Anders Nysteen
Senior Quantitative Analyst, Saxo Bank
Summary: As European nations begin to test-drive new digital currencies, will there be a regulatory backlash?
Major steps have been taken in Europe over the past year to be part of the digital transformation of assets and payment services, as well as being at the forefront of “green” crypto mining. The European Union has a vision to be a leader in digital assets, both in terms of innovation and adoption, but the EU also sees a growing threat to the autonomy of central banks caused by the growing cryptocurrency industry. How far has Europe progressed in the digital adoption and transformation? We take a closer look below.
The crypto space has been booming in Switzerland, with the canton of Zug being known as “Crypto Valley” Switzerland has the highest adoption rate in Europe and in 2018 the Swiss Economy Minister announced that Switzerland should become “the crypto nation”. Looking further across Europe, some countries are more open to the new technology than others, and regulation is done locally by the individual countries. The dream scenario for the EU is to create unified regulation across all EU countries which could spur technological innovation in the digital transformation, as well as protecting citizens using and investing in digital assets. This requires an extremely well-balanced legislative foundation and stringent cybersecurity measures, as well as being an active player in the industry. Valdis Dombrovskis, Executive Vice-President for an Economy that works for People under the European Commission points out that “the future of finance is digital”, and that “technology has much more to offer consumers and businesses, and we should embrace the digital transformation proactively, while mitigating any potential risks”.
Imagine a world where payments and cross-border transactions on a larger scale are carried out by cryptocurrencies which are provided by non-domestic providers or private entities, decoupled from the influence of governments. This is the vision of some crypto enthusiasts and promoters of crypto independency, but central banks are seeing this as an increasing threat, as exemplified with Facebook’s announcement of their digital coin Libra (now called Diem), which faced strong opposition from regulators.
A clear message was sent by the European Central Bank (ECB) in the beginning of June 2021, identifying a significant stability risk if a central bank chooses not to offer a digital currency. According to their report, issuing Central Bank Digital Currency (CBDC) “…would help to maintain the autonomy of domestic payment systems and the international use of a currency in a digital world”, as well as boosting cross-border transactions at lower costs. A survey by the ECB revealed that European citizens and business professionals value privacy as the most important property of a potential digital Euro (although not full anonymity), with security being second-most important feature. And more than two-thirds indicate that it should be integrated into the existing payment and banking systems.
Multiple countries have pilot projects and CBDCs have been launched for public use in both Bahamas and Cambodia, whereas China is one of the major countries running pilot projects. In Europe many countries, such as the Swedish Riksbank with the e-krona, are quite positive towards CBDCs. The head of Germany’s central bank is taking a more concerned stance against CBDCs. He warned back in March that widespread use of a CBDC could have serious consequences, and the business model of banks will be fundamentally changed, so any introduction of CBDCs should be carefully considered. Germany has been conducting its own pilot project with digital assets, and Deutsche Bundesbank announced a successful test of a settlement interface for electronic securities using distributed ledger technologies by issuing a ten-year Federal bond, with settlements being carried out with the new technology. This technology runs counter to a blockchain-based infrastructure, without the need for tokenising assets and money, and would be much faster to implement than issuing a CBDC.
The design of a CBDC should be slightly different from many of the major cryptos today. According to Goldman Sachs, the distributed ledger constituting the network should use a permissioned version where the central bank can choose who should be a part of the system, unlike Bitcoin which is open to the public. And to avoid promoting the use of the CBDC for criminal-related activities and transactions, full anonymity will not be a consideration.
The EU is steadily proceeding with developing a harmonised regulation of digital assets. Back in January 2020 with the 5th Anti-Money Laundering and Counter Terrorist Financing Directive, cryptocurrency businesses were obliged to follow the same data-sharing, anti-money laundering, know-your-customer requirements as central banks.
Cryptocurrencies are on a broad basis being considered legal throughout the EU, although crypto regulation in Europe is ongoing. There has been a change from local regulation to the EU announcing in September 2020 its first major plan for how cryptocurrencies should be regulated; there is still a clear gap in regulation when it comes to protecting investors and avoiding fraud. The proposal by the EU Commission is titled Markets in Crypto-Assets Regulation, MiCA, an addition to the existing MiFID II regulation of traditional financial activities and instruments within the EU. It is a part of a larger Digital Finance Package, seeking to add more digital resilience in the financial sector by boosting Europe’s innovation and competitiveness, as well as reducing the market fragmentation and letting authorised crypto companies carry out their services across the whole union. The package also includes the “Digital Operational Resilience Act” to ensure that all participants in the digitalised financial system are ready for the increased vulnerability of the monetary system to cyberattacks.
The two largest cryptocurrencies, Bitcoin and Ethereum, are using a proof-of-work for verifying transactions on the network, which is an energy-intense process run by crypto miners demanding large computational power. According to Cambridge Centre for Alternative Finance, about 75% of the miners use renewable energy sources as part of their energy mix, although a little less than 40% of total consumption comes from renewables. As illustrated in Figure 1, miners in Europe lead the way in using renewable energy sources. The Nordic countries are popular for sustainable crypto mining as electricity is cheap and mainly comes from renewable energy sources such as hydroelectric power.
Iceland has been one of the mining hotspots in Europe due to its hydroelectric and geothermic energy sources, and the first Bitcoin mining facility opened there in 2014. Up until four years ago, Iceland hosted around 8% of global Bitcoin production, but the mining operations have raised concerns from environmentalists about the damage to waterfalls and the wilderness. Over the years, Iceland seems to have reached its capacity limits of excess energy, and in fact Iceland’s global share of Bitcoin mining has decreased to only around one percent. Norway with its oversupply of power has taken over in terms of mining power, and Sweden has similar potential, as the conditions are similar to those in Iceland. However, crypto mining is competing for the excess renewable energy with other industries such as the “green steel” industry, where the steel industry’s energy supply from coal is being substituted with renewable energy sources and hydrogen. According to data from 2020, the Nordic countries combined only account for a couple of percent of the global mining power (hash rate), so the renewable agenda in the Nordic countries does not have a big impact on the overall mining landscape, although they hope to define new norms within the space.
The European Commission wants the EU to be a leader in blockchain technology, both as an innovator and as a facilitator for blockchain companies and applications, and multiple proposals are in the pipeline towards fulfilling these goals. In an interview with Bloomberg, the ECB president Christine Lagarde says that if ECB policymakers are in favour of a digital currency project, the launch of a digital Euro will happen in around four years’ time. Looking at how much the crypto industry has evolved over the past four years, it seems impossible to predict if cryptocurrencies will be widely adopted for financial transactions and payments, or whether some of the current issues within the major cryptocurrencies, such as high transaction fees and limited bandwidth, will prevent a breakthrough of cryptocurrencies. If the crypto industry continues its rapid developments, it may be necessary to look beyond CBDCs to other ways of digitalising the financial industry, as exemplified by Germany. The regulatory initiatives within the EU have a much shorter timeframe and will, if implemented, be a quantum leap for crypto regulation, and can pave the way for Europe to become a global standard-setter, as well as boosting the sentiment around digital assets.
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