EMERY, Mr David William, Senior Manager, Payments Policy Department, Reserve Bank of Australia

RICHARDS, Dr Anthony John, Head, Payments Policy Department, Reserve Bank of Australia

ACTING CHAIR: I welcome Dr Anthony Richards and Mr David Emery from the Reserve Bank of Australia. Thank you for appearing today. I invite either or both of you to make an opening statement.

Dr Richards : I have prepared some short remarks that may help as background but will still leave us lots of time for your questions. The Reserve Bank has taken an interest in digital currencies and monitors development in this area. Digital currencies represent an interesting development in the payments and financial system landscape. The concept of a decentralised ledger is an innovation with potentially broad applications for a modern economy. At present, digital currencies are not widely used in Australia or in other developed economies. While they do not constitute legal tender in Australia, there is nothing to prevent two parties from agreeing to settle a payment using a digital currency.

Looking ahead, growth in the use of digital currencies will presumably depend both on the evolution of digital currencies and distributed ledger technologies as well as the extent to which digital currencies can better meet the needs of users than existing payment methods. One case where digital currencies might gain traction is in the area of international remittances, which can be expensive and subject to delays in the receipt of funds. More broadly, however, many payment attributes of digital currencies are already available in the traditional payments system or will be available, in the case of the new services that may be facilitated by the New Payments Platform project. Accordingly, it remains to be seen what would drive their widespread use domestically, particularly in light of the price volatility of digital currencies observed to date.

Given the very limited use and acceptance of digital currencies in Australia, digital currencies do not currently raise any issues for the bank in terms of the bank's monetary policy and financial stability mandates. The bank is also the principal regulator of the payments system, and our comments today will focus on this aspect of the bank's mandate. The bank's approach to the use of its regulatory powers under the Payment Systems (Regulation) Act has generally been to rely on industry- or market-driven solutions, only intervening when necessary on the grounds of our responsibility for efficiency and competition in the payments system and controlling systemic risk.

Digital currencies are not currently regulated by the bank or subject to regulatory oversight. However, the bank will continue to monitor the use of digital currencies. In the event that the use of a particular digital currency were to grow significantly and to raise public interest concerns, the bank would consider whether it would be desirable and feasible to designate it as subject to regulation and then to impose standards on participants in that system. The bank will also be assessing whether the regulatory framework can accommodate alternative mediums of exchange such as digital currencies, consistent with the observations of the final report of the financial system inquiry.

At present, however, the bank's judgement is that the very limited use of digital currencies means that they do not raise any significant concerns with respect to competition, efficiency or risk to the financial system. Accordingly, it is currently unlikely that any benefits of regulation would outweigh the potential costs. In this regard, one has to be mindful of the risk of misinterpretation of the degree of protection offered by regulation or oversight, which may lead users to exercise less caution than warranted when selecting and using service providers. Of course, in the event the bank deemed it necessary to take regulatory action in the payments system aspects of digital currencies, the international character of such systems could place constraints on our ability to act unilaterally, so any action might need to be suitably coordinated. One vehicle for coordination would be through the Committee on Payments and Market Infrastructures at the Bank for International Settlements, of which the bank is a member. The CPMI currently monitors developments in digital currencies.

Finally, we note that digital currencies have the potential to raise more immediate concerns over issues relating to taxation, anti-money-laundering and counter-terrorism-financing rules and consumer protection. These are areas that are outside the bank's realm of expertise and responsibility. We would now be happy to answer any questions from the committee on the bank's submission.

ACTING CHAIR: So just generally: 'Remain calm. We've got a watching brief. It's a drop in the ocean. Nothing to see here right now.' Am I paraphrasing your opening statement?

Dr Richards : That is paraphrasing, but broadly speaking I would agree with that. It is a very interesting development—we all find it fascinating—but it is not a widely used means of payment by any means and it is not obvious that it raises concerns for the bank in any of its areas of responsibility.

ACTING CHAIR: This morning we heard from the Australian Payments Clearing Association, who you set a task in 2012 to hit some hurdles. I think largely they have made quite a bit of progress in doing those things, which is heartening. Do you contemplate providing them with any kind of task in relation to cryptocurrencies going forward? Are you talking about that in policy terms now?

