Opening Discussion on Banking Sector Risk Exposures and Vulnerabilities from Virtual Currencies: An Operational Risk Perspective

34 Pages Posted: 6 Sep 2014

See all articles by Gareth Peters

Gareth Peters

Department of Actuarial Mathematics and Statistics, Heriot-Watt University; University College London - Department of Statistical Science; University of Oxford - Oxford-Man Institute of Quantitative Finance; London School of Economics & Political Science (LSE) - Systemic Risk Centre; University of New South Wales (UNSW) - Faculty of Science

Ariane Chapelle

University College London - Department of Computer Science

Efstathios Panayi

University College London - Financial Computing and Analytics Group, Department of Computer Science

Date Written: September 4, 2014

Abstract

We develop the first basic Operational Risk perspective on key risk management issues associated with the development of new forms of electronic currency in the real economy. In particular, we focus on understanding the development of new risks types and the evolution of current risk types as new components of financial institutions arise to cater for an increasing demand for electronic money, micro-payment systems, Virtual money and cryptographic (Crypto) currencies.

In particular, this paper proposes a framework of risk identification and assessment applied to Virtual and Crypto currencies from a banking regulation perspective. In doing so, it addresses the topical issues of understanding important key Operational Risk vulnerabilities and exposure risk drivers under the framework of the Basel II/III banking regulation, specifically associated with Virtual and Crypto currencies. This is critical to consider should such alternative currencies continue to grow in utilisation to the point that they enter into the banking sector, through commercial banks and financial institutions who are beginning to contemplate their recognition in terms of deposits, transactions and exchangeability for fiat currencies.

We highlight how some of the features of Virtual and Crypto currencies are important drivers of Operational Risk, posing both management and regulatory challenges that must start to be considered and addressed both by regulators, central banks and security exchanges. In this paper we focus purely on the Operational Risk perspective of banks operating in an environment where such ‘electronic’ Virtual currencies are available. Some aspects of this discussion are directly relevant now, whilst others can be understood as discussions to raise awareness of issues in Operational Risk that will arise as Virtual currency start to interact more widely in the real economy.

We propose a structure of risk analysis starting with the exposures and vulnerabilities of virtual and crypto currencies as the drivers of operational risk for these new means of exchange. Then by using risk drivers, our approach allows us to highlight the sources of possible adverse consequences, when using or generating virtual and crypto currencies. These are then mapped into the risks associated to the Basel categories, providing an easier view of regulatory response, and better mitigation techniques. In addition, this will help identify and address the root causes of the Operational Risks associated with virtual and crypto currencies, rather than just presenting their symptoms.

Keywords: Virtual Currency, Crypto Currency, Operational Risk, Regulation, Basel II

Suggested Citation

Peters, Gareth and Chapelle, Ariane and Panayi, Efstathios, Opening Discussion on Banking Sector Risk Exposures and Vulnerabilities from Virtual Currencies: An Operational Risk Perspective (September 4, 2014). Available at SSRN: https://ssrn.com/abstract=2491991 or http://dx.doi.org/10.2139/ssrn.2491991

Gareth Peters (Contact Author)

Department of Actuarial Mathematics and Statistics, Heriot-Watt University ( email )

Edinburgh Campus
Edinburgh, EH14 4AS
United Kingdom

HOME PAGE: http://garethpeters78.wixsite.com/garethwpeters

University College London - Department of Statistical Science ( email )

1-19 Torrington Place
London, WC1 7HB
United Kingdom

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

University of Oxford Eagle House
Walton Well Road
Oxford, OX2 6ED
United Kingdom

London School of Economics & Political Science (LSE) - Systemic Risk Centre ( email )

Houghton St
London
United Kingdom

University of New South Wales (UNSW) - Faculty of Science ( email )

Australia

Ariane Chapelle

University College London - Department of Computer Science ( email )

Gower Street
London, WC1E 6BT
United Kingdom
+44(0)7833453854 (Phone)

Efstathios Panayi

University College London - Financial Computing and Analytics Group, Department of Computer Science ( email )

Gower Street
London, WC1E 6BT
United Kingdom

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