Chapter 3
Opportunities and risks
3.1
Advances in technology have produced rapid changes in the way Australians
are managing their money. While the advent of digital currency has opened up a
range of opportunities, it also presents risks. The Australian Payments
Clearing Association (APCA), the self-regulatory body set up by the payments
industry to improve the safety, reliability, equity, convenience and efficiency
of the Australian payments system, recognised both the possible benefits and
drawbacks of emerging digital currencies, observing:
New technologies, particularly network and cloud-based
technologies such as the block chain, offer the potential for valuable
innovation and competition. However payments system regulation must balance
competing policy objectives. It must maintain a balance between stability,
efficiency and competition-driven innovation while ensuring confidence and
integrity.[1]
3.2
In this chapter, the committee explores the potential opportunities and
risks of digital currency.
Benefits of digital currencies
3.3
The European Securities and Markets Authority (ESMA) found that the main
attraction of digital or virtual currencies (VC) appeared to be the speed and
cost. It stated:
The main benefits of VC [virtual currency] based financial
assets and asset transfers seem to be speed and cost. From the perspective of
the user/investor, the speed of VC based financial asset transactions is higher
than traditional financial asset transfers and takes place within a couple of
hours at most. The cost of transactions seems to be currently somewhere around
a couple of Euro cents. Both speed and cost of transactions vary between
different VCs.
The benefit of cost and speed equally holds for issuers in
terms of listing an asset on an asset exchange. In the case of the NXT asset
exchange, a listing currently costs 1000 NXT (currently around 10 Euro) one-off
plus transaction costs when sending rewards to investors. Especially for small
and medium sized companies this could become an attractive source of funding.[2]
3.4
The European Banking Authority similarly referred to the lower
transaction costs and the faster speeds associated with virtual currencies. It
noted:
Although reliable and independent data on the exact costs of
VC transactions is difficult to ascertain, some anecdotal suggestions have been
made that average transaction fees on the Bitcoin network tend to be less than
0.0005 BTC, or 1% of the transaction amount.
This compares with 2%–4% for traditional online payment
systems or an estimated 8%–9% for remittance without involving bank accounts
via money transmitters. Transactions within or between VC schemes are also not
subject to the exchange fees applied to conversions for transactions with third
countries, therefore providing further potential for cost savings, (although
conversion fees would typically apply as and when VC are exchanged against FC [fiat
currency] or vice versa). The increase in competition for transaction services
may also have a cost-reducing effect on the costs of conventional transactions
in FC.[3]
3.5
In respect to the processing time for transactions, it found:
Transactions using VCs can potentially be settled faster than
those of FCs. For Bitcoins, the total process time is said to be between 10 and
60 minutes. It is claimed that, on average, a new block is added every 10
minutes to the blockchain transaction ledger. In this respect, VC payments
appear to compare favourably with credit transfers or card payments,
particularly for payments between different currency areas. Also, processing VC
payments takes place on a 24/7 basis, unlike payments made through traditional
payment systems.[4]
3.6
The European Banking Authority lists a number of other advantages
attached to virtual currencies including:
-
certainty of payments received—allowing merchants to avoid having
to refund transactions, particularly those based on an alleged non-fulfilment
of a contract;
-
contributing to economic growth—spawning new types of businesses;
and
-
security of personal data.[5]
3.7
While digital currencies offer numerous advantages, their benefits are
not as significant in the Australian context. APCA noted that, unlike some
other countries, currently Australia 'enjoys a sophisticated, ubiquitous...globally
competitive payment system with generally high quality regulatory structures
and settings'.[6]
Australia's payment system is already overwhelmingly digital in nature, with
only about 18 per cent of Australian currency existing in physical
form.[7]
3.8
For example, EFTPOS transactions in Australia cost 16 cents on average,
so there is little room for digital currencies to improve on domestic point-of-sale
purchases, which account for around 40 percent of all transactions by value.[8]
Australians already have many different payment systems including EFTPOS,
interbank transfers, PayPal and international transfer via SWIFT. In this
context, digital currencies, such as Bitcoin, do not offer much more additional
capability. But in developing countries, digital currencies may provide secure
international facilities for the transfer of funds at a much lower transaction
cost than available from institutional banking.[9]
Distributed ledger technology
3.9
A distributed public ledger is a major innovation and integral to the
appeal Bitcoin. The Chamber of Digital Commerce, a US not-for-profit trade
association, explained that the underlying source code or algorithm of the
Bitcoin protocol, often referred to as the blockchain, is built for the
transfer of information. While the distributed ledger currently stores,
transfers and accounts for financial assets, there is potential for the
