The Voice of Canadian Credit Unions
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Coin of no realm

Bitcoin is a volatile digital currency that's making waves as credit unions cautiously watch

May2014_F1-Bitcoin2_Letain

I’m at Ottawa’s first Bitcoin Teller Machine (BTM). It’s a small kiosk located in the Byward Market downtown, conveniently placed inside the Clocktower Brew Pub. As I watch, seated in a booth across the aisle, I’m surprised to see the BTM being visited by many patrons, all eagerly and easily interacting with it.

Using it is quite simple – you just have to bring a smartphone with an app on it to generate a personalized code, then scan it through a reader on the front of the machine.

“Yeah, I use it all the time,” says a guy sporting a spiffy pinstripe suit and immaculate red Nike Pumps, who preferred to remain anonymous. “I use my account to buy stuff online – like through Amazon and whatever.” When asked why he does it this way instead by using a credit card or a PayPal account, he replies: “Because this way, it’s like I’m keeping my money in a bank that doesn’t belong to anyone.”

Mr. Pinstripe and many others are using the BTM to convert Canadian dollars into bitcoin, a form of electronic currency that has been seeing a lot of press since its inception in 2009. Actually, a lot of press is putting it quite lightly. It’s been at the centre of stories on hacking, bankruptcy and black market activity. FIs have been shutting down the bank accounts of those with connections to it. Then there’s the matter of its elusive creator. In fact, as of this writing, in the last month alone there have been more than one million tweets on the topic of bitcoin. In short, it has clearly caught the attention of the mainstream.

Yet few people can tell you exactly what bitcoin is other than to describe it as “Internet money.” It’s not surprising, because the cryptocurrency is difficult to explain. Simply put, bitcoin, which is not affiliated with any central bank, runs on a computer network comprised of the desktops, laptops, tablets and cell phones of all its users. These users have apps on their devices to make exchanges – so-called bitcoin wallets. The network keeps track of bitcoin as it moves from wallet to wallet – an electronic public ledger of sorts – that ensures the currency can’t be double-spent.

A chain of digital signatures

“Marc-André Pigeon, director of financial sector policy for Credit Union Central of Canada, described bitcoin in a recent paper as a chain of digital signatures. “In the bitcoin universe,” he writes, “this chain is created by software that adds unique private and public keys to each transaction originating from a unique address held in a user’s virtual wallet. Each transaction is subsequently verified by bitcoin ‘miners,’ people with powerful computers who crunch through the verification task in return for bitcoin.” Are you with me so far?

Bitcoin provides its users with anonymity and the ability to avoid most of the standard transaction fees associated with international transfers. As a result, bitcoin, which came into circulation in 2009, became popular with online enterprises and communities all over the world, as both individuals and businesses opened bitcoin wallets as a means to store their money and conduct transactions. Slowly but surely, even local over-the-counter retailers and restaurants started accepting bitcoin as a form of payment.

Bitcoin provides its users with anonymity and the ability to avoid most of the standard transaction fees associated with international transfers.

In Vancouver, a realtor has begun accepting bitcoin. Toronto’s Smoke Bourbon BBQ House on Harbord Street accepts it. David Mancini accepts it from patrons of his Baie-Saint-Paul bed-and-breakfast business in Quebec. In all, an estimated 212 Canadian merchants now accept bitcoin. As of this March more than 12 million bitcoin were in circulation. Now, BTMs can be found in several cities nationwide. They’re so popular that the BTM in downtown Vancouver, the world’s first, saw over $100,000 in currency traded in its first week. On the face of it, bitcoin’s growth potential seems astounding.

Hackers wreak havoc

Despite bitcoin’s uptake from Ottawa to Vancouver, credit unions in Canada have yet to roll out the red carpet to investors wanting to open business accounts with bitcoin wallets. At the moment, only Vancity ($17.1 billion in assets, 497,000 members) has declared an official stance against bitcoin business accounts in Canada, while no other credit union has made an official declaration of policy. Attempts to reach out to the media departments of several credit unions in Canada universally came back with “No comment at this time.”

The truth is that bitcoin is also highly volatile. For every dramatic skyrocket in value, a series of crushing drops has followed. A market value graph of bitcoin’s last year looks kind of like a game of Pong. Recent evidence of bitcoin’s potential to swing dramatically presented itself with the literal disappearance in February of what was once the world’s largest bitcoin market exchange, Tokyo-based Mt. Gox. In that particular event, all transactions were shut down, its site went offline and word of an alleged hack was all over forums and Reddit threads. The hack purportedly caused 850,000 bitcoins, which equates to hundreds of millions of real dollars, to be lost due to a flaw in bitcoin’s security protocols. The effect? The day before the crash, you could pop by your local BTM to find bitcoin valued at about $900 Canadian per coin. The day after? Less than $500. Mt. Gox later filed for bankruptcy, having lost $71 million of its own invested dollars in the attack. Closer to home, Edmonton-based Flexcoin shut down its operations after an estimated $600,000 worth of bitcoins disappeared into cyberspace, thanks to hackers.

A future for bitcoin?

Regardless, at least one credit union sees a future in bitcoin. “We are big on people’s right to privacy and to do as they want with their own money,” says Jordan Modell, CEO and board member of the Internet Credit Union (IAFCU), which became fully chartered in New Jersey in May 2013. “From a bitcoin perspective, we believe that there should be an alternative to fiat currencies as long as it is done in a safe, sound and legal matter. The key to bitcoin’s appeal lies in one word: decentralization.

