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Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce

Issue 6 - Evidence - March 26, 2014


OTTAWA, Wednesday, March 26, 2014

The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:15 p.m. to study the use of digital currency.

Senator Irving Gerstein (Chair) in the chair.

[English]

The Chair: Good afternoon. I call this meeting of the Standing Senate Committee on Banking, Trade and Commerce to order. It is a pleasure to welcome back Barbara Reynolds, who will be joining us as clerk for a period of time while our present clerk is on maternity leave.

Today the committee is holding its inaugural meeting on the use of digital currency, including the potential risks, threats and advantages of these electronic forms of exchange.

Digital currency is clearly a timely and relevant topic. Hardly a day goes by that there is not a reference of some kind in the news. The goal of this first stage of hearings is to better understand the subject matter before the committee.

As I mentioned yesterday in the Senate, no government to date has defined what digital currency actually is, and this lack of definition has led to much confusion on how to deal with it.

I think that United States Senator Thomas R. Carper, Chairman of the Senate Committee on Homeland Security, put it best when he said:

Virtual currencies, perhaps notably bitcoin, have captured the imagination of some, struck fear among others and confused the heck out of many of us.

Understandably, digital currency is attracting a lot of attention from regulators, law enforcement, and investors and entrepreneurs.

This afternoon, in an effort to give members and the viewing public a better understanding of what digital currency is, we are pleased to welcome, from the Department of Finance, Mr. David Murchison, Director, Financial Sector Division; and also from the Financial Sector Division we welcome Ms. Rachel Grasham, Chief, Financial Crimes - Domestic, and Mr. David Karp, Economist, Financial Crimes - Domestic.

Mr. Murchison and his colleagues have a presentation on digital currency that will last approximately 30 minutes, after which there will be an opportunity for senators to ask questions.

Thank you for being here today. Mr. Murchison, you have the floor, sir.

David Murchison, Director, Financial Sector Division, Department of Finance Canada: Thank you so much Mr. Chair and committee members. You should have in front of you two decks, one in English and one in French. We will subsequently be providing full notes to you in both languages, which will largely follow what I hope to speak to you today about.

To begin, you've asked for some discussion on virtual currencies. I intend to try to answer some of those questions through the course of the deck and subsequently. I should note that we in my group are not experts, and here David Karp is, perhaps, through his youth, best placed to answer many of the technological questions you have before you. This is a rapidly evolving topic and we are working hard to stay up with the subject matter, frankly.

I would note that you are hearing from a variety of stakeholders, including the Bank of Canada, so recognizing in particular that the bank is in to see you, we've chosen not to spend a lot of time on the currency aspects. We imagine they will cover most of that topic for you.

That said, I propose on an overview basis to begin with describing to you what a virtual currency is, what types of virtual currency we see and quickly take you to what we think is probably of most interest to you, and that's bitcoin. That's a certain kind of virtual currency. Then we will speak about what activities we are seeing in the virtual currency marketplace broadly and what roles we see in those virtual currencies. Finally, we'll turn to advantages and disadvantages as we see them and then taking you through our current regulatory framework and how we see bitcoin and virtual currencies fitting in, and what gaps we see in our framework today that we want to address in the form of next steps in the near term.

If that all sounds reasonable, I propose to jump in on slide 3, beginning with what is a virtual currency. I will try to do this in 30 minutes, but I actually fear I will be slightly over. Mr. Chair, you should put your gavel down if I'm taking too long and ask me to speed up.

Slide 3, what is a virtual currency, as I've noted this is a rapidly evolving area. There are no universally agreed-upon definitions here, and so part of the exercise for us early on is to describe to you what we mean by virtual currency, and we choose to do that in the next few slides. The topic, as I say, is quite broad. Depending on the definition one uses, it can include both electronic representations of national currencies as well as what I will refer to as virtual currencies.

There are many electronic mediums of payments that are digital, a digital form of national currency, for example, but not a virtual currency. As examples we have prepaid access cards, wire transfers and virtual or electronic cheques.

