions. But for entirely legitimate reasons, most people place a high
value on the privacy of their financial transactions.
Third, we incorporate into our bank notes the most advanced security features to
ensure they are difficult to fake and easy to authenticate. We also work closely
with law-enforcement agencies to deter counterfeiting.
Fourth, the acceptance of money is a matter of social convention. People accept
cash as a means of payment because they know that others will do the same.
This convention is enshrined in law: Canadians understand that we and the
Royal Canadian Mint have a monopoly on the issuance of what's called legal
tender, the official money used in Canada.
Finally, bank notes are denominated in dollars that offer stable purchasing
power. The Bank of Canada helps preserve their value by keeping inflation low,
stable and predictable. Since the early 1990s, when we adopted our inflation-
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targeting monetary policy framework, we have maintained inflation close to the
midpoint of our 1 to 3 per cent target range. This has allowed Canadians to make
spending and investment decisions with the confidence that the future
purchasing power of their money is secure and predictable.
After a quarter century of successful inflation control in Canada, overall price
stability has become the new norm. But some of us can recall the impact on
households of spiralling inflation during the 1980s, when the interest rate on
mortgages hit 20 per cent. Even today, while many countries have tamed
inflation, some like Venezuela are coping with hyperinflation that is causing
widespread hunger and hardship.
The trust and confidence that Canadians have in our notes and in their
purchasing power is based on our track record and reputation.
Cryptoassets: what's their story?
So where do cryptoassets fit into this picture?
Their proponents argue that the great benefit of Bitcoin and other forms of crypto
cash is that they eliminate the need for public institutions like a central bank or
don't have to trust
large commercial banks. People using this system, they argue,
That's true,
an individual or institution. but they do have to trust the technology.
Cryptoassets are so called because they use cryptography to validate
transactions and prevent fraud. Records are kept through blockchain
technology-a digital ledger stored on thousands of computers worldwide that
keeps track of every coin or token issued. Anybody trying to fraudulently use their
crypto cash multiple times will likely be caught by the validation process on all
these computers.
The use of encryption gives cryptoassets a similar level of privacy as bank notes.
And they are as light and borderless as air. You can transfer them across town or
across continents much more easily than you can a suitcase filled with $100 bills.
A key feature of most cryptoassets is that their value is not tied to the dollar or
other national currencies but has its own unit.
Blockchain provides a mechanism for creating new tokens that makes it difficult
to generate more in any way other than as prescribed by its underlying software.
To create new units of value, cryptoassets must typically be "mined" by running
energy-intensive computer computations. This is, in effect, a form of
preprogrammed monetary policy: the purchasing power of the crypto tokens is
determined by supply and demand, where the supply is limited by the enabling
software.5 This pre-programmed mechanism for creating cryptoassets was
originally a key selling point. Those who believed that central banks could not be
trusted to maintain the value of money were attracted by the idea of a money that
is untouched by any public institution or individual.
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Ironically, this very mechanism has turned out to be its fundamental flaw. When
the limited supply of tokens meets large flows of demand from enthusiasts, the
result-as we have seen-is wild fluctuations in the value of cryptoassets. These
fluctuations have drawn in even more speculative money, which has further
amplified the price movements. Indeed, many Canadians who purchased bitcoins
so for "investment"
in 2017 reported that they did purposes-and that really
means speculation.6
The implication of these price movements is that the purchasing power of
cryptoassets is far less stable than that of almost any sovereign money. The
value of a bitcoin in US dollars topped $20,000 in the last year and is now down
to around $6,000. Such wide price movements make it unlikely that the current
crop of cryptoassets would ever be used as money for ordinary purposes when
there is a stable national currency.
Cryptoassets are also very expensive to use. Transaction costs were high in
2017-as much as $55 per transaction-compared with almost zero for cash.7
These costs have come down since then, but if transaction volumes push the
limits of the network again, costs will jump back up.
In short, the current crop of cryptoassets is not about to replace the Canadian
dollar or other national currencies. They are products that may be largely of
interest to three kinds of users:
•
investors, who should be fully aware of the risks they are taking;
•
residents of countries where there is no trustworthy national currency; and
•
those undertaking illicit transactions, including tax evasion, money
laundering and terrorist financing, for which the property of pseudonymity
makes them an ideal way to move funds.
The crypto ecosystem
So far, I have been talking about digital tokens launched with the ambition of
becoming a form of currency. Now, many digital tokens are being created without
any such ambition.
