Cryptocurrencies – just how scared should central banks be?

Cryptocurrencies – some say they are dangerous pyramid schemes, others say they are the future of trading in the digital age. While the European Central Bank rushes to create its own, traditional banks are running scared. Should they be?

Text: Chris Graeme

In April a sensational and cautionary report by Portuguese private TV channel SIC covered a harrowing tale about ordinary Portuguese citizens getting caught up in fraudulent promises of double-your-money scams in which they lost their savings.
It sounds not dissimilar to the famous Banco Espírito Santo racket where humble, hardworking savers, many of them pensioners, bought into the banks’ commercial paper issue shortly before the bank crashed and left them with nothing.
The Panorama-style programme ‘Essencial’ focused on a handful of people who had literally lost hundreds of thousands of euros in savings by being persuaded to invest in cryptocurrencies by a sleek broker operating out of Dubai.
The promotional videos were slick and convincing, the interviews with the brokers in luxurious offices overlooking the city’s space-age skyline were equally beguiling, with up to 500% returns and little risk, what could possibly go wrong?
First, the dream of massive returns had attracted naive members of the public that had never made investments in any kind of equity instruments, had never bought sovereign bonds, shares, stock, invested in funds or commercial paper, let alone cryptocurrencies. It was a cautionary tale.

What are they anyway?

From humble beginnings in the US where it was worth one or two dollars and used to buy takeaway pizzas in 2010, by 2013 the value of the virtual currencies was ever upwards and this year the digital ‘coins’ exceeded a value of €50,000.
So what exactly are cryptocurrencies? Essentially, it is a digital token that can be exchanged electronically. It does not exist in physical form. Bitcoin, perhaps the most famous, is created and kept track of by a network of computers using complex mathematical formulas, rather than by a single authority or organisation.
In other words, Bitcoin and the other cryptocurrencies are not issued by a central public authority. When you hold a €20 note, for example, the ECB guarantees your right to make payments with it anywhere in the euro area. No one guarantees your right to use bitcoin or works to keep its value stable, so argues the European Central Bank.
Most analysts fall somewhere in the middle of this argument, suggesting that investing in currencies like Bitcoin and Ethereum might be a high-risk investment because the price of crypto currencies is generally volatile; some deals could go wrong, others turnout to be scams, while others increase in value and make a handsome return for investors.
“It’s one thing for you as an individual buying cryptocurrencies, it is quite another thing to give money to a broker to buy cryptocurrencies,” says Lisbon-based Mário Valente, crypto-assets expert, blockchain miner, trader and consultant who has advised the Portuguese banks.
Valente is ready to admit that the SIC documentary was fair overall and points out that when unknown unscrupulous middle men get involved, fraud can happen. Valente says that people need to be aware and careful. On the other hand, he says cryptocurrencies are not something that are going to go away, like a fad. On the other, investors should be careful in whom they trust and what they are doing with the currency.
“Anyone that promises a 25% return on your investment every month, or says you are sure to double your money in three months needs to be extremely wary, as that’s a scam,” warns Valente.

Bank of Portugal involvement

The specialist says that the Portuguese can be very gullible and naive when it comes to complicated financial matters. In fact the Bank of Portugal and the European Central Bank have both issued warnings about the speculative nature of cryptocurrencies, particularly when news began circulating that parents were even getting their teenage kids to invest money in the new virtual currencies from their mobile phones.
Valente says that he has advocated for regulation of the market for a long time. In Portugal the Bank of Portugal was initially assigned a role in supervising companies providing assets in the cryptocurrency area, but since last September the BoP banned this.
He says that despite trading being illegal, it’s like drugs. They are illegal but it does’t stop people dealing in them or consuming.
“That was one of the stupid things the Bank of Portugal did. If we need to regulate this, let’s start working with the industry to create an intermediary process, which is what the other central banks in Europe have been working on, except Portugal which just forbid it,” says Valente critically.
In other words, whereas other central banks created a timeframe whereby regulatory requirements would be less harsh throughout the period while working with sector players on what the regulation should be, Portugal just banned it.
Since April this year, however, companies or entities wishing to exercise one of more activities with ‘virtual assets’ will now have to register first with the Bank of Portugal according to a notice published that month. It covered all companies and persons (collective and singular) and was announced after a consultation period in which it had received the opinions of six entities.
However, for the time being, the Bank of Portugal makes it clear, in line with the European Banking Authority and European Central Bank, that virtual assets do not have a legal status in Portugal, meaning their acceptance at a nominal value is not mandatory; there is no legal protection that guarantees rights of repayment or compensation to consumers who use virtual assets to make payments, and in the case of a partial or total devaluation of the virtual assets, there is no fund that will cover eventual losses to users who will have to support all of the risk associated with operations using such instruments.
Moreover, says the bank, users may not only lose all of their money on the business platform but transactions of virtual assets also run the risk of being used to finance criminal activities, including famous names like Bitcoin and Ethereum.