As I have noted, the Bank of Canada folks are coming in, so we don't intend to go through a history of currency per se. We imagine they will cover that issue for you.

Today we want to focus on virtual currency and how we mean that term at the Department of Finance. By virtual currency we are referring to a medium of exchange that meets the following four characteristics that you see in that slide in front of you. First, a virtual currency allows for value to be held in and exchanged in an electronic, non- physical manner. Second, a virtual currency is not what we call a fiat currency. It's not, for example, the official currency of the country; it is not the Canadian dollar. Third, a virtual currency has the intended purpose of being exchanged either for real or for virtual goods and services. Finally, a virtual currency allows for its units to be transferred between individuals, and we'll come back to that point as a critical point later.

Slide 4, what types of virtual currencies do we see? We have a variety of definitions here. One way of classifying virtual currencies, however, is on whether or not they can be sold for fiat currency or real money, and convertible virtual currencies can be sold for real funds, so that's dollars. Since they can be exchanged for cash, they are relatively versatile, and indeed these are really what I would posit should be the focus of this committee's interest.

Non-convertible virtual currencies cannot be sold for real funds. They can only be used for the purchase of goods and services. In many cases they can only be used to purchase virtual goods and services that are contained in a game or virtual world. Those of you who have children or grandchildren and they are playing games in the basement, they may well be in a world where they are buying and selling these kinds of things. Being non-convertible, they are very limited.

Virtual currencies can also be classified on whether or not they are administered by a central authority. Centralized virtual currencies have a central authority overseeing the currency. The central authority can be involved in verifying transactions, determining the money supply and creating rules restricting who can exchange or use the virtual currency.

The centralized model is used by existing methods of online payments. For example, if you buy something with your credit card online, the financial institution that issues your credit card verifies with the merchant that you have the funds available to buy the particular product you are interested in.

Decentralized virtual currencies, by comparison, have no such central authority. These virtual currencies typically operate through a peer-to-peer process where there is no trusted third party to verify the transaction. Indeed, we'll see that that's what we're talking about when we talk about bitcoin. It's a peer-to-peer network.

Slide 5 is on convertible virtual currencies. These can be exchanged for cash.

Senator Black: Mr. Chair, as we go along in this learning phase, if we have any questions, is it appropriate to ask them now or would you wish us to wait?

The Chair: I don't want to take him off the track that he's leading us through. Perhaps it might be helpful to let Mr. Murchison go through the entire presentation, if you wouldn't mind, Senator Black.

Senator Black: Of course not.

Mr. Murchison: Since these virtual currencies can interact with the non-virtual world and have real world socio- economic effects, we are much more concerned about the convertible types. Again, we come back to the fact that it is the convertible ones we're more interested in.

Virtual currencies that we might note include the defunct Liberty Reserve dollar, which you may have heard of; Pecunix, which is a virtual currency that purports to be backed by gold; and Linden Dollars that are used in an online world called Second Life, which is frankly unknown to me.

On the other side, slide 6, non-convertible virtual currencies cannot be sold for real funds. They can only be used to purchase goods and services. In many cases they may only be used to purchase virtual goods and services — goods and services contained inside a video game or a virtual world. Examples here include something called Simoleons currency, which is used in a video game called The Sims, which again I regret to say I have not played and is unfamiliar to me. However, it is a currency within the gaming world.

Another non-convertible virtual currency is in the World of Warcraft, which you may have heard about. That is a well-known online game we've noted here. Again, most of this is within the video gaming world.

As we look at slide 7, centralized virtual currencies, this is the case where a centralized virtual currency has a single authority that is responsible for overseeing the virtual currency, that, as we noted before, is involved in verifying the transactions, determining the money supply and creating rules restricting who can exchange or use the virtual currency. The centralized model is the model that most of us would be familiar with as we think of online payments, such as credit card transactions, Interac and so on and so forth.

Again, as we noted before, if you use your credit card, your financial institution issues the credit card to you verifying to the merchant that you have the funds available to buy that product.