distributed ledger technology to be used to store and transfer other types of
digital assets.[10]
3.10
In APCA's view, the use of distributed ledger technology in digital
currencies is unique and genuinely new, providing the opportunity to conduct
both storage and transmission of value without the traditional financial
intermediaries. APCA supported the potential for competition and innovation
which could help improve Australia's payment system in the future, noting the
potential for the distributed ledger technology to be used in the broader
sphere—beyond payments and currencies.[11] Mr Christopher Hamilton,
of the APCA, noted:
As a concept, as a way of recording ownership of assets—it
can in principle be any asset including existing currency—it [distributed
ledger technology] is genuinely a new way of doing it. For that reason, it is
worth exploring and understanding the implications of it.[12]
International remittance and
financial inclusion
3.11
As Australia already has a well-established and efficient payments
system, Mr Andreas Antonopoulos, an author and computer security expert, suggested
that Bitcoin may represent a unique opportunity in two areas:
Firstly, bitcoin can introduce much needed competition in the
retail payments industry, undercutting the expensive systems offered by credit
and debit cards, while significantly improving security and privacy for
consumers. Secondly, the bitcoin industry can establish Australia at the
forefront of the next wave of innovation in financial services, a wave that can
extend financial services to more than two billion people throughout Southeast
Asia who are currently underbanked.[13]
International remittance
3.12
Mr Jonathon Miller, co-founder of Bit Trade Australia, advised the
committee that he considered the overseas remittance market would be a growth
area in Australia for digital currency such as Bitcoin.[14]
He also noted benefits for Australians using digital currency to purchase goods
and services from overseas, as these types of transactions currently included a
currency conversion fee.[15]
3.13
For example, the transaction fees for transferring money from Australia
to Samoa are around 12 per cent of the transaction value.[16]
3.14
APCA agreed that there was potential for digital currencies to assist
with offshore transmission of money.[17]
mHITs Limited, an Australian-based mobile money service company, did not
believe that it was likely that digital currencies alone would be used directly
for cross-border remittances in the short term. While end-to-end digital
currency remittances were unlikely, businesses such as BitPesa have used
digital currencies to facilitate remittance services between Kenya and the UK.[18]
3.15
The RBA formed the view that international remittance may be an area
where digital currencies might gain traction, noting currently they can be
expensive and subject to delays in the receipt of funds.[19]
Even so, the RBA considered that the potential offered by digital currency was
not significant and referred to the work being done through the New Payments
Platform, a major industry initiative intended to establish 'new payments
infrastructure that will spur innovation in the Australian payments industry'.[20]
The RBA explained:
More broadly, however, many payment attributes of digital
currencies are already available in the traditional payments system or will be
available, in the case of the new services that may be facilitated by the New
Payments Platform project. Accordingly, it remains to be seen what would drive
their widespread use domestically, particularly in light of the price
volatility of digital currencies observed to date.[21]
Financial inclusion
3.16
Ms Rebecca Bryant, Department of Foreign Affairs and Trade (DFAT), noted
that while DFAT has not provided any funding to date for any initiatives
involving digital currencies, some of its partners have. Ms Bryant noted that:
...the Consultative Group for Assisting the Poor [CGAP], and
the World Bank—are actively considering the applicability of digital currencies
to financial-inclusion initiatives. CGAP has looked closely at the BitPesa
start-up, which, in 2014, launched a service using bitcoin to provide cheap and
fast remittance services. BitPesa is focused on providing remittance services
for the UK-to-Kenya corridor. The UK senders buy bitcoin. These are transferred
to Kenya and immediately transferred into Kenyan shillings, which are then
deposited into mobile wallets or bank accounts. BitPesa charges a variable rate
of three per cent on the transfer. This compares to an average cost of a
remittance from the UK to Kenya of nine per cent. [22]
3.17
Ms Bryant advised the committee that DFAT was 'watching closely to see
whether new business models, such as BitPesa, could have a wider application,
thereby reducing the cost of simple transactions and increasing financial
inclusion more broadly'.[23]
Transparency
3.18
Ripple Labs, the San Francisco based developer of the Ripple protocol,
an open-source distributed protocol that facilitates payments and funds
transfers, suggested that the distributed ledger technology could substantially
improve transparency in cross-border funds transfers. It suggested that this is
'particularly true of the Ripple distributed ledger system, which permits
visibility of all transactions taking place through the protocol, and in which
transaction histories of all accounts are available'.[24]
3.19
The Australia Federal Police (AFP) noted that while distributed ledger
or blockchain technology records all Bitcoin transactions, the identity of the
persons involved in the transactions may not be easily traceable.[25]
The identity of the individuals involved in transactions is discussed later in
this chapter.
