DO ANDROIDS DREAM OF ELECTRONIC SHEEP?13 February 2018 | 11:37 | Buneva, Angelova and Atanasov
What is a ‘virtual currency’ and can it thrive in Bulgaria and the European Union under the current legislation? The reference to the famous novel by Philip K. Dick (perhaps you’ve seen Blade Runner?!) was not accidental. In the past several years we have seen an increased ‘pursuit of electronic sheep,’ the new value in the world of virtual finance. The numerous speculations about the rapidly evolving technological phenomenon of the ‘virtual’ or ‘alternative’ currency, or ‘cryptocurrency,’ are perhaps befuddling for the uninitiated reading audiences beyond their wildest imagination. Often guided by their lack of understanding, as well as by the absence of an established legal framework, consumers are left under the impression that they are dealing with a ‘scam,’ a ‘hoax’ or at least something ‘dubious.’ It turns out, however, that the centralized systems are capable of satisfying the existing legal minimum of regulation, in that they preclude the possibility of money laundering and terrorism financing.
This text is designed to orientate the reader in the legal aspects of the issue and describe the (non)existing forms of regulation.
At present, virtual currency transfers are not monitored in any way by the public authorities of the EU, since no specific rules with binding force exist at either national or Union level to govern such monitoring. To date, there is no Bulgarian or European legislation in place regulating how anyone should acquire, trade or use virtual currencies as legal tender. Therefore, the conclusions presented in this article are based on official statements made on the subject by several financial institutions and authorities.
A leading position at European level is that of the European Banking Authority (EBA)
According to the official communication of the European Banking Authority, EBA/WRG/2013/01, of December 12, 2013, entitled ‘Warning to consumers on virtual currencies,’ a virtual currency is a form of unregulated digital money that is not issued or guaranteed by a central bank and that can act as means of payment (legal tender). Virtual currencies come in many forms, starting with the currencies used in online gaming and social networks, all the way to payment methods accepted ‘offline’ or ‘in real life.’ The communication explicitly stated that EBA was currently assessing all relevant issues associated with virtual currencies, in order to identify whether virtual currencies can and should be regulated and supervised. The EBA warning was intended to highlight the possible risks that consumers could potentially be exposed to when buying, holding or trading virtual currencies, such as Bitcoin. Among the risks identified by the authority as associated with virtual currencies are the following:
- Lack of specific regulatory protections that would help users recoup their losses in the event that the platform exchanging or holding the relevant virtual currency goes out of business or shuts down. This is due to the fact that such platforms are unregulated – exchange platforms are not banks that hold the virtual currencies as a deposit. If an exchange platform loses money or fails, there is no specific legal protection, e.g. through a deposit guarantee scheme, that would cover the users for loss of funds they may have held in that exchange platform, even if said exchange platform had been registered with a national authority.
- Money can get stolen from the digital wallet.
- When digital currencies are used as a payment method for goods and services, consumers are not protected by any refund rights under EU law offered, for example, for transfers from a conventional bank or other payment account.
- The value of your virtual currency can change quickly, and could even drop to zero.
- Transactions in virtual currencies are public, but the owners and recipients of the funds under these transactions are not.
Transactions are largely untraceable, providing virtual currency users with a high degree of anonymity. It is therefore possible for the virtual currency network to be used for transactions associated with criminal activities, including money laundering.
On July 4, 2014, EBA issued an Opinion to the Council of the EU, the European Commission and the European Parliament, defining the requirements that would be necessary for regulating ‘virtual currencies’ . The Opinion, which was also addressed to the national supervisory authorities, cautions financial institutions to refrain from acquiring, owning or selling virtual currencies until a regulatory regime is in place. In its Opinion, EBA identifies the potential benefits and risks associated with virtual currencies, including risks for consumers, and the goals of the regulatory bodies in counteracting money laundering, financial crime and terrorism financing. Some of the benefits cited are the following:
- Economic benefits, e.g. lower cost and faster execution of transactions, security of payment, a contribution to economic growth, financial inclusion outside the EU.
- Personal benefits, e.g. personal data security and limited intervention by public authorities.
The EBA’s conclusion to date is that the risks could be mitigated and the potential benefits—utilized within a comprehensive regulatory regime specific for the virtual currencies.
On August 11, 2016, the European Banking Authority published an Opinion on the Commission’s proposal to bring virtual currency entities in the scope of Directive (ЕU) 2015/849 of the European Parliament and of the Council of 20 May 2015 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing. According to the wording of the Opinion, said proposals concern:
- Issues arising from the unclear deadlines for transposing the amendments;
- Virtual currency transactions must remain outside the scope of the Payment Services Directive;
- The status of virtual currency exchange platforms and wallet providers should be clarified;
- The need to facilitate cooperation and exchange of information between the national competent authorities with respect to virtual currency exchange platforms and wallet providers;
- The absence of specificity with regard to how the competent authorities should conduct proper and accurate tests of the owners and administrators of virtual currency exchange platforms and wallet providers;
- Amendments to the Directive should clarify the scope of the proposed licensing or registration regime for virtual currency exchange platforms and wallet providers.
