The Senior Deputy Governor of the Bank of Canada, Carolyn Wilkins, gave a speech yesterday about Bitcoin that outlines some of the Bank's thinking. Ms. Wilkins seems quite knowledgeable about digital currencies (she mentions Ripple and Litecoin in the speech) but she makes a few errors. These errors are completely understandable because digital currencies are complicated but it's worth correcting these mistakes because the Bank of Canada needs to thoroughly understand these new money-like technologies. As a lawyer who works in the cryptocurrency space and computer programmer, here are my views on Ms. Wilkins' speech.
Bank of Canada Claim vs. Fact
At the bottom of this post are longer quotations and explanations for each of the claims and facts below.
Bank of Canada Claim #1: Bitcoin is high-risk because there's no deposit insurance or user protection.
Truth: Bitcoin does not require the user of third party company services so there's no counterparty risk that would require deposit insurance. If someone wants to use a third party service they could find one that's insured or buy their own insurance.
Bank of Canada Claim #2: Bitcoin transactions are public and "can be linked to a specific IP address".
Truth: Bitcoin transactions generally cannot be linked to IP addresses. IP addresses are not a part of the protocol.
Bank of Canada Claim #3: "[T]here is still a big risk that if you acquire bitcoins you won’t be able to find someone to accept them later when you want to spend them."
Truth: Bitcoin has thriving, highly liquid markets. You could sell Bitcoins in seconds using one of hundreds of online services, available in most countries of the world now (e.g. Canadian service QuadrigaCX).
Bank of Canada Claim #4: "Cryptocurrencies ... still require users to put their trust in numerous private businesses ..."
Truth: Bitcoin was invented to be a decentralized platform that does not require trusting private businesses (this is actually the main achievement of the technology). This is absolutely not true.
Bank of Canada Claim #5: "Crypotocurrencies can be used for money laundering, terrorist financing, and other criminal activities."
Truth: This is actually true but there's no evidence that criminals are the main users or that criminals are adopting Bitcoin at a faster rate than anyone else. Our regular financial systems and cash are the main conduits for crime. In fact, widespread use of Bitcoin could massively reduce certain crimes like debit and credit card theft.
Bank of Canada Claim #6: "[T]he Bank of Canada sees risks to the economy in a structure that would allow the benefits of money issuance to accrue to the private sector while any losses would be borne by the government and taxpayers".
Truth: The benefits of issuance for Bitcoin do not accrue to a centralized issuer (like the Bank of Canada). The technology is analogous to email in that no company or entity benefits from wider use of the protocol. There's never been a bailout of Bitcoin users and there's no reason to think that losses would be borne by taxpayers, in the same way that a drop in the market for fine artwork would not result in a bailout for art collectors.
Longer Explanations and Analysis of Speech
"People need to be aware of the risk of putting their trust in an e-money scheme that is lightly regulated with limited or no user protection. For example, debit cards are linked to deposit accounts that are insured by the government and held in banks that are closely regulated. Balances stored with PayPal or other e-money providers do not have those protections. Aside from posing risk to individual users, it is also a level playing field issue for Canadian banks."
Banks need deposit insurance because otherwise they could cheat their customers. Bitcoin doesn't suffer from this problem because you can securely hold on to your own "money" so the lack of a "level playing field" is really just that one system is more efficient. If someone wanted to use a third party storer of Bitcoins (which most people advise against) they could pick one that has insurance or perhaps buy insurance privately. Wilkins mentions debit cards: a system that's riddled with fraud (who doesn't know at least one person who's had money withdrawn by fraudsters?). Bitcoin does not require you to provide your authentication credentials to the person you're paying and so is immune from this type of risk. This kind of thinking is not surprising given that the Bank of Canada has only previously been exposed to the traditional banking model and that is their institutional competence.
"It is not as anonymous as cash, and all Bitcoin transactions are public in the open source ledger, and so they can be linked to a specific IP address. This means that the user could be identified eventually."
The Bitcoin protocol does not store IP addresses of senders and recipients. Furthermore, most users of Bitcoin aren't running their own "node" so the only IP address that could ever be displayed is the one of the service they're using (the node they connect to through some non-Bitcoin means [e.g. BitPay]). The IP address that shows up as connected to a transaction is the IP of the first node that was spotted with that transaction and isn't necessarily the origin node. There are theoretical attacks (see this 2011 Black Hat talk) that could expose someone's IP but there's certainly no guarantee that a user's IP address could be uncovered.
"[T]here is still a big risk that if you acquire bitcoins you won’t be able to find someone to accept them later when you want to spend them"
This is incorrect. Since the first trade of Bitcoins for pizza there has never been a shortage of people willing to accept Bitcoins. There's now a massive international market that does millions a day in volume. Bitcoins could be disposed of in seconds using an online exchange and converted to Canadian dollars.
"While cryptocurrencies do not require a trusted third party to authenticate and validate transactions, they still require users to put their trust in numerous private businesses, such as exchanges and Bitcoin wallets. This leaves them exposed to theft, fraud and loss. The biggest example is the failure of Mt. Gox, which resulted in hundreds of millions of dollars in losses. And while these problems could happen with other forms of e-money, cryptocurrencies offer little recourse because the legal status of the players is still quite ambiguous."
It is not true that users need to trust "numerous private businesses". The first release of Bitcoin included an open-source wallet program that anyone can use for free (and it's still being developed). There is no part of Bitcoin that requires the use of exchanges and that concept is one that's developed over time (the concept doesn't appear in the original whitepaper). Even if these third-party private businesses were required to use Bitcoin, people would have the same recourse as they do against any other private business.
"Crypotocurrencies can be used for money laundering, terrorist financing, and other criminal activities."
This is hardly a strike against cryptocurrencies since all of these things take place within the regulated financial markets and there's no evidence that cryptocurrencies have been adopted en masse by criminals. There's lots of evidence that it's been adopted by technology enthusiasts and Libertarians.
"A crash or failure of one type of e-money can be a concern even if the e-money is not widely used. This is because the failure of one issuer could result in a loss of confidence in other issuers and in the payments system more generally. That is why the Bank of Canada sees risks to the economy in a structure that would allow the benefits of money issuance to accrue to the private sector while any losses would be borne by the government and taxpayers. Let’s remember, these issuers are getting the equivalent of seigniorage but have limited or no oversight at this time."
This is a complicated issue because of the diversity of issuance models out there but for Bitcoin this isn't true. There is no "issuer" of Bitcoin in the same way there's no issuer of email. Bitcoin is a technology that anyone can use. There's no equivalent of seignorage in Bitcoin (in fact that's one of the appeals of the technology for some people). There have been crashes in the price of Bitcoin (as Wilkins discusses earlier in her speech) and the losses were NOT borne by taxpayers. Unlike the financial system (which received many billions in government support between 2008 and 2010) there's been no bailout for Bitcoiners and losses are completely privatized.
Why the Bank of Canada Shouldn't Issue Their Own Cryptocurrency
"This matters because it affects the risks faced by people who use e-money and it has the potential to affect risks to the Canadian financial system as a whole. That is why the federal government, with the Bank’s help, is modernizing our oversight frameworks for payments. The Bank is also undertaking research on the potential merits of issuing e-money."
The Bitcoin model is antithetical to a central issuer and that would undermine most of the advantages of the system. Furthermore, the Canadian government has tried this before with the MintChip (shut down earlier this year). Banks are not known for their technical prowess. What's the chance that the Bank of Canada can outcompete the open-source, world-wide, venture-backed (hundreds of millions a a year are pouring into Bitcoin companies) cryptocurrency movement?