Slide 8 is on decentralized virtual currency. Again, this is probably of most interest to you. These currencies typically operate through a peer-to-peer process. With bitcoin, for example, there is no centralized authority that verifies that a person wanting to send funds actually has enough bitcoins to spend. Rather, when one makes a transaction here, they broadcast that transaction to the entire network of users and the transaction is recorded in a very large ledger, which continually gets bigger and bigger, otherwise called a block chain. These transactions are verified through a process called mining, which is also used to create new coins and increase the money supply. This money supply in the case of bitcoin is determined by a mathematical formulation, so there is no central authority that could print more bitcoins if it wanted to do so. There are other examples of virtual currency that we have noted. One is litecoin, which operates similarly to bitcoin.

Slide 9 just summarizes the previous slides into a chart form and shows you the intersection with convertible, non- convertible, centralized, decentralized. You will note that there are no decentralized, non-convertible currencies that we could point to here, and, as we've mentioned, it's the decentralized, convertible currencies that are of most interest to us. I've put a circle on that chart around bitcoin, which we will spend a bit of time talking about in the coming slides.

Slide 10 shows that the best known of the virtual currencies in our work is bitcoin. Bitcoin is both a network protocol and a unit of virtual currency. So big B ``Bitcoin'' is the network; little b ``bitcoin'' is the currency. Here is something that is actually widely agreed to in this world, which is a bit unusual, frankly. Most people agree that these virtual currencies are a decentralized peer-to-peer network that allows for the proof and transfer of ownership without the need for a trusted third party. From there we have lots of divergence, but that seems to be a broadly accepted definition.

It has two features under that. Money supply is controlled and transactions are verified through mining; and transactions are recorded in a block chain, which is a massive transparent ledger. The unit is bitcoin, as we said, and it is convertible.

To give you a sense of the activity, on slide 11 we have some statistics for you. Bitcoin market capitalization is where we have taken the outstanding number of bitcoins and what its current daily market value is. That would give you a number like $8.4 billion, which would be a good-sized company were it to be a company. It would certainly list on a senior exchange. It would be substantially less than Apple, which has market capitalization of $490 billion; nonetheless, these are big numbers.

There are about 100 exchanges globally, of which we have about 10 in Canada. The world's first bitcoin ATM went into Vancouver in November 2013, as I see from the notes here. Since then we have had a number of other Canadian cities, including Ottawa. I am not sure where it is, but David Karp could tell you where the bitcoin machine is in Ottawa if you are interested in transacting there. A number of Canadian cities have followed suit. Most exchanges are either a stock exchange style or a currency exchange style.

We find about 1,500 merchants globally who are prepared to transact with bitcoins; some 200 are listed in Canada. It is most commonly used for online gambling as a currency, but it is popular with online retailers, particularly in the tech sector. You will see that we have put a couple of names there for you: Overstock.com, which is a popular site; Wordpress; Zynga; Tesla, which is the electric automotive company; and Virgin Galactic, which I suspect is mostly about marketing.

We have seen a proliferation of virtual currency-related businesses. These include payment processing services, prepaid cards, consultants, legal services and special interest groups promoting virtual currency usage.

Slide 12 is next. Virtual currencies are borderless in nature and transacted online. When you look at a particular transaction, we don't know what country the transaction took place in nor what nationalities the parties are. As such, it is difficult to get an indication of the amount of virtual currency activity directly in Canada. However, we can say that it is a topic of great interest. I get a lot of calls on it. It would be one of the number one media calls coming into the department these days. It tends to ebb and flow, but it would certainly be one of the top three coming in these days.

We note that the Canadian Virtual Exchange, which is one of the major virtual currency exchanges in Canada, claims to have traded more than $80 million worth of virtual currency to date, although that is a small figure if you compare it to foreign exchange numbers. Daily foreign exchange turnover is many billions of dollars.