Dr Richards : No. The initiative you are talking about is what is grown into the new payments platform, which will be a new set of payments infrastructure that will enable real-time data reach, simple addressing et cetera for payments. So it will mean I can make a—

ACTING CHAIR: In real time, I believe.

Dr Richards : Exactly. For example, if you and I were to have lunch and I was wanting to pay you, even if you were at a different financial institution, I could pull out my mobile and you would see the money in five or 10 seconds.

ACTING CHAIR: The same time as it takes to get an email.

Dr Richards : Yes. That is something the industry is making very good progress on. The bank is working closely with the industry there. We are providing real-time settlement for those transactions. That is an area where there was a gap in the existing payment system. In many instances, we think the industry is pretty good at providing the services that end users want. Competition means that institutions will go out and compete aggressively to provide the types of services that end users want. That is except in one aspect, and that is where you need to build some cooperative or common infrastructure. Sometimes the industry has trouble coming together to build that infrastructure. That is one area where the bank saw a gap and that the ability to deliver real-time payments required building a common infrastructure. We were able to get industry together to build that infrastructure. It will be a new set of rails that a lot of different types of payments will be able to run on in the future. But in general we see no shortage of innovation in the digital currency sphere. The presumption for most aspects of the payment system is that the market is able to deal with these issues. We will only intervene where we see an aspect where competitive forces are not delivering what we think are competitive and efficient payment services.

Senator EDWARDS: Just on that, before I hand back to the Chair, a number of people that we have heard from were quite excited about the blockchain technology for payments in the process that surrounds them. Do you share their view? This is not so much on Bitcoin or the others but just about that advanced technology for making payments.

Dr Richards : Certainly the distributed ledger technology is a very interesting one. It has implications for the payments area but it could have implications in a lot of other areas. It may well be that those are the areas where in 10 or 20 years time we would say there has been a growth surge. Dave, do you want to add anything?

Mr Emery : Yes. I think various people who have thought about these things have noted the potential for the distributed ledger where you removed the need to have a trusted central party managing—

Senator EDWARDS: And charging you.

Mr Emery : a set of arrangements. Obviously that comes with a cost. There might be a range of different applications where currently the cost or the scale in order to centrally manage whatever those arrangements are is too high for what people are prepared to pay and a decentralised approach might deliver the scale and the low cost that lets you do that. A slightly imperfect analogy is the decentralised Wikipedia compared to the centralised Encyclopaedia Britannica or World Book and the extent to which the decentralised nature of Wikipedia has, in many respects, replaced the central arrangement. You can only push that analogy so far because you can look up a range of things on Wikipedia but, if it is really important, you might want to do a bit more research and check that your information is correct.

Senator EDWARDS: I would not want to rely on Wikipedia, I guarantee you. I would much rather go back to the Britannica or Encarta. The RBA do not have a role in oversighting money laundering and terrorism. Those topics are more for the inquiries in the next few days. What department within government is charged with the oversight of this emerging digital currency? Is it you? When does it become an issue which you start to look at? What is the trigger point for a framework of regulation, legislation or a recommendation to the Treasurer as to what you foresee is coming?

Dr Richards : I am not sure that there is a single agency with responsibility in this area. On the payment system issues, we would view ourselves as the lead regulator. There are lead regulators in many other areas, including AML/CTF.

Senator EDWARDS: You had a great deal of experience, Dr Richards, in the International Monetary Fund going back to earlier in your career. We heard testimony from DFAT that I thought was quite positive that, through the emergence of smartphones—it is a little bit different to Bitcoin; it is a currency on its own—they are delivering banking and money to people in Kenya through BitPesa. Through those things they are delivering it into the hands of people. They still have to go into a banking institution and get shillings, as I understand it. But the next step, of course, is everybody trading and tapping phones together through Bluetooth. Market traders in street stalls will have the ability to change a couple of dollars for no cost at all by virtue of this. It is quite revolutionary in foreign aid. The IMF would have to be looking at this. The G20 is obviously looking at this. Do you have a role in those discussions at G20 in making sure we are keeping pace with what it is that we need to do in a regulatory sense? There are a couple of questions in there on foreign aid and what you think the G20 and the RBA need to do.