Another important document is the Position Paper of the European Commission
On July 5, 2016, the European Commission issued a proposal for a Directive amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing . The proposal coins for the first time ever a legal term for virtual currencies, namely: ‘virtual currencies’ means ‘digital representation of value that is neither issued by a central bank or a public authority, nor necessarily attached to a fiat currency, but is accepted by natural or legal persons as a means of payment and can be transferred, stored or traded electronically.’
To prevent the abuse of virtual currencies for purposes of money laundering or terrorism financing, the Commission proposes that virtual currency exchange platforms and wallet providers be included in the scope of the Anti-Money Laundering Directive. Such structures will be mandated to enforce statutory comprehensive background checks on their customers applying to exchange virtual into real currencies, thus putting an end to anonymity in this kind of operation.
At this time, the proposal for a Directive to amend Directive (ЕU) 2015/849 of the European Parliament and of the Council of 20 May 2015 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing is in the process of being coordinated with all interested parties, therefore the envisioned amendments are not yet effective.
But what about Bulgaria?!
The authority supposed to regulate or at least concern itself with the issue is the Financial Supervision Commission (FSC) of Bulgaria.
The earliest opinion officially issued by the FSC on the matter becomes evident from its Decision No. 834/24.04.2015 issued in respect of Corporate Lawsuit No. 24.04.2015 of the Sofia Appellate Court. In the course of proceedings, the court requested an opinion from the Financial Supervision Commission, which, by virtue of its letter ref. No. 07-00-114/23.10.2014, stated that none of the activities pertinent to the acquisition, trading and payment using ‘Bitcoin’ are regulated by the current European or national legislation and are not subject to any registration or licensing regime.’ Article 3 of the Markets and Financial Instruments Act (MFIA) explicitly lists the financial instruments that are subject to regulation by the FSC. At this time, ‘Bitcoin’ and other virtual currencies are not recognized or treated as financial instruments within the meaning of the MFIA and the provisions of that Act do not apply to them. For an entity to execute transactions in ‘Bitcoin,’ it does not have to be licensed by the FSC for the performance of investment activities within the meaning of the MFIA, Article 5 (2) and (3). The decision reflects that, considering the nature of ‘Bitcoin’ and other similar ‘cryptocurrencies,’ numbering more than 200 different kinds, they could constitute and/or serve as the underlying asset for derivative financial instruments, which is not currently reflected in the effective laws and regulations.
Next, according to the announcement published on September 30, 2015, on the official website of the FSC, the Commission informs potential online investors and consumers that none of the activities pertinent to the acquisition, trading and payment using OneCoin are regulated by the current European or national legislation applicable to capital markets. To date, neither OneCoin nor any other virtual currency is recognized or treated as a financial instrument within the meaning of the MFIA, and the provisions and requirements of the MFIA should not apply to them. Would-be investors and consumers are advised to bear in mind that investing in such ‘cryptocurrencies,’ already numbering more than 400 different kinds, carries a high level of risk. Should the operator of such activity become insolvent, no person will be eligible for a refund from the Investor Compensation Fund.
The Bulgarian National Bank (BNB) also has a position
Firstly, we should note that the EBA warning to consumers about virtual currencies, referred to in Section 1 above, has been published on the BNB website.
The actual position of the BNB can be seen in Par. 2 of the above-mentioned Decision No. 834/24.04.2015 issued in respect of Corporate Lawsuit No. 24.04.2015 of the Sofia Appellate Court. In the course of proceedings, the Court also requested an opinion from the BNB; the Under-Governor of the Bulgarian National Bank replied by a letter, No. 108809/19.09.2014, stating that the virtual currency Bitcoin is not legal tender. None of the activities pertinent to the acquisition, trading and payment using ‘Bitcoin’ are regulated by the current European or national legislation and are not subject to registration or licensing. The purchase, sale and any use of virtual currencies for payment, including Bitcoin, do not fall within the scope of Directive 2009/110/ЕC of the European Parliament and of the Council of 16 September 2009 on the taking up, pursuit and prudential supervision of the business of electronic money institutions or of Directive 2007/64/EC of the European Parliament and of the Council of 13 November 2007 on payment services in the internal market, respectively, the scope of the Payment Services and Payment Systems Act which transposes the above cited European legislation into Bulgarian law. The provisions of these pieces of legislation do not apply to the sale and purchase of Bitcoin and the execution of payment operations using Bitcoin. Said Decision also points out that the BNB has no jurisdiction over transactions involving financial instruments.
