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Cryptocurrencies and transition

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The countries of Central and Eastern Europe have faced many problems during the transition period from centrally planned economies to the free market. After almost three decades of transition, only Poland – in September 2018 – has so far been declared a ‘developed country’. For all other countries, the transition process will continue for some time.

Meanwhile, a new policy and monetary issue, amongst many other serious challenges, has appeared: how to handle cryptocurrencies (which are basically a string of computer codes and which started to be used for payments outside the monetary base of any country). In the new schemes of the so-called cryptocurrencies, amazing assets amounting to billions of US dollars have so far been accumulated. There are estimations that over 1,650 such cryptocurrencies (or even more) were in existence/circulation with a total market capitalisation of 369 billion US dollars as of March 2018, and 131 billion US dollars as of 28 November 2018 – obviously these are very volatile figures.

The Eastern European markets have begun to be aware of/concerned by this new problem in their transition process. Of this large group, the most used and known are bitcoin, ethereum, ripple and bitcoin cash. In most cases, these instruments using blockchain technology are not regulated by central banks or indeed by any other financial authorities, although strong voices are being heard (see the declarations made by the governor of the Bank of England in December 2017, for instance) that they should be. To be fair to these emerging regions and to their efforts to understand the concept, implications and consequences of such new instruments, even the developed countries are not yet fully clear about if and how to regulate these new ‘currencies’. Even the concept of currencies is debated. Many countries have publicly declared that that cryptocurrencies are not “legal means of payments” in their respective jurisdictions. As such, they are treated more as assets rather than anything else, but their trading has raised additional questions about the risks involved, the taxation aspects of gains made and ways to bring them from shadow economies to transparency, similar to those in which normal currencies, issued by the central banks, exist and operate.

Regarding the legality of transactions with cryptocurrencies, there is currently a very large diversity of cases with Eastern European countries positioned between the two extremes, from the highly prohibitive to the highly permissive.

Macedonia and Serbia are part of the first group. Belarus (where a ‘super liberal’ regime was introduced in December 2017 providing official support for cryptocurrencies) and Ukraine (who abandoned the licensing of cryptocurrency companies in June 2018) and in a way the Russian Federation are good examples of a permissive approach. However, most of the transition countries (Poland, Romania, Republic of Moldova (Moldova), Czech Republic, Croatia, Estonia, etc.) are somewhere in between. All these countries still struggle to understand the essence of these instruments although the first (bitcoin) was introduced by an anonymous person (Satoshi Nakamoto) more than a decade ago.

‘Mining’ in Eastern Europe

The technical aspect of the cryptocurrencies needs to be further explored. It has obvious merits, but these are not the focus of this article. One aspect which needs a closer look at is why mining (the computerised process to generate a cryptocurrency) is encouraged and developed in some countries of Eastern Europe. Ukraine, Belarus and Moldova are the front runners in the region. First of all, mining requires a lot of electricity (it is energy intensive) which is still much cheaper in such countries than in the developed ones (for the same reasons, India and China also encourage this activity). According to some studies, the cost of mining a bitcoin, for instance, is around 3,500 US dollars. Even if compared to its current quotation (3,710.6004 US dollars on November 27, 2018 – NYSE Bitcoin Index, $NYXBT, admittedly with a decreasing trend) it is clear that producing a bitcoin is still a lucrative industry.

As such, ‘crypto-farms’ of computers working continuously to obtain bitcoins have been established in some countries, Second, legislation has not yet been introduced (or is not yet clear enough) to provide precisely for what is allowed and what is not. Third, specifically for these cases, in this part of the region, there is an unrecognised and separatist Republic of Transnistria (sandwiched between Moldova and Ukraine) where the rule of international law is not a priority and where energy is produced with gas imported from the Russian Federation. The gas used by the Cuciurgan Power Plant (GRES), controlled by Russia’s Inter RAO, is not paid for by Transnistria (it is conveniently transferred to the Moldovan foreign debt via Moldovagaz, controlled by Gazprom). Therefore, the energy has been supplied to crypto-farmers at very cheap tariffs (if paid at all, as scams and theft are widespread).

Another case is that of a photovoltaic park project in Moldova, which according to the Moldovan mass media was allegedly developed to generate cheap electricity for mining cryptocurrencies.

Cryptocurrencies and interest rates

One collateral result of the current distortion of markets, including of those in Eastern Europe which are flooded with large amounts of liquidity and where low interest rates are applied, is that many peoples started to turn to innovative schemes/platforms to place their money/savings. Moreover, the main cryptocurrency, bitcoin, was in bubble mode during 2017-2018. Its price increased from 700 US dollars at the beginning of 2017 to a peak of 19,666 US dollars, registered on December 17, 2017. It subsequently decreased to around 11,000 US dollars and then increased again to around 15,000 US dollars following severe warnings from regulators (such as China and South Korea) that such levels may not be sustainable and measures will be soon introduced. It is currently in the range of 3,500 – 5,000 US dollars. Bitcoin and other instruments using blockchain technology are not regulated by the central banks or indeed by any other financial authorities.