Every month, dozens of new crypto products are launched through initial coin
offerings (ICOs). In an ICO, investors purchase a new digital token in exchange
for cash or for other, more established cryptoassets. Some of these resemble the
initial public offerings that private companies use to raise capital by offering their
stock to the public for the first time. In this way, they are like crowdfunding-a
means to raise equity capital without jumping through all the regulatory hoops
needed to issue publicly traded securities. Other ICOs offer the purchaser the
right to use services on a platform that has yet to be built-and are thus more like
the economic equivalent of a gift card. In yet other cases, the promised benefits
to the purchaser are more nebulous.
6
See the results of the 2017 Bitcoin Omnibus Survey conducted by the Bank of Canada.
7
See Bitcoin average transaction fee.
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Those ICOs that function in a similar way as shares in a new company raise all
the same issues as any other stock offering. Their value is based on the profits
from some enterprise, so investors need to be able to verify that the enterprise
actually exists and keep track of what it is doing with the funding it raises.
In practice, ICOs have not always met that standard. For example, failure to meet
hasn't
funding targets always resulted in the return of money to investors. And in
exceeded, it's not always clear how
cases where funding targets were ICOs are
using the extra money.
Thus, while there are certainly advantages to a flexible, technologically advanced
method of funding innovative enterprises, investors in ICOs need to be wary of
fraud and misrepresentation.
Given the steady introduction of new types, crypto products are often hard to
classify. Many will prove to be short-lived.
Yet it would be a mistake to dismiss all these innovations as fleeting fads. Some
products may turn out to be smart and useful-by finding better, cheaper, more
competitive ways of filling an actual need. If they do that, they could also
challenge the existing business models of established financial institutions. For
example, if the risks are properly managed, cryptoassets could potentially serve
as a new funding tool, allowing small businesses to find the capital they need.
Some also argue that cryptoassets could deliver financial services to segments
of the population that are underserved by existing financial institutions.
Even if the products themselves ultimately fail, they advance the development of
technologies that are likely to be useful for a range of other purposes.
Cryptoassets spurred the development of distributed ledger technology (DLT),
which may have many valuable applications. At the Bank of Canada, through our
Project Jasper, we have been exploring the potential use of DLT to streamline
the settlement of financial transactions and the associated back-office activities.8
This technology may have many other uses, such as registries for anything from
land to commodities, trade finance and parolees in China.
Although cryptoassets themselves exist only in cyberspace, they connect with
the real economy and the financial system at various junctions-comprising a
kind of crypto ecosystem. One point of contact is the direct use of these products
to pay for goods and services over the Internet. A second is ICOs.
Third, certain investment products in the mainstream financial system are linked
in some way to the valuations of cryptoassets. These include derivatives
contracts that have been launched on some commodity exchanges and
exchange-traded funds.
A fourth important point of contact is crypto exchanges, where cryptoassets are
traded for money or for other cryptoassets. Crypto exchanges have been set up
in different ways, which makes them hard to classify. Some exchanges have an
8
See Could DLT underpin an entire wholesale payment system?
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economic function similar to banks: they hold cryptoassets on behalf of their
clients, so the client gives up direct control of the cryptoassets themselves and
has a claim on the exchange.9 Other crypto exchanges function more like
electronic trading platforms for cryptoassets.
The regulatory arena
The newness of crypto products and the fact that they claim to be delivering
some of the same services provided by regulated financial institutions raises key
questions. What risks could they pose? Should they be regulated? If so, how?
As I mentioned earlier, the Bank of Canada is not responsible for regulating
crypto products. Nonetheless, we have been examining their potential impact on
the stability of Canada's financial system. We've also been participating in
international research on them, through the Financial Stability Board (FSB), G20
and G7.
Regulators need to examine cryptoassets from a number of angles:
•
the potential risks to the stability of the financial system,
•
the integrity of markets and protection of investors, and
•
protection against abusive financial flows such as money laundering and
terrorist financing.
The consensus of policy-makers is that crypto products do not yet pose financial
stability risks.10 This is in part because, despite their rapid growth, crypto
products have a relatively small footprint in the financial system. The market
capitalization of all cryptoassets was recently estimated at $230 billion and the
volume of trading in these products at about $15 billion annually. While these
seem like big numbers, they are dwarfed by other global financial markets: global
equity markets alone have a market capitalization of around $100 trillion.
Moreover, crypto products are not deeply interconnected with the mainstream
financial system. For example, there is little evidence that commercial banks are
investing in cryptoassets or accepting them as collateral.
In this context, the immediate priorities are to address the other two issues I
mentioned: investor protection and abusive financial flows. In these areas, the
relevant regulators are working hard to adapt their frameworks to cover these
new products.
But things are evolving rapidly. Cryptoassets are growing in size, complexity and
interconnectedness. As the underlying technologies and the design of crypto
products evolve, we need to be ready to reassess how they might affect financial
stability. Some potential aspects include the integrity of payment systems, bank
business models, and the exposures of financial institutions and infrastructures.
