The European Banking Authority is warning financial institutions to avoid dealing in Bitcoin and other virtual currencies until a forthcoming regulatory regime is established. It also laid out various elements that should be a part of future regulation.

The EBA, in a recent opinion, identified nearly 70 risks stemming from the new type of currency that could affect users, market participants, and the financial integrity of institutions. The authority, which conducted its research with other EU financial agencies, acknowledged virtual currencies have some benefits, such as financial inclusion and faster, less costly transactions. But the EBA said currently “the risks outweigh the benefits.” It also pointed out the benefits are “less relevant” in the EU because of existing regulations providing for faster transactions in the bloc.

The authority is advising financial institutions to refrain from buying, holding, or selling any virtual currency until a regulatory regime is implemented. The EBA also sent its opinion to the national supervisory authorities, advising them to discourage the institutions they regulate from engaging in virtual currency deals.

It is a small but growing trend, the EBA found, estimating global Bitcoin transactions to number, at most, 100,000 a day globally. That compares to 295 million conventional transactions each day in Europe alone. The agency, however, did notice an uptick in virtual currency activity last year and launched its investigation as a response.

Specific risks to users identified by the EBA include losses from fraudulent exchanges, losses from changes in protocols, hacking of ‘e-wallet” accounts, and unexpected value fluctuations. Because of the lack of regulations, the virtual currencies also pose high risks for money laundering and other financial crimes, mainly due to the fast, global, and anonymous nature of transactions, the EBA said. There also could be risks to existing payments in ‘flat' or conventional currencies, as well as legal and reputational risks to regulatory authorities themselves.

Many of these problems may stem from a lack of transparency around virtual currencies. The authority noted that anyone can create or subsequently alter a virtual currency scheme. For decentralized currencies like Bitcoin, anyone with enough computational power can alter those schemes. The possibility of anonymity for creators, the “miners” who validate transactions, payers, and payees all pose specific risks, the EBA said. Added to that is uncertainty about both IT security and financial viability with no auditing or governance in place.

Addressed to the European Parliament, the European Commission, and the EU Council, the EBA's opinion also set forth what would be needed to regulate virtual currencies. “A regulatory approach that addresses these [risk] drivers comprehensively would require a substantial body of regulation, some components of which are untested,” it says.

Specifically, a regulatory regime would  include governance requirements for various market participants, the segregation of client accounts, and capital requirements. Exchanges also should have to comply with customer due diligence requirements. The most pressing need, according to the EBA, is for the creation of non-governmental authorities to oversee virtual currency schemes. Those authorities would be responsible for verifying the integrity of individual virtual currency schemes, their transaction ledgers, and other main components.

Ideally, the regulatory regime should be global because of the global nature of virtual currency, the EBA said.

Because a new regulatory regime cannot materialize overnight, the EBA urged supervisory authorities to mitigate risk immediately by discouraging credit institutions, payment institutions, and e-money institutions from dealing directly with virtual currencies. That will help address risk between virtual currency schemes and regulated financial institutions, although it won't tackle the risks within the schemes themselves.

The EBA also is urging EU lawmakers to consider declaring market participants directly involved in virtual currencies, including exchanges, “obliged entities” under the EU Anti-Money Laundering Directive and subject to its regulations. That would help shield regulated financial institutions from some of the risks associated with virtual currency schemes, the EBA said.

The EBA issued a public warning directly to consumers in December, making clear that Bitcoin and its counterparts are unregulated and present unmitigated risks.  

The authority said taking some immediate steps to mitigate risks will help protect financial institutions and markets while still allowing virtual currency schemes to develop “outside the financial services sector.”

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