There are a couple of other things to note. The ATM that we mentioned before in Vancouver processed roughly $1 million in transactions in its first month of operations. This is a machine that takes in cash and spits out bitcoins. That is a reasonable amount of cash if you think about it. These are not machines that are hooked up to a payment network. So it's not hooked up to a bank or to Interac; it is only taking cash.

Senator Hervieux-Payette: Do you have a bitcoin with you so that we can see it?

Mr. Murchison: In the back of your deck, I think on page 26 in the annex, we have a receipt for a bitcoin. That actually shows a transaction between two of my staff: one who is sitting at the back of the room and one who is sitting to my left. Jonathan is sitting in the back of the room. They sent a very modest amount of bitcoin to one another through a company called VirtEx, which is affiliated with Larry O'Brien. We were having a chat about —

The Chair: The former mayor of Ottawa.

Mr. Murchison: Yes, the former mayor of Ottawa who is now in this business and who expressed some interest in talking to the committee about that business.

The Chair: We do no advertising on this committee. We must be very cautious.

Mr. Murchison: That is probably the best example.

There are coins, but they are really just facsimiles of the same information put into a coin format.

Senator Tkachuk: It is a great business if you can get away with it, right? Throw in cash and I will give you bitcoins, right?

Mr. Murchison: And the reverse, although I am not sure how much of the reverse goes on.

The Chair: You are doing very well, Mr. Murchison. Keep it up. You have our interest.

Mr. Murchison: The last bullet notes — and this speaks to the cash point, too — that we have seen some evidence that Canadians were likely using bitcoins for illicit activity. An academic study looked at products for sale on Silk Road — and you may have heard about this — which is a now defunct marketplace for illicit goods that accepted bitcoin as its payment. It found that Canada was the fourth most common country of origin for items listed on Silk Road after the U.S., U.K. and the Netherlands. That is a cause for concern.

I would like to spend a bit of time on slide 13 because I think it is an important slide. It is about the role of virtual currencies. There are really three facts that you might hear about as you read commentary on this. The first plays to its potential role as a currency. We have noted — and I imagine the bank will speak to this point further — that virtual currencies have a potential role to play as a currency. Currency is a generally accepted form of money. The Currency Act defines the monetary unit as the dollar. If virtual currencies continue to be widely accepted as a method of payment for goods and services as well as a stable store of value — the two key terms there are ``widely accepted'' and ``stable store of value'' — then they might become more widely used as a currency. However, I would say that we are a bit of a way off from that world.

Virtual currencies can also function as a commodity. Many people have chosen to invest in virtual currencies. As I have noted before, we see a market value of $8.4 billion. Indeed, a lot of people have made money on that. They are being put into some asset managers' books as a speculative way to make money in much the same way that commodities such as zinc, copper or gold might be speculated on. That is another way to think about it. I have put in the words there ``as an asset to invest in.''

That is an area that is worth your attention, I think. Indeed, there has been some speculation that shortly an ETF will be launched on virtual currencies. That, of course, will bring a regulatory forbearance down on it.

Senator Greene: An ETF?

Senator Massicotte: Exchange-traded fund.

Mr. Murchison: An ETF is an exchanged-traded fund. Thank you.

Virtual currencies may also function as a value transfer system much like an inner bank wire transfer system or proprietary system such as Western Union, which some of you may have used to transfer funds either domestically or internationally. It is a popular way to do so. My father has a war-time pension in the U.K., and we use that service to transfer U.K. pounds into his bank account in Canada. We use a money services business for that transaction. Bitcoin provides a mechanism to do that, and it holds some promise for doing so on a much cheaper basis than transferring through banks or money services businesses.

The government's role is shaped by all of those aspects that we touched on there, and we will return to some of them as we look forward.

In slide 14 we look to the potential advantages and disadvantages of this. It is important to recognize that virtual currencies do have benefits. Many of you will have looked at some of the disadvantages. On the positive side, they have relatively low transaction fees, so this can be very attractive to merchants who today are faced with high credit card costs, for example.

Senator Ringuette: Yes. I totally agree with you.