Basically, cryptocurrencies are unpredictable and unstable. Generating and holding cryptocurrencies is highly speculative and it is very likely that these virtual assets will eventually deflate. While the relation may not be immediately obvious, the large amounts of money accumulated into cryptocurrencies have, inter alia, something to do with the low interest rates currently available in the emerging markets. The fact that the rates are currently so low could be a stimulating factor to place money into cryptocurrencies where investors hope that the capital gains will be much higher. If a simple judgement is made regarding the price of the bitcoin, such a hope seems to be a correct one. However, the risks of this unregulated segment of the market are much higher and much more probable. Requests from many central banks to regulate it are long overdue.

Mortgages and cryptocurrencies

The direct correlation between cryptocurrencies and interest rates has been signaled many times by various people, such as the general manager with the Bank for International Settlements (BIS), the current governor of the Bank of England, the managing director of International Monetary Fund (IMF) and many others (from China, South Korea etc.). Hence the aim of this article to explore if there are obvious links between the housing markets and cryptocurrencies in Eastern Europe as well.

The answer requires some caveats. While the relation may not be immediately obvious, the large amounts of money accumulated into cryptocurrencies have, inter alia, something to do with real estate properties markets (villas and the likes, from the upper end of the market amongst the newly rich of Eastern Europe). The anonymity offered by cryptocurrencies would be a strong incentive for cryptocurrency holders to buy large houses in non-transparent jurisdictions as many tycoons from the Russian Federation, Moldova, Romania, Ukraine, Hungary and others already have. This can significantly distort the markets, especially in developed countries where there is a high demand for houses and the supply is not very strong. This is, of course, a direct link. Moreover, a certain impact on the housing market is also that such opaque transactions will be finally translated into higher prices for all properties. This could be identified as the second direct link. The next step will be obviously new real estate bubbles, which are already brewing in many countries. However, it is fair to note that there are cases in which the link between cryptocurrencies and mortgage lending will not be immediately visible, as there could be no mortgage loans granted and no risk analysis (Loan-to-Value, Debt-to-Income ratios, etc.) undertaken.

All in all, it is very likely that the volatility of bitcoin and of the other cryptocurrencies will continue, which is a high risk for the emerging markets of the Eastern Europe and for international ones as well. This risk should not be ignored.

Cryptocurrencies and corruption/money laundering

There is speculation and/or allegations that cryptocurrencies are used for money laundering and other criminal activities as both the issuers and users are anonymous. Therefore, many central banks are now clearly stating that the cryptocurrencies could easily be labeled as Ponzi schemes. Calls for strict regulations are becoming more and more frequent. Romania, Macedonia and Moldova have all followed this trend and the governors of the respective central banks have clearly asked for effective and urgent regulations. These connections with money laundering and the financing of terrorism are possible as the new ‘currencies’ are ‘stateless instruments’ which lack the basic transparency required on domestic and international transactions. According to estimations made in 2018 in a study prepared in the US, some 44 per cent of transactions with bitcoins were associated with illegal activities. All commercial banks in Eastern Europe should apply the Know-Your-Customer (KYC), anti-money laundering (AML) and fighting terrorism principles in their activities and this is not possible in transactions with such assets.

Need for clear and stronger regulations

The most common prediction made by influential European bankers is that the cryptocurrencies will “end up as short-lived curiosities”, as the Bank for International Settlements put it. Their evolution is highly speculative and it is very likely that these assets will eventually deflate. However, the risks of this unregulated segment in the Eastern European markets are much higher and have higher probability of happening, with material negative consequences. The requests from many central banks from emerging markets and from the European Union to regulate these activities are welcome. In September 2018, the governor of the National Bank of Romania, to cite just one example, clearly requested that cryptocurrencies should be regulated before they become pyramidal schemes such as those which plagued Romania in early 1990s (Caritas, the National Investment Fund, to name just two).

When complete, the transition process, monetary and banking sectors and housing markets will be more stable as a significant part of these activities will no longer be subject to non-transparent transactions. These could eventually return into their normal transparent zones, where they should have been in first instance. No doubt, Eastern European countries had and still will face many challenges, but handling the issue of cryptocurrencies in a proper way should be a high priority in the interest of much needed full transparency in the region and for its speedier and successful transition.

Mihai Radoi, a director of an investment fund specialising in Romania/Bulgaria/Serbia and a former CEO of the Anglo-Romanian Bank co-authored this article. The views expressed in this opinion editorial are the author’s own and do not necessarily reflect Emerging Europe’s editorial policy. 

About the author

Alexandru M. Tanase

Alexandru M. Tanase

Alex Tanase is an independent consultant and former associate director, senior banker at the EBRD, and a former IMF advisor.

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