“The beauty of digital currency is it’s available instantaneously worldwide. You can go to lots of places in the world that accept payment denominated in bitcoin, and whatever costs you a hundredth of a bitcoin in New York costs you a hundredth of a bitcoin in Vancouver or Berlin.”

Modell believes that in one way or another, bitcoin will weather this volatility. “Do I think bitcoin will replace traditional fiat currencies? Heavens no,” he says, “but I do think there will be an ecosystem where they can co-exist. Bitcoin has proven pretty resilient considering everything that has happened and I think it will continue to be a factor in some shape or form. Consider that eight per cent of all bitcoin in circulation literally vanished in the Mt. Gox crash. Imagine that eight per cent of all Canadian dollars in circulation disappeared overnight. The entire economy [might] crash, same as the U.S. or China or any other country. Despite that, it’s still hovering around $600 U.S.”

Tulip mania?

Critics of bitcoin describe people’s interest in it as comparable to “Tulip Mania,” a period in the 1600s in The Netherlands when prices for tulip bulbs reached absurd heights, then suddenly collapsed. At the time, a single tulip bulb was worth about 10 times the salary of a skilled craftsman. Some studies believe that the bitcoin market will see a similar catastrophe.

“Yeah, I’m sorry, that’s just stupid,” says Modell, obviously passionate on the subject. “Sure there’s speculation in bitcoin and there was speculation during the 1655 tulip bubble, but it was lack of information about tulips and hybrids that ended up leading to the eventual crash of the market. Right now, there are thousands of stories and media outlets where people can educate themselves. Will there be losers in this? Yes, absolutely. [But] I can’t tell you where bitcoin will end up as far as pricing goes.”

He maintains that at present, in any event, average Canadians aren’t buying and selling bitcoin so they’re not going to be the people hurt by it. “Over 90 per cent of all bitcoins in circulation belong to a small number of people. During the tulip bubble, anybody could buy tulips,” he says. In other words, speculators always take risks: They know that they stand to lose – or to gain – a great deal.

When the Internet Credit Union opened its virtual doors, it had several members with bitcoin accounts and it was open to more. Then, very recently, new regulations in the U.S. obliged the IACFCU to enforce stiff measures on bitcoin accounts. “It was kind of the wild west phase at that point, where no one was really sure if bitcoin firms were a money-service business or not,” says Modell, who describes the regulations as rigid but necessary, given bitcoin’s potential for money laundering. Still, the current requirements are significant. “The difference between opening up a standard account and a bitcoin account is a lot like going from opening a restaurant to opening a restaurant with a liquor licence. One is open almost immediately, while the other could take as long as a year to open.”

FINTRAC’s role

The same is largely true in Canada, where bitcoin is outside the scope of the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC). FINTRAC’s job is to track down suspected money laundering, among other activities. However, because money is defined as “the currency of any country,” bitcoin does not fall within its purview. Still, if at any point Canadian bitcoin dealers were to facilitate a transaction that converted bitcoins into U.S. dollars or euros, they would have to declare themselves a money-service business with FINTRAC. As a result, according to the Bitcoin Banking Society of Canada, the Bank of Montreal is the only financial institution in Canada with an open-door policy on bitcoin business accounts.

For its part, Canada’s Department of Finance doesn’t consider bitcoin to be legal tender, according to a release on its website. Furthermore, according to a detailed Economic Action Plan released in February, regulations are currently being proposed to control virtual currencies.

“Canada’s regime remains strong and effective and is consistent with international standards,” it states. “However, it is important to continually improve Canada’s regime to address emerging risks, including virtual currencies, such as bitcoin, that threaten Canada’s international leadership in the fight against money laundering and terrorist financing.”

The report goes on to explain that the Standing Senate Committee of Banking, Trade and Commerce completed a five-year review of the Proceeds of Crime (Money Laundering) and Terrorist Finance Act. Pursuant to the review, legislative amendments are to be instituted by the Government of Canada that propose to “introduce anti-money laundering and antiterrorist financing regulations for virtual currencies, such as bitcoin.” To back up that position, the Canadian government plans to provide FINTRAC up to $10.5 million over five years and $2.2 million a year ongoing to implementation of these amendments.

Cryptocurrencies to spur growth in security apps?

Will this help legitimize cryptocurrencies and bring them out of the shadows, or is it another blow to bitcoin that will drive it underground or devalue it? Modell believes one of the biggest areas of growth will be in security apps that work in tandem with bitcoin apps to provide a more dependable experience for both the wallet holder and for financial institutions. “There are already bitcoin security firms like Zerocoin that are acting as intermediaries for bitcoin users, and creating a more secure facility for bitcoin in general. So you’ll see bitcoin and bitcoin addons becoming a bigger thing in the coming months,” he says.

Until security applications are up and running, however – and credit unions might be able to take the lead in this respect – it’s unlikely that financial services cooperatives will put members at risk. However, as we emerge from the “wild west” of digital currency exchange and move on into more civilized times, we might find that not only is bitcoin going to be around for a while, it and cryptocurrencies of its kind may dominate their own financial space. In short, so far credit unions have been wise to observe at a distance until the market really takes shape. ◊