The ECB recently released a report on “Virtual Currency Schemes”.  It is, in parts, surprisingly well done. It includes a good definition of money, it recognizes that virtual currencies are ‘digital cash’, it discusses Austrian economics and even quotes Rothbard, Hayek and Mises! The guys that put this together are smart and understand “Virtual Currency Schemes” i.e. Bitcoin.

But the piece can be summed up with this line… Should Bitcoin ever truly catch on, it will damage the current banking system and threaten “financial stability”.

The piece starts by defining money and categorizing “Virtual Currency Schemes” into three groups. The report focuses on “Type 3” which includes currencies that can be both bought and sold for “real” money, Linden Dollars and Bitcoin.

They also define Virtual currencies and note the legal grey area that they are in.

“A virtual currency can be defined as a type of unregulated, digital money … used and accepted among the members of a specific virtual community.”

The absence of a distinct legal framework leads to other important differences as well. Firstly, traditional financial actors, including central banks, are not involved … This implies that typical financial sector regulation and supervision arrangements are not applicable.”

It is now quite clear that they see currencies, such as Bitcoin, not only as money but as competition.

“specifically for Type 3 schemes, a virtual currency scheme may also be implemented in order to compete with traditional currencies, such as the euro or the US dollar.

Unsurprisingly the ECB has decided that these currencies should be rightfully subject to their control.

“[Virtual currencies] do indeed fall within central banks’ responsibility”

The report does manage to say a few nice things about virtual currencies calling them “financial innovation” and latter noting that they have “lower transaction costs” and are “more direct and faster”.

The report makes it quite clear that at the moment virtual currencies have no significant impact on the “real” economy. But the ECB also very well understands that they could, and very well may saying…

”This assessment could change if usage increases significantly, for example if it were boosted by innovations which are currently being developed or offered.”

“innovations in this field are growing and spreading significantly”

And if you’re thinking that this report is really about Bitcoin vs fiat, your right.

of particular interest are the schemes designed to compete against real currencies as a medium of exchange. For the time being, the most prominent case is Bitcoin which, according to its creators and supporters, should overcome the limitations of traditional currencies that result from the monopolistic supply and management by central banks.”

“Bitcoin is probably the most successful … It operates at a global level and can be used as a currency for all kinds of transactions (for both virtual and real goods and services), thereby competing with official currencies like the euro or US dollar.”

“[Supporters] see Bitcoin as a good starting point to end the monopoly central banks have in the issuance of money.”

They make an interesting reference to the gold standard saying, “The scheme is inspired by the former gold standard.” Well I don’t know if that’s what inspired it, but gold bugs and Bitcoin supporters do have quite a lot in common.

Again, “financial stability” seems to be the core issue this paper is concerned with. And what “financial stability” really means of course, is maintaining the status quo. And they are rightfully concerned that the growing popularity of virtual currencies could change the way the financial system works.

The ECB is particularly concerned with a possible change in the unit of account.

“In virtual currency schemes the unit of account is changed…This is not a minor issue”

“it is important to safeguard a currency’s role as a unit of account, … [virtual currencies] would threaten to undermine the role of money in providing a single unit of account as a common financial denominator for the whole economy.”

Further comments on stability…

Conceptually, virtual currency schemes could have an impact on price stability and monetary policy if they affect the demand for the central bank’s liabilities and interfere in the control of the supply of money through open market operations.”

In an extreme case, virtual currencies could have a substitution effect on central bank money if they become widely accepted. The increase in the use of virtual money might lead to a decrease in the use of ‘real’ money,

a widespread substitution of central bank money by privately issued virtual currency could significantly reduce the size of central banks’ balance sheets, and thus also their ability to influence the short-term interest rates.”

They mention the very interesting case of a virtual currency in China called Q-coin and the Chinese governments reaction to it, they banned it to limit it’s impact on ‘the real financial system’.

“However, if a virtual currency scheme was to be focused on one specific country, it could indeed have an impact on the money supply of this country. This is what happened in China with the Chinese virtual currency scheme Q-coin,”

In addition, several online games rewarded users with points that could be exchanged against Q-coins and ultimately also against yuan in the black market. The virtual currency had evolved into an illegal money scheme.”

“In June 2009, the Chinese authorities decided to ban this currency for trading in real goods in order to ‘limit its possible impact on the real financial system’”

The ECB believes that virtual currencies might eventually pose similar issues in Europe saying…

 special attention should be paid to Type 3 schemes”  i.e. Bitcoin.

The ECB also understands that attempting to control or ban Bitcoin would be very difficult, if not near impossible.

“Furthermore, the global scope that most of these virtual communities enjoy not only hinders the identification of the jurisdiction under which the system’s rules and procedures should eventually be interpreted, it also means the location of the participants and the scheme owner are hard to establish. As a consequence, governments and central banks would face serious difficulties if they tried to control or ban any virtual currency scheme, and it is not even clear to what extent they are permitted to obtain information from them. In the particular case of Bitcoin, which is a decentralised peer-to-peer virtual currency scheme, there is not even a central point of access, i.e. there is no server that could be shut down if the authorities deemed it necessary.”

Bitcoin could fall under a few different pieces of European legislation.


  • Electronic Money Directive (2009/110/EC)
  • Payment Services Directive (2007/64/EC)

Further notes on regulation…

“In the meantime, some initial attempts to define the legal status of Bitcoin are already happening in Europe. The French law courts are looking into the issue after local banks shut down the currency exchange facility for accounts handling the currency, on the presumption that Bitcoin should conform to electronic money regulations.”

“Finally, the issue of Bitcoin’s legal framework has been raised in the European Commission’s Payments Committee.”

“Usually regulation lags behind technological developments by some years. … It was only in 2006 that a number of US government agencies started considering these schemes. …The following year, some of these companies were charged with operating unlicensed money transmitting businesses. Since then, a number of other legal actions have been taken and many of these schemes operating in the United States have been closed. Subsequently, China has also taken a stance against the use of virtual currency schemes for the purchase of real goods and services.”

“Authorities need to consider whether they intend to formalise or acknowledge and regulate these schemes. In this regard, a likely suggestion could sooner or later involve virtual currency scheme owners registering as financial institutions with their local regulating authorities.”

The last few sections of the report they move on to being very concerned with the reputation of central banks. They are of course correct in being concerned about Bitcoin’s impact on the effectiveness of central banks as a fiat system survives only by confidence in the central bank. They are very well aware of this…

“The reputation of central banks is a key element determining the effectiveness of their various policies, especially monetary policy. A reputation is hard to earn, but very easy to lose.”

“Virtual currency schemes are able to have a reputational impact. They are about money and about payments and therefore, for the general public, they clearly fall under the responsibility of central banks, even though this might not be the case from a statutory and legal point of view.”

There isn’t too much to disagree with in this report. Given that the ECB sees ‘financial stability’ as maintaining the status quo, they are absolutely correct to be concerned about Bitcoins ability to damage it.

The important point here is not that these guys are smart and understand the impact that Bitcoin and other ‘virtual currencies’ could have on the financial system, but that they interpret this impact as a “threat”. They make this clear on page 34 in a section titled “The relevance of virtual currency schemes for central banks” …

“A similar problem exists with regard to the quantitative information and statistics that would be needed in order to assess the speed at which these virtual currency schemes are growing and the point at which they could become a real threat.”