The Taiwan Banker

As digital currency ascends globally, it is important for Taiwan to understand how this trend will impact the financial world. What type of strategy should Taiwan formulate? The Taiwan Academy of Banking and Finance together with National Taiwan University recently held a seminar exploring this important topic. Cryptocurrency is one of the hottest topics globally among market observers. Statistics show that as of the end of January, there were more than 1500 types of virtual currency globally with a total value of nearly US$599 billion, exceeding Taiwan's $455.7 billion in foreign-exchange reserves. What accounts for cryptocurrency's popularity? For one thing, because it uses blockchain technology and is decentralized, it can serve as a peer-to-peer payment platform. In theory, distributed ledger/blockchain technology ensures that all transactions are secure. At the same time, anyone involved in a transaction uses a private electronic key verified by a signature; the person's identity is not disclosed. Virtual currency has a number of benefits. It speeds up transactions, lowers their costs and makes it easier to process them across borders. The process is fast and convenient. As a result, cryptocurrencies' values have been rising steadily in recent years. The most widely used digital currency, Bitcoin, surged in value in 2017, reaching US$20,000 in December. However, it has since plunged, falling to about US$6,000 at one point in January. Central banks react to digital currencyAgustin Carstens, general manager of the Switzerland-based Bank for International Settlements, said in February that Bitcoin is a "bubble," "Ponzi scheme," and "environmental disaster." Speaking at Goethe University in Germany, he said that "if authorities do not act pre-emptively, cryptocurrencies could become more interconnected with the main financial system and become a threat to financial stability.” Meanwhile renowned economist Nouriel Roubini, best known as "Doctor Doom" for his correct prediction of the 2008-09 global financial crisis, is bearish on virtual currency too, calling it "the mother of all bubbles." Roubini believes that virtual currencies will eventually become worthless. For a nation's central bank, the ability to issue currency symbolizes sovereignty. For instance, the Central Bank of the Republic of China issues the New Taiwan dollar. The United States Federal Reserve Bank issues the US dollar. The value freely fluctuates. The issuers do not have the obligation for the currency to be exchangable for actual commodities. Indubitably, digital currency challenges central banks' sovereignty. If businesses and consumers are able to conduct transactions using decentralized virtual currencies, then the need for the currencies issued by central banks may decrease, undermining the central banks' authority and influence. Carsten's harsh criticism of virtual currency reflects this deep-seated concern. Meanwhile, it's undeniable that cryptocurrency is part of a new wave of innovative financial services, and will play a key role in the development of new payment systems, especially those using blockchain technology. Last October, IMF CEO Christine Lagarde presented her opinion on cryptocurrency. She said that central banks need to start taking digital currency seriously. Government, business and academia discuss digital currency together Japan is the first country to develop a regulatory framework to govern digital currency use. In the second half of 2017, Japan passed legislation legalizing use of cryptocurrency for payments. Now that Japan has taken that first step, other countries are starting to consider passing similar legislation - and even issuing digital fiat currency. These countries include South Korea, the United States, the United Kingdom and nations in continental Europe. To be sure, Taiwan wants to be able to capitalize on the opportunities offered by digital currency. In the view of Hank Huang, president of the Taiwan Academy of Banking and Finance, Taiwan is well poised to tap such opportunities. He points out that Taiwan has complete industry supply chains, a well-developed financial sector and superb technology talent. To help industry leaders, the government and academics better understand digital currency, TABF and the National Taiwan University Center of Economic Research recently held a forum in Taipei. The forum attracted a wide variety of important officials, academics and business leaders to exchange ideas. Among the key participants from the government were Vice-Premier Shih Jun-ji, Financial Supervisor Commission Chairman Wellington Koo, Financial Supervisory Vice Chairman Cheng Mount-cheng and Chiou Jiunn-rong, deputy minister of the National Development Council (NDC). During his speech, Vice-Premier Shih Jun-ji quoted the eminent British playwright William Shakespeare. "Nothing will come of nothing," Shih said, adding that in bitcoin's case something (the digital currency) did come from nothing. At present, a unit of Bitcoin is valued at US$10,000 while the total value of all Bitcoin globally is US$160 billion (NT$4.6 trillion), close to the aggregate assets of the Taiwan banking system: NT$4.8 trillion, and about 1/3 of Taiwan's foreign-currency holdings, which is double the annual budget of the Central Bank. Shih pointed out that regardless if Bitcoin is nothing or something that grew out of nothing, given