Mr. Murchison: I would note that while it would be close to zero transaction costs peer-to-peer if I were to send David something over the network, to convert it into currency there is a transaction cost. Today that is around 1 per cent, so not zero, but still below what typical credit card costs are although a bit higher than what might be thought of by some people.

It can provide a very cost-effective mechanism for remittances. For example, you may have heard that the Philippines takes a lot of remittances from North America. This would be a potential cost-effective mechanism for sending those remittances in a much cheaper way. They have the possibility to provide consumers and merchants with greater payment choices and, as some of you may have noted, additional competition into the payments marketplace. I think there is an important innovation aspect to this.

Virtual currencies also provide irreversible payments. Depending on your perspective, that can be a terrific thing or not such a terrific thing. Credit card payments, for example, can be reversed because of fraud. This is called a charge- back. Some people like it, some people don't, depending on which side of that transaction you are on. It does have a cost attached to it of something like 30 basis points.

Much has been made in the media of illicit transactions with virtual currencies. As we have noted before, however, interestingly, this is in some ways the most transparent network you can imagine. All transactions are recorded on a ledger which everybody can see. While people note that much of this is anonymous, it is actually a pseudonym that people are using perhaps on the block chain. If you are trying to access that through an email account, for example, that is fully traceable. It would be hard to mask yourself in accessing money out of this network.

We have noted the vehicle for innovation, which is the last point I would point to on the advantages side.

On the disadvantages side, there is no surprise: very vulnerable to exploitation for money laundering or terrorist financing. Some of you, I think, were thinking of cash going into a vending machine. That is obviously one place to look. We know there is lots of documentation on currencies being used in illicit transactions to purchase illegal drugs; Silk Road was a prominent one. While it is nice to be able to send money back home cheaply, it is all pretty convenient for terrorists to use the same vehicle, and drug traffickers as well. We do have this issue of ``pseudo-anonymous,'' as we use it here.

I would note two other prominent disadvantages. One is around the area of consumer protection. They are not well understood. Many people are stepping into this not understanding the full perils. Virtual currencies are subject to cyber theft. Hackers can steal virtual currencies in the same way that they can hack into your computer. You may have heard reports about Mt. Gox recently, a large bitcoin exchange which had quite substantial hacking and stolen property.

Bitcoins are not subject to deposit insurance, of course, and they are subject to massive volatility. In January 2013, one bitcoin was about $13; one year later it was $745; at one point last year it was $1,300. As a medium of exchange, it has volatility attached to it.

The final point you will see there is a relatively lengthy transaction verification process. While we noted that relative to a credit card payment it would be much less, a credit card payment is, nonetheless, quite quick. A transaction on bitcoin can take up to 10 minutes as it grinds through a verification of that long chain. That might not matter for money that you are sending from one country to another; it might matter a lot at Christmastime if you are standing and paying for presents. That is an issue.

The next section I would turn to is, how do we think about this within our regulatory framework? As we turn to that area, we think about it from a number of perspectives. One is our currency legislation; another is anti-money laundering — we have talked to this committee in the past about that — consumer protection; taxation; and payment system oversight.

I would like to turn to each of these individually, if I could. I am already over my time, I see.

The Chair: Please continue.

Mr. Murchison: Okay. On the currency side, the Currency Act defines the monetary unit of Canada as the dollar, of course. The act contains provisions governing legal tender and currency, defines what constitutes a current coin or note in Canada. We have both the Royal Canadian Mint under this and the Bank of Canada: one for coins and one for notes. None of these laws, currently anyway, applies to or restricts the use of virtual currencies in transactions in Canada.

In the same way, I would point out that some of us continue to get Canadian Tire money. If there are merchants who choose to take my Canadian Tire money, we don't stand up and say they can't do that. Similarly, if people want to use U.S. dollars, so be it.

On the anti-money laundering and terrorist financing, we have an act called the Proceeds of Crime (Money Laundering) and Terrorist Financing Act, PCMLTFA for short. That's the legislative basis that we have for Canada's anti-money laundering and terrorist financing regime. This act regulates a number of financial and non-financial entities, from banks and securities dealers to casinos and real estate agents. I think this committee is largely familiar with this work.

