The Director of Federal Reserve Bank of San Francisco has recently published an article targeted at the community banks operating under its jurisdiction. The Director, Wallace Young has explained about bitcoin and cryptocurrencies in the article which also talks about various risks involved in dealing with bitcoin based customers and businesses.
The article gives an overview of the history of digital currencies starting from the time bitcoin was first launched in the year 2009 to the emergence of other cryptocurrencies like Litecoin, Dogecoin peer coin and a lot more. He goes on to explain the specific usage of certain coins like Dopecoin and Darkcoin.
While accepting the increasing popularity of bitcoin, virtual currencies and services associated with it (bitcoin exchanges, trading platforms, microlending platforms etc.), he cautions the community banks about providing banking services to these entities as they present unique risks and challenges.
The risks discussed by Wallace Young includes compliance risk, reputational risks, credit risk and operational risk. According to Young’s article, the compliance risks is part of legal risk similar to the ones presented by traditional money transmitters. A certain degree of anonymity associated with virtual currencies makes it hard for the banks to understand whether there user of virtual currency is involved in anything illegal or not, which will end up presenting a higher risk for the banks. He advises the banks to handle bitcoin exchanges as money transmitters as per the FinCEN designation.
Similarly, by referring to the case of Mt. Gox and the lawsuit accusing the banking partner for not having prior knowledge of the fraud. The referred lawsuit also accuses the bank for profiting from the fraud. He explains the possible reputation risk while dealing with virtual currency businesses. The article also covers the credit risk associated with accepting bitcoin or other virtual currency as loan collaterals. The volatility of digital currency may reduce the value of collateral and there are challenges associated with taking control of borrower’s wallet in case of loan default.He also advised the banks to not take any operational risk by holding virtual currency as assets until they become mainstream and proper procedures are set in place to hold bitcoin.
Wallace Young’s suggestions holds good for the time being, until more people adopt bitcoin, and with various banks already exploring the use of bitcoin technology, there will be enough procedures and safeguards built around the digital currency to reduce the risks. Also, when that day comes, bitcoin will emerge as a stable cryptocurrency.