G7 group calls for urgent action on cryptocurrencies

31 July 2019

As many blockchain-based technologies are flourishing, a prominent collection of finance officials recently sounded the alarm over cryptocurrencies. Earlier this month, a G7 working group warned that cryptocurrencies could destabilise the global financial system unless they are tightly regulated.

The working group was composed of central bankers from G7 nations (the U.S., Germany, France, United Kingdom, Italy, Japan and Canada), along with officials from the International Monetary Fund, the Bank for International Settlements and the Financial Stability Board. The group issued a report saying considerable work needed to be done before the much-hyped Libra “stablecoin” led by Facebook could formally gain approval.

The report was published at the conclusion of a G7 finance ministers meeting that took place on July 17 and 18 in Chantilly, France, a prelude to the broader G7 summit to be held August 24 and 26 in Biarritz, France. Central bankers will certainly have more to say about cryptocurrencies at the Biarritz summit. They view digital currencies as a threat to monetary policymaking, as well as a potential haven for money laundering and terrorism financing.

The July working group focused its attention on stablecoins, a type of cryptocurrency whose value is tied to other assets, such as a basket of state-backed currencies (eg the U.S. dollar) or precious metals (eg gold). The group offered four recommendations for stablecoin issuers hoping to gain approval: they should agree to government oversight, demonstrate a sound legal underpinning, offer “cyber resilience,” and provide safe and transparent management.

The group called for “urgent action” to address their concerns. “The sovereignty of nations cannot be jeopardized,” French Finance Minister Bruno Le Maire told reporters.

Other global organizations, while concerned, see no immediate danger. Leaders at a recent G20 summit concluded that “crypto-assets” do not pose a threat to global financial stability at this point, though they should be closely monitored for risks. And financial authorities have recently approved institutional cryptocurrency trading. In the UK, regulators recently okayed the first crypto hedge fund. In the U.S., LedgerX was given a green light to trade Bitcoin futures.

Distrust of Facebook

Though digital currencies have been a central bank concern for some time, the current pronouncement seems to have been precipitated by Facebook’s recently-announced intention to launch a stablecoin called Libra. The coin would not be managed by Facebook directly, but by a non-profit association consisting of 20 companies, including Visa and Uber, each of which have invested $10 million or more in the venture.

Like other stablecoins, Libra would be tied to a basket of established currencies. Its purpose would be to enable simple, low-fee transfers of money and goods across borders. But because Facebook — with over 2 billion active users — is so big, bankers fear it could amount to a sovereign currency without regulatory controls.

Facebook’s timing in announcing the coin, which it wants to launch in 2020, could hardly have been worse from a PR standpoint. The company is reeling from a record $5 billion fine over privacy breaches, including the Cambridge Analytica scandal, in which it improperly allowed a political consulting firm to access the personal information of 87 million members and use it to promote the Trump campaign. It is also facing an antitrust investigation by the Federal Trade Commission and several other probes by agencies in the U.S. and Europe. U.S. congressional lawmakers jeered the company and its planned coin at a recent hearing.

Facebook is an easy target, and its proposed coin does bypass normal financial rules. But other forms of cryptocurrency may pose a more serious worry for central bankers.

Stablecoin vs. bitcoin

Stablecoins are fundamentally different from cryptocurrencies like bitcoin. Both are based on blockchain technology, which creates a distributed ledger — an indelible record of every component of a transaction visible to all parties, though their personal identities are not normally revealed.

After that, the similarities mostly end. While stablecoins are based on existing currencies or other real-world assets, bitcoin, litecoin, namecoin and others were created expressly to bypass “fiat” currencies issued by states. Governments can inflate or deflate their currencies’ values by controlling the amount of money they print, a practice some believe leads to uncontrolled government spending. While the number of dollars the U.S. Federal Reserve can print is infinite, the number bitcoins that can be issued is capped at 21 million.

In addition, bitcoin and other cryptocurrencies are decentralized, and by design pegged to no other currencies. That’s a far cry from a stablecoin like Libra, with its governing association and ties to fiat currencies. Because of these aspects, some cryptocurrency backers have questioned whether Libra’s is a true cryptocurrency. 

With their ties to the financial system, stablecoins are more mainstream than other digital currencies. JPMorgan Chase recently created a stablecoin, redeemable in dollars, to transfer payments between institutional clients. In the Philippines, a large bank recently launched its own cryptocurrency stablecoin that will allow citizens — notably the 70% of the country’s population that is unbanked — to digitally transfer money and pay for goods.

Despite their ties to state-backed currencies, however, stablecoins don’t always live up to the stability their name promises. Their management remains opaque, unless a serious dispute arises, as happened with Tether.

Though stablecoins are less of a threat to the financial system than other digital currencies, both operate outside of banking regulations, creating problems for central bankers to reckon with.

Cryptocurrencies and blockchain

While they are suspicious of digital currencies, regulators are more sanguine about the blockchain technology that underpins them. Multinationals can use blockchain for many purposes besides creating coins. A World Economic Forum report says the technology has far-reaching potential for global trade, providing increased efficiency, transparency and integration, though it requires careful stewardship and needs to develop standards.

Blockchain can pinpoint problems in supply chains, allowing companies to fix issues faster and move perishable goods like food or drugs with greater confidence. Pfizer, McKesson and other large pharma companies are working on a plan to use blockchain in their supply chains, and some believe it could revolutionize the industry.

In banking and other industries, blockchain-based contracts create an unalterable record of terms and fulfilments, putting all parties on the same page. They could potentially eliminate contract disputes. HSBC, Société Générale and other large banks are experimenting with a blockchain platform to increase trust in international trading, where buyers and sellers don’t know each other and current procedures are bogged down in masses of paperwork. In the U.S., states are increasingly legalizing“smart” contracts, which could someday open the door to services like peer-to-peer lending.

The recent G7 meeting underscores the potential threats financial authorities believe unregulated cryptocurrencies pose to the global economy. Blockchain technology, meanwhile, continues to develop across multiple industries with seemingly less volatility and potential for risk. As always, though, new regulations will follow new technologies. For investors in cryptocurrencies and blockchain, the nature of those regulations will likely prove just as important as the technologies themselves.