Dr Richards : The bank is very much involved in the G20, but I suspect that we are not that involved in that aspect of the G20's work. Kenya is an interesting case. That is one example where there was a population that was not particularly heavily banked and now there is this new technology. They have skipped a stage in the standard evolution of financial systems in that they do not have very many physical banks but everyone now has accounts with M-Pesa. That is an instance where there was a relatively unbanked population and then there was some new infrastructure—that is, the mobile phone system—which helped to bring in financial services.

Here in Australia we have a very different situation. We have a very heavily banked population. We estimate that about 98 per cent of Australians have access to a debit transaction account. There is potential for mobile money solutions. The mobile money that we are looking at is with M-Pesa. The options for mobile money and possibly digital money are probably much greater in a place like Kenya then they are in Australia because we have a financial system that is doing a pretty good job of delivering the services that Australians want. We look at what is going on in Kenya and other places with great interest, but I suspect it does not have many implications for our core business, which is regulating the Australian payments system.

Senator EDWARDS: I guess so, but from an observation point of view it must interest you, given the background that you have, that it is most likely that digital currency will find its home in these underdeveloped countries before it will in developed, Westernised countries with banking infrastructure. The heartland of this is probably going to rely on the Philippines, Malaysia and certainly the African nations for the growth in this nascent area.

Mr Emery : Yes. I think the observation I would add to what Ms Bryant said earlier is that the scope for distributed ledger technology or other variants of e-money in delivering remittances does seem to have quite a bit of potential. That reflects that there is a potential gap in these arrangements. In the case of remittances, I think the arrangement could indeed be in developed countries and developing countries as well because the flow of funds typically goes from developed to developing on the remittance sector side. I would add to that by saying that that remittances channel is somewhere digital currency certainly could play a role.

Senator CANAVAN: I will start with a broader economic question. We have heard from a lot of regulatory agencies and people involved in the bitcoin sector, but what about the underlying economics of digital currency? Take bitcoin. You have some discussion about the price of bitcoin in your submission. In your view, what provides for bitcoin to have a positive price in any regard? Why do people view it as having value? How does it maintain value? What determines its price? What are the underlying drivers of supply and demand in the marketplace?

Dr Richards : I will start on that. I suppose the value of any asset depends on expectations about its value tomorrow and the day after that and the day after that.

Senator CANAVAN: Then what are the expectations about tomorrow?

Dr Richards : If one thought that a digital currency was going to be used on an ongoing basis, it could then have some value even if it is not backed by anything. It is not backed by the taxing power of government. It is not backed by a physical commodity like gold or anything like that. I think the jury is still out as to whether or not any particular digital currency will be around in six months time or a year. We know that the price of bitcoin rose to about US$1,200 in late 2013, and it is now US$250 or something like that, so there have been significant swings, presumably in expectations about its future value.

As you would know, money is often thought to have three key attributes: it is a medium of exchange, it is a store of value and it is a unit of account. When we look at bitcoin, it meets those three things to different extents. It is used as a medium of exchange. I would not say it is widely used. I am not sure if this is like the ABC Radio on Saturday morning where you cannot mention the name of a particular product, but I have some digital currency—some bitcoin—in my wallet. If, for example, we were to go and have a cup of coffee, I believe there are three cafes in Sydney where I could buy you a cup of coffee and four bars and restaurants where bitcoin is accepted. So it does not have widespread use domestically. In terms of a store of value, there clearly are there some people buying it as a financial asset, but it has been a fairly volatile one. And I do not think it is really being used as a unit of account. When you go to those cafes, they are not saying, 'Here's the price of the coffee in bitcoin,' they are saying, 'Here's the price in Australian dollars.' For me to buy the coffee, I have to convert it, and I do not get a particularly good exchange rate. I suspect that the merchant probably has to pay a spread too, so both of us would probably prefer not to use bitcoin, but the merchant is probably using bitcoin as a bit of a marketing ploy.

