The virtual banking markets: Bitcoin

The experience of the global financial crisis, where rapid innovation masked fundamental vulnerabilities, has naturally raised some concern that the latest wave of innovation in financial technology could be a precursor to future financial instability. This is not the only perspective, FinTech could be used to promote macroeconomic and financial stability, for example, allowing the practical implementation of full reserve banking to eliminate the negative consequences of credit expansions. For instance, the rise of virtual currencies, such as Bitcoin, demonstrates the spread of alternative forms of money that circulate through digital platforms without the intervention of financial intermediaries.50

Virtual currencies are not regulated by any central bank or other form of governmental authority; Bitcoin, for example, is a P2P electronic cash system. In this sense, virtual currencies are a species of financial hybrid that defies straightforward placement in established categories and exacerbates ‘border problems’ between the regulated and unregulated space and between national jurisdictions. Virtual currencies allow for anonymous ownership and include a public register of every transaction involving a particular blockchain to show the present owner. The fundamental difference between digital currencies and conventional currency is that they avoid the need for intermediaries, including central banks and commercial banks, through the creation of a global collaborative endeavour.

Bitcoin uses a combination of private and public cryptographic keys. Private keys are always kept confidential within an individual’s wallet. Bitcoin uses an Elliptic Curve Digital Signature Algorithm. Bitcoin works as a payment network and as money. Blockchain-based payment network solutions provide a cheap and secure cross-border payment and settle

ment framework.[1] Bitcoin has been lauded on the grounds that it creates a fast, secure and efficient money generation and payment system although the highly technical nature of the software used creates substantial technological dependence. Bitcoin blockchain can be the foundation of future financial market infrastructure; however, there are doubts whether it is robust enough to form the base of payment, settlement, clearing and trading systems. Bitcoin as a software is vulnerable to attack, it has bugs and only few investors understand how it works; this means that operational risks make it unsuitable to serve as the base of the financial system.

Another development has been the phenomenal rise of speculative investment in cryptocurrencies and, in the case of the associated opportunity for raising finance for start-ups through cryptocurrency, ‘initial coin offerings’ (ICOs) represent a truly transformative innovation. The consequent market valuations are large (despite a near 50% decline in valuations since late 2017, their total ‘market cap’ was still $454bn as of June 2019 but this remains small compared to the global market cap of traded equities of around S80,000bn). Chohan argues that there is a greater risk of fraud in ICOs than Bitcoin: ICOs require traditional securities regulation but Bitcoin which is trust-less does not.

Cryptocurrencies have risen up the regulatory agenda of global bodies (e.g. the Basel Committee), but there is a clear distinction between cryptocurrencies, cryptoassets -i.e. the new experimental forms of finance that uses pseudo-anonymity (participation determined by internal network identifiers not real-world identity) and cryptographic security to operate entirely outside of the regulated industry - and the application of new technologies in regulated financial services. The first category (‘cryptofinance’ to distinguish it from the second category of mainstream ‘fintech’) is important as an inspiration and source of technical innovations, but the separation of cryptofinance and FinTech reflects a continuing real-world divide between radical exploration of possible technological alternatives to our existing financial institutions and the many more practically focused innovations and start-ups that are challenging conventional regulated financial services.

Garratt and Wallace point out that the value of Bitcoin is that it rests on self-fulfilling beliefs.[2] It is assumed there is a fixed stock of Bitcoin that is valuable today only as it is believed others will treat it as valuable in the future, hence the difficulties in determining money prices in the one-money model and two-money world, including Bitcoin and standard fiat money. In substance, the problem of determining Bitcoin’s value is due to the ease of creating perfect substitutes. Most interestingly, Milne investigates the potential improvement on monetary arrangements using time-ordered immutable transaction records (i.e. blockchains, mutual distributed ledgers) to record cryptocurrency transactions. By putting money (government fiat money and bank money) off-balance sheet, a distributed ledger can ensure the integrity of money and payments arrangements in the event of bank failure. If successful, this could potentially mean central bank reserves would not be required for bank payments settlements and consequently no requirement for ‘too big to fail’ protection of banks.

As argued, Bitcoin operates as a speculative currency with excessive volatility: this raises the question whether Bitcoin and other blockchain-based networks are a decentralised infrastructure which suffers from lack of transparency. The transparency problem is that individuals can obtain the history of all transactions and potentially sensitive information about others. There is, however, an element of in-built privacy, as individuals can transact with each other without disclosing their identity: cryptographic techniques can ensure transaction data remains confidential and users can uncloak their transaction data to a third party in a certified way. Like other forms of modern money that lacks inherent value, Bitcoin is a promise. However, it is a different promise than central bank issued money, a promise backed by an algorithm with expression in a digital P2P network.

  • [1] Paolo Tasca, ‘The Dual Nature of Bitcoin as Payment Network and Money’ in Christian Beer, Ernest Gnan and Urs W. Birchler (eds), Cash on Trial (SUERF Studies, The European Money and Finance Forum 2016) 71-72, available at (accessed 18 June 2020). 2 The system is nevertheless arguably too complex with over 380,000 blocks already having been generated. The system is slow and only allows for two transactions per second with Visa allowing over 1,700 transactions per second. Substantial delays can occur in using transferred coin with payees having to wait up to one hour, therefore the value of Bitcoins have fluctuated widely. See Gerald P. Dwyer, ‘The Economics of Bitcoin and Similar Private Digital Currencies’ (2015) 17 Journal of Financial Stability 81-82. 3 Angela Walch, ‘The Bitcoin Blockchain as Financial Market Infrastructure: A Consideration of Operational Risk’ (2015) 18 NYU Journal of Legislation and Public Policy 883-884. 4 See (accessed 27 June 2019). 5 Usman Chohan, ‘Initial Coin Offerings (ICOs): Risks, Regulation, and Accountability’ (2017) Discussion Paper Series: Notes on the 21st Century, 3-4, available at (accessed 20 June 2020). 6 Morten L. Bech and Rodney Garratt, ‘Central Bank Cryptocurrencies’ (2017) 2017 BIS Quarterly Review 58-59. 7 Maria Demertzis and Guntram B. Wolff, ‘The Economic Potential and Risks of Crypto Assets: Is a Regulatory Framework Needed?’ (September 2018) Bruegel Report Policy Contribution Issue No. 14, 8-10, available at (accessed 24 June 2020).
  • [2] Rodney Garratt and Neil Wallace» ‘Bitcoin 1, Bitcoin 2,...: An Experiment in Privately Issued Outside Monies* (2018) 56(3) Economic Inquiry 1888-1889. 2 Alistair Milne, ‘Cryptocurrencies from an Austrian Perspective’ (2017) 13-14, available at (accessed 11 June 2020). 3 On this discussion see Primavera de Filippi, ‘The Interplay between Decentralization and Privacy: The Case of Blockchain Technologies’ (2016) 7 Journal of Peer Production 7-8, available at (accessed 27 June 2020). 4 Bill Maurer, Taylor C. Nelms and Lana Swartz, “‘When Perhaps the Real Problem Is Money Itself!”: The Practical Materiality of Bitcoin’ (2013) 23 Social Semiotics 261-262. 5 John Engen, ‘Lesson from a Mobile Payments Revolution’ (29 April 2018) American Banker, available at (accessed 28 June 2020). 6 Kieran Garvey, Hung-Yi Chen, Bryan Zhang, Edward Buckingham, Deborah Ralston, Yianni Katiforis, Kong Ying et aL, ‘Cultivating Growth. The 2nd Asia Pacific Region Alternative Finance Industry Report’ (September 2017) 57, available at (accessed 10 June 2020).
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