Risks
Taxation non-compliance risk
3.20
The ATO noted that digital currencies had similar compliance risks as
those associated with the cash economy. In particular, the capacity for
transactions to go unreported and be handled pseudo-anonymously. There was also
the potential for digital currency to facilitate international profit shifting
or to help hide transactions, as the nature of digital currencies means
transactions can be highly mobile internationally.
3.21
Mr Michael Hardy, ATO, advised the committee that the ATO does 'not have
a sense of an enhanced non-compliance risk with Bitcoin transactions.' He
stated:
Of course, people do
not put on their tax returns, 'This was my money from bitcoin.' It is just part
of their assessable income. But our own monitoring has not indicated that there
is a particularly high non-compliance risk from bitcoin transactions.[26]
3.22
In addition to its assessment that the fiscal risk associated with Bitcoin
was low, the ATO's submission noted that the total worldwide value of Bitcoin
was relatively small at approximately AU $5.96 billion when compared to
Australia's GDP in 2012–13 which was $1.5 trillion.[27]
Financial stability
3.23
Researchers from the Finance Discipline Group, University of Technology,
Sydney, analysed the Bitcoin public ledger and found that Bitcoin is currently
held primarily for investment, rather than used as a medium of exchange. The
researchers noted that the size of Bitcoin investments and transactions was
relatively small compared to other assets. As such, they did not consider that Bitcoin
is an immediate risk to financial stability or the Australian economy as a
whole. However, they emphasised the level of risk was based on size, and may be
affected by a significant increase in the acceptance of Bitcoin or similar
digital currencies in the future.[28]
3.24
Ripple Labs did not consider digital currencies to be a threat to
financial stability and encouraged the committee to look at digital currencies
as 'complementary currencies' rather than currencies that compete with
government-issued currencies, stating:
While we believe that utilizing digital currencies could be
particularly attractive for facilitating cross-border payments, Ripple Labs
does not share the view that digital currencies should replace fiat currencies.
For many reasons, including geo-political considerations, it is highly unlikely
that any digital currency could pose a meaningful threat to monetary or fiscal
stability for the foreseeable future.[29]
3.25
Mr Shapiro from Promontory Financial Group LLC, a regulatory risk
management and compliance consultancy, told the committee he did not believe
digital currencies would replace national currencies:
It is simple. People understand their Australian dollars,
their US dollars and their British pound, and I think a lot of the future of
this is actually going to be allowing consumers to hold balances in the
currencies they understand and use the back end of this for payments just as
merchants today can use services.[30]
3.26
APCA maintained that private currencies were not a new phenomenon and
unlikely to affect the payment system adversely, so long as the bulk of
activity continued to occur in fiat currencies.[31] It also noted
that while the distributed ledger technology has a lot of interesting
potential, it did not necessarily follow that digital currencies would have a
massive role in the Australian economy.[32]
Price volatility
3.27
A number of submitters referred to the price instability of Bitcoin. Ripple
Labs noted that as digital currencies involve volatile assets with inherent
price volatility and risks, they may not be suited for direct consumer
interaction.[33]
3.28
Mr Christopher Guzowski, ABA Technology, observed, however, that there
had been a downward trend in volatility of Bitcoin noting, the main reason for
this development was that 'more exchanges are opening up around the world,
there are more traders, there are more market makers, there is more market
depth, more liquidity and therefore the spreads are being lowered and the
volatility is reducing'.[34]
Pseudo-anonymity
3.29
Digital currencies such as Bitcoin do not provide complete anonymity for
users. This type of digital currency is better described as offering pseudo-anonymity.