The FSB and related bodies are monitoring this evolution closely.
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Regulators also have to be forward-thinking about what kind of action may be
required. That means putting in place a framework that is sufficiently adaptable
so when new products emerge that potentially pose new risks, regulatory
agencies will be ready.
Crypto products are already regulated in many countries at the national or
regional level. But in many jurisdictions the regulatory framework is far from
complete. Also, given that cryptoassets are global in scope and not confined by
borders, an emerging problem is the gaps between regulatory regimes.
Different jurisdictions have adopted different regulatory approaches, depending
on how they have defined these assets. When a new product is launched, is it
classified as a payment instrument, a security, a commodity or none of the
above? Should crypto exchanges be called banks, financial market
infrastructures or something else? These classifications differ across jurisdictions
and in some cases remain nebulous.
Beyond these differences in classification, the regulatory treatment of these
assets differs. In China, the response has been to ban them. In Japan,
authorities are creating a framework to manage the risks associated with their
growth.
Such differences among regulations globally, together with the incompleteness of
regulation in many jurisdictions, open room for promoters to engage in regulatory
arbitrage, developing new products to exploit them. Regulators must decide how
far they need to go in harmonizing their approaches with other countries.
Differences in the regulatory treatment of these products for controlling money
laundering and terrorist financing are a particularly pressing concern.
Such factors pose key challenges for regulatory agencies. Data and a consistent
means of collecting them are required to assess emerging risks. And an agreed
system is needed to classify new products by their attributes and economic
functions.
At the same time, we need to avoid regulation that is so heavy-handed or
cumbersome that it stifles innovation. New crypto products could deliver more of
what the public wants and bring more competition and financial inclusion to the
system. Developments in this space could spur the growth of technologies that
have important positive spinoffs. These concerns must be carefully balanced.
The regulatory framework in Canada is still a work in progress, but a number of
steps have been taken by the federal and provincial governments, which share
jurisdiction in this area.
amended Canada's
In 2014, the federal government anti-money laundering
legislation to include businesses dealing in cryptoassets. Regulations based on
the legislation are now being finalized. The Canada Revenue Agency also
published a note on the tax laws that apply to cryptoassets. And the Financial
Consumer Agency of Canada has a useful backgrounder on the risks and tips for
using cryptoassets.
At the provincial level, the Canadian Securities Administrators issued a staff
notice in 2017 on crypto offerings, warning investors about issues such as
volatility, transparency, valuation, custody and liquidity, as well as the use of
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unregulated cryptocurrency exchanges. The notice also offers guidance on the
applicability of securities laws and what steps businesses should take if they are
raising capital through ICOs.
Central bank digital currency
At the Bank of Canada, we are also considering the potential implications of
these developments for our own core functions. In particular, we are assessing
how we could respond if cryptoassets were to evolve in a way that undermines
our ability to provide Canadians with a means of payment with stable purchasing
power that they can use with confidence. This is related to our ability to
implement effective monetary policy as well as to the security and finality of
settlement we provide through our bank notes. While we do not have any doubts
currently about our ability to fulfill our mandate, contingency planning is
important: the changes driven by technology may be rapid.
In this context, one of our priorities is to explore under what conditions, if any, we
might recommend to the government that we issue our own digital currency. At
the same time, we are studying key design questions related to a central bank
digital currency (CBDC), such as what form it might take and whether it would be
anonymous like cash. As it turns out, the questions of "under what conditions"
and "in what form" are closely intertwined.
The design of a CBDC has important implications for its risks and benefits. For
example, some major reasons for caution about a central bank digital currency
are concerns that it could become a vehicle for illicit transactions or that it could
have significant negative implications for financial intermediation. Unless such
risks could be managed through appropriate design, the Bank would not
recommend issuing such a currency.
Ultimately, then, this exploration is going to require a unique combination of
economics, technology and business strategy as well as thorough consultations
with all stakeholders. We have assembled a multidisciplinary team to do this
work and will provide more details as the research unfolds. We are also
exchanging information with other central banks, notably the Swedish Riksbank,
which is well along in examining CBDCs. The results of our work in this area are
available on a special page on our website.11
Conclusion
It's important that Canadians benefit from financial products and services that are
better, cheaper and more flexible. At the same time, we will continue to keep a
close eye on the risks associated with cryptoassets. We are working with our
domestic and international partners to ensure they do not pose a risk to the
Canadian or global financial system.
Canadians need universal access to means of payment that they can trust. As
advances in technology open up new opportunities and transform the financial
11
See Digital Currencies and Fintech.
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system, we at the Bank of Canada will continue to do what is needed to maintain
that trust.