I think the jury is out as to whether or not any particular digital currency will continue to have value, but it is clearly a very interesting technology. We have been watching it for a while and will continue to do so.

Senator CANAVAN: So there is nothing in the supply curve—like the cost of producing bitcoin, mining it—which provides a floor for the value? If it fell below a certain value, would that stop people mining? I am trying to understand what keeps it within an equilibrium. Are there equilibrium tendencies within this market that, if there were swings one way or another, would bring it back to a value?

Mr Emery : From a supply perspective, looking at bitcoin specifically, the nature of the code is such that there will only ever be just shy of 21 million bitcoin created. Those are done at a decreasing rate. Initially the number of bitcoins created was 50 every approximately 10 minutes, every time a new block was created. That process halves approximately every four years, so the reward went down to 25 bitcoins, which is what it is at the moment, and at some point it will go down to 12½ and then asymptotically down. So most of the bitcoin supply is created in the next decade or so. I think we get to about 20 million or so in the next decade, and then over the next, according to the schedule, hundred or so years the remaining one million, with only one being created in the last 40 years. So that is a long intro into supply.

The way the bitcoin protocol works is there is a dynamic for people seeking to mine in that the difficulty of the reward—the difficulty of getting that 25 bitcoins by being the successful miner—is harder the more people are trying. As people direct computers with greater processing speed and high-speed graphics cards towards these in environments where they have cheap electricity and natural cooling, as more people enter that, the difficulty gets harder. As the price falls, some of that then becomes unprofitable to run from a marginal cost perspective, and that means some of the people will pull out of the mining process. That may mean that there could be a reduced demand for bitcoin, and so the price might fall in response to that, but the determination of supply is slightly independent from the people who are looking to do that mining. There is an actual trade-off in the way the mining works that encourages people, if the price is high, to go in, which makes it harder to mine or makes it easier to mine if the price falls, so people will jump in.

Dr Richards : I think that, if the price of bitcoin were to fall precipitously, it would become unprofitable for many miners. Unless someone has completely free electricity et cetera, I do not think there would be anything to stop the price of bitcoin from falling precipitously if there were to be significant doubts about the protocol.

Senator CANAVAN: But that is a demand issue, not a supply one. Mr Emery was saying that, if the price falls, people will stop supplying it because it will not be profitable for them to do that. But you are right that it might lead to some kind of price spiral if people feel that the value tomorrow is going to be 20 per cent of what it is today and there are negative expectations. That might happen, just like presumably there were these positive speculations which pushed it up to $1,200.

Dr Richards : I should note the miners are not just creating bitcoin; they are also verifying the transactions, and you need them. If they were to say, 'It's not worth my while,' I think there is a problem.

Senator CANAVAN: Good point.

Is the marginal cost of producing bitcoin around that US$250 to US$300 at the moment? Is that why the price is where it is at? Do we not know?

Mr Emery : I apologise. I have seen some research on what the marginal costs of mining is and calculations made about the profitability of bitcoin mining given assumptions about the number of people mining and the cost of electricity for a particular jurisdiction, but I do not have those numbers to hand. I can at least think of an article which talked about that. At the given price, which was high at that stage, it said, 'Yes, mining is profitable.'

Senator CANAVAN: It is not mainstream here in Australia and I do not personally see any great pressure for it to become that way any time soon, but presumably in countries with less of a record on controlling inflation there would be more incentive to move to alternative currencies or transactions. That does already occur, of course. Is there any potential that the emergence of digital currencies in the broad sense would help restrain the incentives of governments to oversupply currency, particularly in developing countries? Is there research at the moment that is looking at that?

Dr Richards : I am not aware of any. As you have noted, a country where there is not a lot of faith in the currency tends to use another currency. We are obviously not in that situation because of some very good institutional reforms that have been done across the public sector in the past 30, 40 years. We have a pretty good history in generating low inflation outcomes. The Australian dollar is about the fifth or sixth most traded currency and most held currency according to data from the Bank for International Settlements and the IMF. As you hinted, these are not really issues for Australia.