The Attorney-General's Department explained:
To use Bitcoin as an example, every Bitcoin transaction is
linked to a corresponding public key, which is then stored and made publicly available
to view in the block chain. If a person's identity were linked to a public key,
then it would be possible to look through the recorded transactions in the
block chain and easily see all transactions associated with that key. In other
words, Bitcoin offers users the ability to transact under the concealed identity
of their Bitcoin address/public key, but all of their transactions are
available for full public viewing and therefore for law enforcement scrutiny. When
these transactions were examined and used to construct a pattern of behaviour, analysts
in a simulated experiment were able to reveal the identities of approximately
forty percent of Bitcoin users.[35]
3.30
The AFP also noted that although the distributed ledger is public, the
identity of persons involved in the transactions may not be readily traceable.
The AFP was concerned that pseudo-anonymity and the ability to conduct digital
currency transactions outside the regulated financial framework would make it
difficult to determine the true owners of digital currencies.[36]
Criminal activities
3.31
The nature of digital currencies, which can be traded online without
face-to-face customer relationships, provides a greater degree of anonymity compared
to traditional non-cash payments methods. The Attorney-General's Department
observed that digital currencies provide 'a powerful new tool for criminals,
terrorist financiers and sanctions evaders to both move and store illicit funds
out of the reach of law enforcement and other authorities and purchase illicit
goods and services'.[37]
3.32
The Attorney-General's Department also noted that the risks associated
with digital currencies were not hypothetical. In May 2013 the US Treasury and
the Department of Justice undertook a coordinated enforcement action against
Liberty Reserve, a centralised convertible digital currency system being used
to facilitate US $6 billion worth of illicit online activity, including
identity fraud, credit card fraud, computer hacking and online scams. Liberty
Reserve was designed to avoid regulatory and law enforcement scrutiny to assist
criminals to distribute, store and launder the proceeds of illegal activities
by enabling anonymous, untraceable financial transactions.[38]
3.33
Further, decentralised digital currencies such as Bitcoin, which do not
have a central server or service provider, are of greater concern for law
enforcement authorities and regulators than centralised convertible currencies
such as Liberty Reserve. The Attorney General's Department explained that the
now-defunct Silk Road website demonstrated features that make decentralised
digital currencies attractive to criminals seeking to launder money and either
purchase or accept payment for illicit goods and services. The Silk Road
website was a black market site on the Dark Net, the portion of internet content
that is not indexed by standard search engines. Silk Road took advantage of the
pseudo-anonymous nature of Bitcoin and anonymising 'Tor' software to create a marketplace
where mail-order drugs and other licit and illicit goods and services could be
traded. The FBI shut down the Silk Road website in October 2013 following a two-year
investigation.[39]
3.34
The Attorney-General's Department advised that there appeared to be
little evidence to date indicating the use of digital currencies as a means of
financing terrorism. It noted that AUSTRAC concluded in its 2012 typologies and
case studies report that while the 'anonymous nature of digital currencies may
appeal to criminal groups and individuals, their overall utility for criminals
at this point may currently be limited to niche crimes in the cyber environment
and individual or smaller-scale illicit activity'.[40]
3.35
The AFP noted in its submission that its main experience with digital
currencies to date had been with Bitcoin. It identified four main areas of
crime involving digital currency that had been investigated:
-
the alleged theft of Bitcoin via hacking;
-
Bitcoin exchanged as payment for the importation of illicit narcotics
into Australia from major online black marketplaces such as Silk Road;
-
domestic supply and trafficking of narcotics for payment in
Bitcoin; and
-
money laundering and dealing with the proceeds of crime via
Bitcoin.[41]
Hacking
3.36
A number of submitters noted that custodial accounts pose a significant
risk to consumers and should be the focus of regulation.[42]
Mr Antonopoulos stated:
In fact, any accounts that take control of Bitcoin keys, and
therefore remove them from the protection and security of the Bitcoin network,
create areas of centralisation. And we have seen before, many times, that such
environments are prone to hacking, theft and, in many cases, what we suspect to
be embezzlement and insider action. Those types of organisations that have
custodial access have all of the problems of traditional centralised financial
networks. In short, if you give someone your money they will run away with it.