Wild volatility

Vítor Constâncio, a former governor of the Bank of Portugal and ex-vice-president of the European Central Bank famously disparaged cryptocurrencies as just a “series of zeros and ones”.
The man who did not exactly leave a good impression at Portugal’s central bank after it was discovered that there was dubious supervision at the bank concerning highly leveraged loans on mega tourism projects over a decade ago, which left several Portuguese banks badly burnt, now went on to issue a cascade of criticisms about Bitcoin on twitter earlier this year calling it a “dangerous investment” and “regretting the complacency of the authorities” in not pressing forward with appropriate regulation for digital currencies, resulting in people continuing to be cheated.
“Bitcoin has no fundamental useful value because it will never be a (genuine) currency. More institutions are investing in Bitcoin but it is just a series of zeros and ones on a computer network. At least gold, that ‘barbarous relic’ (Keynes) has some industrial and jewellery uses,” he tweeted back in February this year.
And went on “with its wild volatility (it is trading 375% higher now in relation to October 2020) Bitcoin cannot be used as a stable unit of account to take and plan price decisions or do financial planning based on a unit that can vary so much in just three months.”

Stablecoins – has the horse already bolted?

Nevertheless, the European Central Bank is sufficiently spooked by it to introduce its own ‘digital euro’ on the back of the correct argument that digitalisation has spread to “every corner of our lives and transformed how we pay”.
“In this new era, a digital euro would guarantee that citizens in the euro area can maintain costless access to a simple, safe and trusted means of payment. The digital euro would still be a euro: like banknotes but digital. It would be an electronic form of money issued by the Eurosystem (ECB and central banks) and accessible to all citizens and firms but not replace gas but complement it.”
So, a bit like a sanctioned and regulated cryptocurrency then? Not quite, says the ECB.
“Crypto-assets are fundamentally different from central bank money: their prices are volatile because they lack any stable value and there is no reliable institution backing them. People using a digital euro would have the same level of confidence as with cash, since they would be both backed by a central bank, which is something crypto-assets such as ‘stablecoins’ (Bitcoin, etc) cannot provide”.
The ECB readily admits it is not yet ready to launch, but optimistically suggests that it could have a framework by the summer of 2021 with a rollout “at some time in the future”. Meanwhile, there seems no shortage of people buying, selling and investing in its rather more up and dashing illegal crypto cousins. But is it too late? Has the ECB left the stable door open for the horse to bolt?
Valente says that for the past three to four years, before the Portuguese ban, the half a dozen companies that were providing crypto-related assets and services were bona fide, but now investors don’t have any way to recognise which are scammers and which are not because the operations are now illegal.
One of the reasons why Portugal has made operations illegal is because of pressure from the country’s vulnerable banking system which frankly does not want the competition. Put simply, they fear that by cutting out the middleman (the banks) they will be put out of business or severely compromised much as the recording industry was in the late 1990s onwards with the advent of MP3 and online digital streaming music services like Spotify.
But does it really spell the end of the current banking system as we know it? Valente is equivocal – Yes and No.
“If the banks refuse to change and continue with their quest against crypto assets, they will fail just like hotel chains are losing market share to AirBnB and taxi firms are losing out to Uber. No, if they can adopt the technology. If they don’t change, adapt and embrace the new technology, they will become less relevant and lose,” concludes Mário Valente.