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Virtual Currencies & Blockchain Technology Virtual Currencies & Blockchain Technology CTAGGL May 1 & 2, 2019 The views expressed are those of the presenter only and do not necessarily represent the views of the Federal Reserve Bank of Dallas or the Federal Reserve System 2 What is a “virtual currency”? ❑ “A type of stored-value product or digital money…issued and usually controlled by its developers, and used and accepted among the members of a virtual community.” (FRB Board) ▪ a.k.a. digital currencies, alternative currencies, cryptocurrencies, altcoins; decentralized Internet protocols ❑ Not issued by a federal government (not a “fiat currency”) or backed by a central bank ❑ Generally used in electronic, Web-based transactions 3 Virtual Currencies ❑ “Open source”: All rules, algorithms, security scheme, etc., openly available ❑ May involve legal, credit, liquidity, fraud, operational, information security, privacy, law enforcement, and other payment system risks 4 Potential benefits of VCs ❑ Reduction in transaction costs ▪ Especially for cross-border transactions ▪ Possibly for merchant processing ❑ Useful in countries where: ▪ Social or political climate may lead to distrust of local currencies, and ▪ There is a high degree of Internet connectivity ❑ Opportunities in areas like “smart contracts,” notary services and tracking asset ownership ▪ More on that later… 5 Bitcoin ❑ Launched 2009 (“Satoshi Nakamoto”) ❑ Permits transfer of currency online, directly, anonymously and outside government control ❑ Origins: Fundamentally political; attracted followers among libertarian and anarchist groups ▪ A means of removing the money supply from the hands of government ❑ Subsequently attracted attention from computer developers, venture capitalists, and merchants (alternative to traditional payments) 6 Bitcoin ❑ All transactions are recorded in the “blockchain” ▪ Searchable public ledger where all transactions are confirmed, in a matter of minutes, by a network of computers working to perform complex algorithms ❑ New bitcoins are created through “mining” ▪ The first to perform the complicated hash correctly earns bitcoins ▪ When you request a bitcoin transaction, you can increase the incentive for a miner to process it quickly by adding a fee (a.k.a. “tip”) ▪ The average person can’t really be a bitcoin miner, because of the computing power now required 7 Is it money? Or a tulip? ❑ $136b of digital currencies in circulation (CoinMarketCap.com) ▪ 2,086 Cryptocurrencies Bitcoin – 2017 asset surge, 2018 asset plunge, 2019 ? ❑ Bitcoin: ▪ Dec 17, 2017: ‒ Price = $19,410 ▪ Feb 6, 2018: ‒ Price = $6,852 ▪ Dec 13, 2018: ‒ Price = $3,433 ▪ Jan 7, 2019 – Price = $4,047 Source: bitinfocharts.com 8 Bitcoin and other platforms… A snapshot in time January 7, 2019 12:38:42 CT Bitcoin Ripple Ethereum Bitcoin Litecoin Dash Cash 17,468,417 40,794,121,066 104,247,513 17,540,527 59,932,546 8,558,206 Total: BTC XRP ETH BCH LTC DASH Price: $4,047.42 $0.37 $154.53 $161.38 $38.16 $83.29 Market $70,701,964,462 $15,081,165,275 $16,109,522,530 $2,830,616,570 $2,287,097,447 $712,795,359 Capitalization: Average Transaction $13,169 $830.58 $52,454 $12,895 $4,485 Value: Transactions – Avg. number 11,656 1,230 22,567 308 978 839 per hour Block Time: 9m 40s 15.3s 11m 5s 2m 30s 2m 38s Source: bitinfocharts.com 9 Double Spends If the VC is just digital codes, why not copy and paste to make more money? ❑ Timestamp ▪ Each transaction is packaged and publicly recorded in the order it was carried out ❑ Hash ▪ The time-stamped group of transactions are given a unique, algorithmically-derived number ❑ Blockchain ▪ Transactions are recorded in a community-built record of all transactions that acts as a proof-of-work ▪ Computers connected to the network accept the longest chain as accurate 10 Bitcoin & Merchants ❑ Bitcoin does not allow chargebacks ▪ At least theoretically, less protection for consumers ▪ On the flip side, more protection for merchants ❑ Bitcoin transaction costs are generally cheaper than those associated with credit/debit cards ▪ Fees for credit card acceptance average 2-3% ▪ Fee for a service like Coinbase is around 1% ❑ Most merchants contract with a service (e.g., Coinbase), which converts consumers’ bitcoins into dollars and transfers dollars to the merchant 11 Bringing Bitcoin payments to the masses? Coinbase reports 47,000 merchant clients accepting Bitcoin payments 12 Where to spend my Bitcoins? ❑ Bitcoin as a medium of exchange ▪ More than 100,000 merchants worldwide accept Bitcoin (Source: Spendbitcoins.com) ❑ Sept. 2017: Aliant Payment Systems Inc. announced it will be first ISO to enlist merchants for Bitcoin acceptance ▪ Will recruit merchants for Atlanta-based BitPay (exchange) ▪ Some retailers of high-end merchandise are now accepting Bitcoin payments