So the need for regulation is paramount, as is the need for oversight, audit
and all of the traditional financial controls that are imposed in those
situations.[43]
Organised crime, purchase of
illicit drugs and avoiding detection
3.37
The committee reiterates ASIC's advice to consumers on the risks
associated with digital currency, including the possibility of being hacked,
fluctuations in value and money being stolen from a digital wallet.
3.38
Veda, a company best known for consumer credit reporting, is also a
provider of online fraud, identity and credit risk services. It noted that 'wherever
there is something of value, there will be fraud and
money-laundering—regardless if it cash, property or a painting'.[44]
3.39
Dr John Moss, Australian Crime Commission (ACC), commented that with
every emerging technology criminal elements would be among the early adopters.
Organised crime groups such as outlaw motor cycle gangs have used Bitcoins to
store and move value.[45]
He reported that the ACC was not currently seeing digital currency being used for
large scale money laundering; however it was being used by 'mums and dads' to
purchase illicit commodities, such as narcotics, over the internet.[46]
Dr Moss noted that we have a unique window which should be seized for the
regulation of digital currency before use escalates from purchasing a coffee to
moving millions of dollars.[47]
3.40
The Justice
and International Mission Unit, Synod of Victoria and Tasmania, Uniting Church
of Australia, was
concerned that digital currencies, along with a range of other payments
methods, are being used on commercial child abuse websites to help users avoid
detection.[48]
Scams
3.41
The ACCC advised that over the last three years there had been only
about 100 complaints through its information centres regarding digital
currencies. Mr Marcus Bezzi, ACCC, reported that the vast proportion of
the complaints received were related to alleged scams. He stated:
What we have noticed
in relation to those issues is that digital currencies have been alleged by the
complainants to have been used in a way that perhaps would have been able to be
used by ordinary currencies. So it is just another tool used by a scammer to
rip off—to use a colloquial expression—consumers.[49]
3.42
With regard to another aspect of potential criminal activity, the AFP
noted that the nature of digital currencies created challenges for the ability
of law enforcement agencies to recover proceeds of crime.[50]
The Centre for Internet Safety recommended that law enforcement should be resourced
so they are able to 'innovate their investigative tools and techniques alongside
this new technology in order to ensure investigations are not impeded by any
improvement in criminals' ability to move funds anonymously'.[51]
Current level of risk
3.43
Despite the potential for digital currencies to be used for criminal
activity, Mr Jared Taggart, AFP, noted that digital currencies were not
currently a significant operational issue. He warned, however, that if the
predictions were correct and digital currencies become more widely used, it
could become an issue in the future.[52]
3.44
Mr Antonopoulos argued that Bitcoin was a rather benign form of digital
currency, noting:
There are other [digital currencies] that are much
stealthier, much more anonymous, and may be encouraged to grow if onerous
legislation is passed. Now, certainly bitcoin has been used for criminal
purposes. That is a fact. To use a slightly humorous analogy, it has come to my
attention that the vast majority of criminals also use shoes. That does not mean
that shoes are the problem.[53]
3.45
Mr Hamish Hansford, ACC, explained that from a law enforcement
perspective, digital currency was just another type of encryption:
Encryption is used in a whole range of different areas, from
communications, where we are seeing encrypted communications...right through to
the use of darknets, or hidden parts of the internet, and payment through
virtual currencies.[54]
Conclusion
3.46
The committee acknowledges that digital currency presents opportunities,
including the broader application of the distributed ledger technology, increased
competition in the payments system, and especially in transactions involving international
remittances and providing services in developing countries. There are, however,
risks associated with the use of this new technology requiring careful and
constant monitoring.
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