the vast amount of virtual currency involved (which inevitably involves sovereign currencies too), should digital currency turn out to be a bubble, it will be one of the biggest bubbles in history. Citing a graph from The Economist, Shih pointed out that three years ago, bitcoin's unit price was $US1 and it recently peaked about US$20,000, a 20,000-fold expansion. During the infamous tulip bubble of 1637, unit prices grew just 40-fold. Similar bubbles have occurred throughout history, more recently the 2000 dot-com bubble. Shih concluded that bitcoin's enormous increase in unit price over a short period appears even more severe than previous proven bubbles. However, he does not believe that means bitcoin will simply fade into oblivion. He points out that some assets whose values skyrocket are not part of a bubble. Digital currency brings challenges to financial supervisionSo that brings us to the million-dollar (or Bitcoin) question: Is there a Bitcoin bubble? At this stage, we don't know yet. However, it is undoubtedly positive that the financial industry and regulators are actively discussing the potential applications for virtual currency. In addition to opportunities, virtual currency presents quite a few challenges to governments, businesses and consumers. FSC Chairman Wellington Koo pointed out during his speech that thieves recently hacked Japan's well-known digital-currency exchange Coincheck and stole 58 billion Japanese yen (about NT$15.5 billion). Japanese authorities are currently investigating the crime. Further, South Korea has announced that it will implement regulations banning anonymous transactions with digital currency. Henceforth, Korean users of digital currency will need to use their real names when engaging in transactions. In Koo's view, it's important to fully understand how virtual currency works, including the technology behind it, to identity market opportunities as well as risks, such as data breaches and money laundering. It's also essential for the regulatory framework for virtual currency to protect businesses and consumers, he said. To date, the financial sector has been cautious about virtual currency. However, some countries have previously experimented with sovereign digital currency. Deputy governor of the Central Bank Chen Nan-kuang points out that Brazil in 1994 issued digital fiat currency. He explained that at the time Brazil's inflation rate was out of control, growing at a rate of 2500%. To try and quell inflation, the Brazilian government created an additional currency called URV on top of their original legal currency (cruzeiro R$) URV was used to settle small daily transactions and payments to workers. Otherwise, the cruzeiro was used for everything else. The Brazilian government ultimately used the URV to stabilize its currency. For instance, if the price of a product in cruzeiro was 10 and increased to 20 several months later, the price didn't change in URV. After several months, the Brazilian government announced that the URV would be the new currency - called the Real (R$). Chen Nan-kuang concluded that in this case, the main function of currency is the calculating unit rather than a media for transactions. Bitcoin is a highly speculative financial product Since there is a precedent for digital currency, why do regulators still view it suspiciously? Probably because many of them do not believe it qualifies as currency. Thus far, only Japan and Germany have recognized virtual currency as legal tender. Other countries see it as a commodity. In Taiwan, it is seen as a highly speculative financial product so it is being regulated here the same way Taiwan regulates other financial products. Wang Chien Nan, an economics professor at Michigan State University, pointed out that Brazil's experience with digital currency is not analagous to bitcoin's situation. In Brazil's case, the government backed the virtual currency - it was a digital fiat currency. Thus it was possible to calculate its value relatively easily using traditional means. In contrast, Bitcoin is decentralized. Its value is based entirely on how much legal currency it can be exchanged for or how many commodities it can buy. Further, due to a supply shortage, it is volatile, with regular big price fluctuations. Thus, Bitcoin transactions are closer to gambling than to transactions done with legal circulating currency. Finally, because of its volatility and the intense amount of speculation in the market, any type of major shock, whether a government policy restricting its use or otherwise, could send its value plummeting to new depths. Chang Kai Jiun, an associate researcher at the Taiwan Academy of Banking and Finance, pointed out that the functions of a fiat currency should include transaction media, pricing units and value storage. Some businesses already accept Bitcoin payments, but such transactions are limited in volume because Bitcoin circulation is small and price volatility is high. It still has a long way to go as a universal pricing unit and value storage tool. Digital currency, because of its decentralized nature, is prone to abuse. For instance, anonymous transactions in virtual currency can allow some people to evade foreign exchange and capital controls, making it possible to easily complete gray-area cross-border transactions. There's also the threat that virtual currency poses to banks. It squeezes their savings and may