Senator CANAVAN: Presumably one of the reasons we are one of the more traded is the stability of the currency—and the good economic management and institutions we have. Is it still the case that you believe that those countries without that record are more likely to go to another international currency through dollarisation than to alternative digital currencies at the moment?

Dr Richards : I think that is right. As I said in my opening remarks, it is not difficult to see a role for digital currencies in remittances, in moving money from one country to another. But, in terms of day-to-day transactions, I think we have a fair way to go before we see digital currencies being used for buying groceries and things like that simply because you have to put a whole lot of infrastructure in place. In the countries that you referred to there is probably already a fairly good infrastructure for dealing in US dollars or something like that.

Senator CANAVAN: In terms of remittances, bitcoin can do it, as you have noted in your submission, a lot cheaper than currently. That seems to be principally because of the block chain or distributed ledger technology not the digital currency per se, because presumably people at this end are converting dollars into bitcoins, sending them over to the other end and then converting them straight back. They are not holding them for any length of time. Why can't we develop something similar using that technology to bring down the cost of international transactions? Is that a lot of work that the BIS or other international organisations are looking at? Why can't we solve this problem among governments or countries to bring down the costs?

Dr Richards : There are some goals to get down the costs of remittances. I think the World Bank is the lead agency there. There are two elements: correspondent banking arrangements often involve significant costs and also delays, and then you also have the on-ramps and off-ramps to get into the national currency. When you send a remittance to say a Pacific island country, often the receiving institution takes a fairly big chunk of the money. I should note that digital currencies, for example, bitcoin, provide a very inexpensive way for people to send bitcoin to each other. But the on- and off-ramps in getting the money into bitcoin if you do not already have some and then getting it out of it if you want to put it back into your domestic currency are not particularly competitive at the moment. There is a significant spread that is not unlike the traditional foreign currencies.

Senator CANAVAN: Senator Edwards mentioned earlier today that the committee was in Canada last year and spoke to your equivalent bodies there, ASIC and others. The Central Bank in Canada had developed their own digital currency—and I do not know if 'backed' is quite the right word, but it was certainly underwritten by Canadian dollars. Presumably you have not looked at that; otherwise, I am sure you would have told us. But have you looked at what Canada has done and why they did it? I know they are trying to sell it now, actually.

Dr Richards : There are two jurisdictions that have talked about digital currencies. There is Canada, as you said—the digital currency there was called 'MintChip'. I think it was developed by the Royal Canadian Mint, but about a year ago they announced they were looking to sell that technology off. As you said, it was not about a whole new currency—it was just a digital form of the existing currency. Quite recently the UK Treasury said the Bank of England would be doing research in this area.

Senator CANAVAN: But they are not necessarily producing their own currency?

Dr Richards : That is right. We are all looking into the future here. Again, the Treasury was not specific about it, but I think they would have in mind creating some sort of more electronic or digital version of the Pound Sterling. That is not something that we have gone very far into, but we will clearly be looking very closely at what other countries do. It is important to remember that most transactions in Australia are already using an electronic form of the Australian dollar, or a digital form, if you like. It is just that we are using existing financial intermediaries, and for many purposes that serves us very well.

Senator CANAVAN: In your submission you mentioned this thing called 'Ripple' that I have not looked at much. Is that looking at basically using Australian dollar transactions but providing digital currency-like services? Am I reading that correctly? What exactly is Ripple?

Mr Emery : Ripple is a slightly different thing from the types of digital currencies that have received a lot of attention, like bitcoin and the others. There are more than 500 different alternative altcoins and the like from Litecoin and Peercoin to Dogecoin and BBQcoin—a range of things with increasingly entertaining names, in some cases. Ripple is somewhat different. It does have a native digital currency, the Ripple or XRP, but it also provides for transactions in existing national currencies or, indeed, any other asset. It can be thought of as a series of connected trusted nodes which—and I am going to give a loose explanation of; forgive me if it is not exactly right. The Ripple—

Senator EDWARDS: We will not know.

Senator CANAVAN: No, we will not. Tell us whatever you like!