as some investors look to spend their newfound wealth ‒ E.g., Old Road Harley-Davidson (CA), Lamborghini dealer (CA) 13 Barriers to Cryptocurrency Payments ❑ Volatility: +1,700% increase in Bitcoin price in 2017 ❑ Slow transactions: Increased traffic on blockchain has slowed transaction times, leading to rising fees for users ▪ Bitcoin can process ~3 transactions/sec.; Visa: 24,000/sec. ❑ High costs: Miners charge fees to give priority to payments “If you’re sending a $10 transaction right now, you may see a miner fee of $3 or $4. It’s a big problem for people who want to move smaller payments.” —BitPay spokesperson 14 Volatility: Up and Down We Go! ❑ Is this the bottom? ▪ Feb 2018: “stunning collapse” ▪ Analysts: Too soon to tell – watching the 100-day average ❑ Are we there yet? ▪ Jun 2018: “could post new 2018 lows” – June 28: BTC closed below $6k for the first time since Nov 12, 2017 ▪ Jan 2019: BTC back above $4,000 – its highest price in over 2 weeks Source: coinbase.com 15 Volatile transaction fees Source: bitinfocharts.com Other cryptocurrencies are also seeing volatility, just not as dramatic 16 Bitcoin & Consumers ❑ Many consumers want to earn points/miles ❑ Miner fees/high transaction costs ▪ Especially for small-dollar payments ❑ See also ‘IRS’ slide… ❑ Result: low consumer adoption ▪ Dish Network began accepting bitcoin in 2014 ▪ Less than 1% of total payments are made in Bitcoin ❑ The volume of payment transactions using Bitcoin fell from $427m in Dec 2017 to $96m in Sep 2018, according to data from Chainalysis SOURCE: Digital Transactions News, Nov. 20, 2018 17 VCs: [Not] Everywhere You Want to Be… ❑ Jan 2018: Visa CEO Al Kelly: Visa will not process cryptocurrency transactions (CNBC interview at the Natl. Retail Federation conference) ▪ Cryptocurrencies are not a “payment system player” ▪ Visa will accept only fiat currency transactions ❑ 2018: Capital One, BofA, JPMC, Citi and Wells Fargo no longer allow their cardholders to use credit cards to buy VCs through Coinbase and other companies ▪ Some issuers charging cash advance fees 18 High costs are even squeezing criminals! ❑ 2018: Message posted on Carder’s Paradise (Dark Web marketplace): …“If the Bitcoin price continues increasing, this business is not going to be profitable for us anymore because all our revenue is going to be spent on the Bitcoin fees.” “We urge you to start using Litecoin as much as possible. Litecoin is a very fast and cheap way of depositing funds into the store. We are not going to charge any additional fees if you deposit Litecoins.” 19 A “Regulatory Platypus” ❑ VCs are a “regulatory platypus”; they don’t neatly fit under any of the familiar asset categories.—Marco Santori, partner/head of the blockchain practice, Cooley (NY law firm) 20 Regulating VCs: CFTC ❑ CFTC: Bitcoin is a commodity; therefore… ❑ CFTC oversees bitcoin derivatives (e.g., futures contracts listed on CBOE Global Markets and CME Group) 21 Regulating VCs: IRS ❑ IRS: Bitcoin is property, not currency ❑ Advantage for investors: Bitcoin is treated like stocks, a capital asset subject to a more favorable long-term capital gains rate ❑ Disadvantage for consumers: ALL Bitcoin transactions are technically taxable events, whose gains or losses must be individually tabulated ▪ Contrast this with more streamlined rules regarding foreign-currency holdings ❑ Nov 2016: IRS served a summons against Coinbase, seeking details about customers who traded VCs from 2013 to 2015 22 Regulating VCs: States ❑ New York Division of Financial Services (NYDFS) ▪ VC firms must obtain “BitLicense” and hold higher levels of capital ▪ 7 BitLicenses have been issued: ‒ Square (June 2018); Coinbase; Circle; Xapo; Genesis; bitFlyer; and XRP II (Ripple affiliate) ❑ “California Considers Bill Setting VC Guidelines,” AmericanBanker.com, Mar 3, 2015 ▪ “Shelved” 23 OFAC & Virtual Currencies ❑March 2018: Virtual Currencies FAQ published ❑Two important take-a-ways: ▪ OFAC sanctions regulations apply equally to both fiat currency and virtual currency transactions ▪ OFAC will respond to growing threats posed by bad actors utilizing emerging payment systems by adding digital currency addresses that are associated with blocked persons to the SDN list https://www.treasury.gov/resource-center/faqs/Sanctions/Pages/faq_compliance.aspx#vc_faqs Are the rumors of the death of Bitcoin greatly exaggerated? Adobe Stock 25 Blockchain/DLT Initiatives ❑ Most new blockchain proposals are looking at: ▪ Limited participant nodes (“permissioned” ledger; only permitted, known participants can validate transactions); ▪ Centralizing all or part of the blockchain ledger; ▪ Paring the blockchain ledger under certain circumstances; ▪ Making blockchain sizes and their analysis more variable; ▪ Incorporating data analytics and probabilities
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