even cause them to be short of capital, which will have a negative impact on their core businesses, like lending. If banks don't lend to companies and individuals, the overall economy will suffer. Similar thinking of the central banks of Taiwan and Europe Looking at this issue from another perspective, since the current amount of total virtual currency is relatively small and most people don't use it, the average person's life is not impacted by digital currency, and it's not affecting commodity prices. For that reason, the European Central Bank said not long ago that cryptocurrency has little connection to the real economy and does not currently threaten financial stability. At present, Taiwan's Central Bank views cryptocurrency similarly. The Central Bank does not feel virtual currency is yet impacting Taiwan's payment system, financial stability or currency policy execution. However, regulators are advising investors to be careful given digital currency's volatility. There is no inherent strong opposition to digital currency being used in Taiwan at present. Therefore, based on the current situation, virtual currency does have a reasonable chance of becoming legal tender in Taiwan, once regulators create a framework to govern its use. Can ICOs be included in the fintech sandbox? Another major issue arising from the advent of digital currencies is regulation of ICOs, a digital currency initial public offering. The concept of an ICO is very close to a stock-market IPO (initial public offering). The difference is that an IPO serves to allow businesses to raise funds from the public that will help the businesses grow, while an ICO raises digital currency from investors and then the company issues its own cryptocurrency. After obtaining the company's cryptocurrency, investors become the company's shareholders. The most successful example of this is bitcoin. The developed economies have shown relative openness towards ICOs. In the USA, UK and Canada, ICOs are evaluated on a case-by-case basis. The US has set up an ICO Commission to handle this job. Russia more or less permits ICOs, but mandates that the fundraising scale is 10 billion rubles or less, about NT$5 billion. In Asia, China and South Korea have both banned ICOs. Meanwhile, Taiwan originally intended to include ICOs and virtual currency in its fintech regulatory sandbox, market insiders say, but currently there is no consensus on whether that will happen. From the FSC's perspective, transparency and proper supervision will be integral to developing Taiwan's ICO market, Vice Chairman Cheng said. Transparency and proper supervision can help ICOs promote new business ventures in Taiwan, he said, noting that P2P platforms (another type of internet finance) have helped small businesses and sole proprietors gain better access to much-needed credit. In Wang Chien Nan's view, digital currency fundraising should be subject to the same high regulatory standards as publicly offered securities, in which there is profit sharing and shareholders exercise voting rights. In the event that someone deliberately releases false information in an attempt to manipulate the market or cause price fluctuations, the regulator must investigate the situation and punish the guilty party or parties accordingly. Of course, prior to permitting ICOs in Taiwan, industry players, government and the general public should have a thorough understanding of cryptocurrency and be comfortable using it. Ideally, the public should first become familiar with cryptocurrency through a multi-stage process, said DPP Legislator Karen Yu. That process would involve first understanding what cryptocurrency is, validating it as a form of currency, monetary nature, and then experimenting with it in areas such as electronic payments, taxation, consumer protection, and information security. After all of those stages are complete, we can possibly move towards ICO, she said. Researching digital currency's future The rise of cryptocurrency globally has central banks wondering whether they should issue their own sovereign digital currencyIn Chen Nan Kuang’s view, there are many options with regards to a digital fiat currency. He said a digital fiat currency has certain advantages. It can be dedicated to financial transactions, liquidation, or other industries. For the central bank, it can also be used as an additional monetary policy tool to help central banks set inflation targets. Brazil is an example. However, he also emphasized that the characteristics of digital currency encryption and decentralization will inevitably impact bank’s position in the payment system and will also result in the loss of deposits. Over time, the bank’s balance sheet will shrink, and “narrow banking” may occur. Can central bankers accept this? It's hard to say right now. Chen thinks that what we should continue researching the possibility of a sovereign digital currency and make a choice that fits the needs of Taiwan's financial system. If the Central Bank chooses not to issue a sovereign digital currency, then it needs to improve its payment system. If it decides to issue a sovereign digital currency, should the Central Bank directly issue the currency or should that be the responsibility of commercial banks? Should transactions require using one's real identity or could anonymity be permitted? There are many important issues to ponder before making a decision.