Mr Emery : The Ripple algorithm operates via a series of trusted nodes and aims to partner with existing institutions, market makers or financial institutions to act as gateways. For example, say I have a trust relationship with gateway A and Tony has a trust relationship with gateway C and those two gateways do not themselves have a trust relationship, but they both have a trust relationship with gateway B. My understanding is that the Ripple algorithm can identify that yes, I have got some funds in any sort of asset to send to Tony and there is a path that this can go through. I think the Ripple algorithm operates every two to five seconds to work out whether a transaction can go ahead. It identifies that there is a path for these IOUs to go through the trusted node network, then provides that settlement of those obligations.

Senator CANAVAN: It is not decentralised as such.

Mr Emery : It is not decentralised in the same manner that other digital currencies are, but it does have its own digital currency which is decentralised, the Ripple. My understanding is that it is effectively used as a bit of a liquidity provision to the system. If I have Aussie dollars and want to send Tony some euros and it cannot make the link between Aussie and euro, it could do Aussie to Ripple, Ripple to euro and then euro in that way. Some people have compared it to the hawala system, which is a medieval series of trust relationships but in the digital age.

Dr Richards : One other important thing is that Ripple is a more efficient verification mechanism. Bitcoin, in many ways, is incredibly inefficient. You have all the incredibly powerful computers competing and using lots of electricity to verify a transaction. Ripple is much more efficient in that respect.

Senator CANAVAN: That is an interesting point. It is often put to the committee that Bitcoin is a cheaper and faster way of transacting, but it does require a lot of resources behind the scenes to make these things happen—to make the magic happen, so to speak. It is hard to get a handle on how much that actually costs relative to our existing payment system.

Dr Richards : There are some benefits in having a central ledger and a single entity running it. Those have served us reasonably well for generations.

Senator CANAVAN: On page 3 of your submission, you very usefully have a table outlining the different types of services by Bitcoin providers or intermediaries. It is very useful for us. I want to specifically ask about each of these. I asked ASIC a similar question. How are they regulated right now? Are there any gaps in the system or loopholes in our current payment system regulation, prudential regulation and consumer protection laws where Bitcoin companies could provide financial products and slip through the cracks, so to speak? I understand that you might not have the knowledge of all of that, but do you see any gaps in each of these categories that might currently exist?

Mr Emery : I preface this with: this is a table of Bitcoin intermediaries. ASIC has a lot more expertise in that intermediation process. From a Reserve Bank perspective, the payments policy function has, as Tony noted, an approach where anyone can come in and operate a payment system. The approach is to intervene only if there are public interest grounds to do so. We do not have a licensing regime for payment systems that obliges you to get a payment system licence before you operate as a payment system. We think that approach is broadly appropriate.

Senator CANAVAN: When you say 'payment systems', so that it is clear in my mind, that would include store cards or public transport passes? They are a form of payment system.

Mr Emery : They will often run on the rails of an existing payment system. There will be a payment network that will provide the ability for a service provider—say, a couple of financial institutions—to interact, clear and settle payments between them. ASIC probably touched on elements of this. It is not so much a gap as something that the Murray inquiry identified was the current regulation of purchased payment facilities. It made a few recommendations that suggested that some of the existing regime could be streamlined and clarified. It is currently a relatively complex regime. Others have commented as well. PayPal is regulated by APRA as a purchased payment facility that needs to be authorised as an authorised deposit-taking institution. Then there are a series of exemptions and declarations that cover limited-use facilities, small-value facilities, electronic-tolling arrangements, public transport systems and the like. Some of that, in the view of the Financial System Inquiry, and it is consistent with what the Reserve Bank submitted—could be streamlined, because there is, I guess, a bit of uncertainty there. For digital currency intermediaries that are potentially caught by the purchased payment facility definition, there is potential for that set of arrangements to be streamlined. That is something that would cover the responsibility of APRA, ASIC, Treasury and the RBA; it would perhaps be best progressed through the Council of Financial Regulators.

Senator CANAVAN: Thank you very much for that.

CHAIR: Thank you so much for your time and for your participation in our inquiry.