Out-Law / Your Daily Need-To-Know

Digital currency could be classed as money, says Bank of England

Out-Law News | 12 Sep 2014 | 3:57 pm | 2 min. read

The functions performed by digital currencies determine whether those currencies can be classed as 'money' and regulated as such, the Bank of England (the Bank) has said.

The Bank suggested that digital currencies do not serve the same functions as other money (11-page / 163KB PDF) but could be said to do so in future. The UK government is currently assessing whether virtual currencies should be regulated.

"In theory, digital currencies could serve as money for anybody with an internet-enabled computer or device," the Bank said in a new research paper it has published. "At present, however, digital currencies fulfil the roles of money only to some extent and only for a small number of people. They are likely at present to regularly serve all three purposes for perhaps only a few thousand people worldwide, and even then only in parallel with users’ traditional currencies."

According to the Bank's paper, money serves three functions. Money is a "store of value with which to transfer ‘purchasing power’ (the ability to buy goods and services) from today to some future date; a medium of exchange with which to make payments; [and] a unit of account with which to measure the value of any particular item that is for sale", it said.

Digital currencies function differently from money at the moment, the Bank said. It said that there is a lack of "intrinsic demand" for digital currencies at the moment and that future demand for them should be calculated on the basis of whether they may be used as a "media of exchange" and remain in demand in the longer term.

The Bank appeared to suggest that the more stable the value of digital currencies are and the extent to which users transact using digital currencies will determine the extent to which digital currencies function the same as money in future.

It also said, though, there is currently "little evidence of any digital currency being used as a unit of account", suggesting something would need to change before digital currencies would be treated the same as money for regulatory purposes.

"Although a small number of transactions between individuals will occur in which the parties negotiate and agree a price in bitcoins, these are believed to be isolated and largely unconnected," the Bank said. "Retailers that quote prices in bitcoins appear to usually update those prices at a high frequency so as to maintain a relatively stable price when expressed in traditional currencies such as US dollars or sterling."

"Indeed, start-up companies seeking to offer bitcoin payment facilities typically offer retailers the opportunity to price entirely in fiat currencies, using the digital currency only temporarily as a payment system. The Bank is not aware of any business that accepts bitcoins in payment that also maintains its accounts denominated in that digital currency," it said.

The Bank said that digital currencies do not currently pose a "material risk" to financial stability in the UK but said it was conceivable that such risks could emerge in future. A crash in the price for digital currencies could affect financial stability if the currencies were, at that stage, in wider use that is the case at the moment. Lenders could be impacted as could "systemically important financial institution[s]" if they had "a significant unhedged exposure to a digital currency", it said.

If digital currencies developed to the stage that they were linked to derivatives contracts or other financial instruments to the extent that currency users and investors "could hold leveraged positions against the currency" then this could have a "magnified impact on the economy", the Bank said. However, the limited adoption of digital currencies as payment systems would be "unlikely to undermine the Bank’s ability to achieve monetary stability", it said.

A separate paper published by the Bank explored payment systems innovations and the rise of digital currencies (14-page / 435KB PDF) in more detail. It said decentralisation of the Bitcoin payments system is "a key technological innovation" that should be more resilient to "systemic operational risk" than payment systems built around a central payment authorisation body. However, it said decentralised systems are more susceptible to fraudulent activity.