Sci-Fi or a real opportunity for the future?
While European and national financial institutions still consider virtual currencies to be something like ‘electronic sheep’ and seek ways to count them, the trading of such instruments is getting increasingly dynamic, and new ones crop up in the marketplace literally every day – or about 200 new ones appear annually, according to an estimate. It is therefore only natural in the circumstances to have people trying their hand at fraud or speculation. Yet, one thing is certain: it is exactly with respect to the so-called money laundering that virtual currencies, at least the top ten ones (Bitcoin, OneCoin, etc.), provide a lot more hope and opportunity for security to the international financial networks. No clear answer has yet been given as to where the risk claimed by the institutions is hiding, and whether the virtual currencies are not, in fact, the future of the financial system and a technological revolution to boot.
In a communication dated Feb. 1, 2018, titled ‘The European Commission Launches the EU Blockchain Observatory and Forum,’ the European Commission professes the view that the blockchain technology, which allows distributed storage of blocks of information throughout the network, is considered a great achievement as it ensures high traceability and security of online economic transactions. According to experts, blockchain technology has enormous potential for boosting the online security of social and economic transactions by preventing cyberattacks while also cutting out the middleman. According to the communication, by the year 2020, the Commission is to allocate 340 million euros for the funding of projects based on blockchain technology; it also encourages governments, European industry and the public to take advantage of the capabilities of blockchains.
So, are virtual currencies really all that bad, given the fact that they are based on a technology touted by Europe as one that provides a high measure of traceability and security of online economic transactions, a technology that Europe itself is poised to finance? Yes, new things often seem frightening, but let us leave the scary hunters chase their androids in the movies and Sci-Fi, as we try to tidy up the world of finance through reasonable legislative initiatives and timely legal norms and regulations.
So, OK, what is cryptocurrency?
As usual when something new, something unknown comes into being, our mind immediately tries to fit it into the reference frame of what is familiar – because what is familiar is controllable, it is not scary – the same is happening now with the so-called cryptocurrencies. So … are they a harbinger of yet another crisis of capitalism, or an adequate reflection of the virtual reality that we are getting deeper into – this is something that remains to be seen.
As it often happens, an innovation simply burst upon us without waiting for the regulators to structure the right legal environment for it. The result was chaos, in which regulators regulate and issue warnings about something that is not entirely clear. To offer some clarity: the so-called cryptocurrencies are electronic/virtual units whose value is determined by their users who, as they ‘mine’ such virtual units, effectively create the market for them.
The price of those virtual units is determined by demand and supply – those well-known functions of the economy and market self-regulation, so nothing unusual this far, right?
Suddenly, however, and contrary to all the cravings of regulatory bodies, it turns out that (as long as the prototype is always seen as the source of truth) the ‘true’ cryptocurrency is the decentralized one, where everyone, like in a socialist utopia, has access to the common good … well, not quite … as, at the same time, it turns out that regulators must carry on regulating, and all of a sudden it also became apparent that centralized cryptocurrencies are also vying for a place under the sun, and that they offer even more security, price stability, traceability and are therefore a lot more acceptable that the prototype: the Bitcoin that circulates freely around us, serving God knows what purpose.
(1). The European Banking Authority (EBA) is an independent body of the EU that seeks to guarantee the effective and consistent level of prudential regulation and supervision in the European banking sector. Its general goals are to maintain financial stability within the EU while guaranteeing the integrity, efficiency and normal functioning of the banking sector. While national supervisory bodies remain responsible for supervising individual financial institutions, the role of EBA is to improve the functioning of the internal market by guaranteeing the proper efficient and harmonized European supervision and harmonization.
(2) https://www.eba.europa.eu/-/eba- warns-consumers- on-virtual- currencies
(3) http://www.eba.europa.eu/-/eba- proposes-potential- regulatory-regime- for-virtual- currencies-but- also-advises-that-financial- institutions-should- not-buy- hold-or- sell-them- whilst-n
(4) https://www.eba.europa.eu/-/eba- publishes-an- opinion-on- the-commission- s-proposal- to-bring- virtual-currency-entities- in-the- scope-of- the-anti- money-laundering- directive
(5) http://eur-lex.europa.eu/legal- content/BG/TXT/?uri=CELEX%3A52016PC0450
(6) http://www.fsc.bg/bg/novini/saobshtenie-onecoin- 7726.html
(8) Standing behind most forms of virtual currency is a relatively new technology, one called blockchain. For lay people like most consumers, we should explain that the blockchain technology represents something like a digital accounting book - digital ledger, a database of executed transactions, whether involving cryptocurrency or data from another activity, stored online
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