I would point to money services businesses in particular, as we think about bitcoins. That includes foreign exchange dealers, businesses that transmit funds, and issuers and redeemers of travellers cheques. The activities of money services businesses are similar to virtual currency exchanges. Virtual currency exchanges, however, are not considered money services businesses under the existing legislation, but we'll come back to this as we look at what we're doing, as announced through Economic Action Plan 2014, where we have made some steps forward on this.

FINTRAC, which you know of, the Financial Transactions and Reports Analysis Centre of Canada, our financial intelligence unit, receives reports from these entities it regulates, relating to suspicious transactions related to money laundering. As you probably know, money services businesses must register with FINTRAC. They have to identify their clients and keep records for us.

This is a legislative framework that is consistent with international standards and provides key tools to help detect, deter and prevent money laundering. As I say, I'll come back to that in a minute.

Finally, we look at consumer protection. This is on slide 18. We would look at products and services offered by federally regulated financial institutions. We have noted that virtual currencies are not subject to deposit insurance. Virtual currencies represent a risk to consumers because they can be subject to large changes in value and are vulnerable to cybertheft if they're not stored securely. Users should exercise extreme caution.

With respect to taxation issues, the CRA has offered public guidance on how virtual currencies are treated under the Income Tax Act. The exchange of virtual currency for goods and services is considered to be a barter transaction and, as such, is taxable.

Yesterday, the IRS in the U.S. issued a notice that declared that virtual currencies are considered property as opposed to currency for tax purposes. Basically they are fully captured, as far as I can tell from our read of it. If they are bought or sold as a commodity, profits are taxed for income or capital gains, depending on the circumstances.

Finally I would note that the federal government has broad oversight of and responsibility for Canada's payment system. In this respect, virtual currencies represent an innovation that could bring potential benefit to consumers and merchants, which I discussed earlier.

On slide 19, we note that it's not just the federal government that has a role here but provincial governments as well. Securities regulators are starting to look at these issues. In Quebec, the Autorité des marchés financiers issued an alert about bitcoin in February. They warned about fraud risks, as well as the fact that virtual currencies are not covered under Quebec's financial services compensation fund or under its deposit insurance fund. I'm quite sure that the other securities regulators in Canada will start to issue similar warnings as they wake up to these issues.

There are a number of approaches internationally, and I think this committee would find some of them quite interesting as you delve into this. Many are, frankly, studying the issue. They haven't concluded what to do yet. They continue to ponder, and we put ourselves in that camp until quite recently. Some have issued public warnings; some have adopted anti-money laundering and anti-terrorist financing regulation. That would be the U.S., for example, FinCEN, which I think this committee would be familiar with. In March 2013, FinCEN, the Financial Crimes Enforcement Network in the U.S., the equivalent to our FINTRAC, issued guidance that clarified that persons and entities engaged in certain virtual currencies activities are considered to be money services businesses with anti-money laundering and anti-terrorist financing obligations.

Earlier this month, Singapore also announced a plan to regulate virtual currencies through the intermediaries like the exchanges. Some countries have also issued prohibitions on certain virtual currency activities. In China, perhaps no surprise, the government has prohibited banks from trading in virtual currencies at all.

Annex 3 of my presentation provides some references for you. There is a paper there entitled Regulation of Bitcoin in Selected Jurisdictions, which we found to be a very helpful document. I might encourage you to at some point read that. It provides a good overview of various approaches to virtual currencies in more than three dozen countries.

On the second-to-last slide, slide 20, I want to say what we are doing, our next steps. In Economic Action Plan 2014 we have committed to two important initiatives which were announced in the recent budget.

First, we announced the development of a comprehensive, risk-based approach to the oversight of the Canadian payments system and the government's intention to consult publicly on the oversight of the retail payment system specifically, including virtual currencies, this spring. That's one of my responsibilities. We will be seeking to go out with a consultation paper which, among other things, will seek to address how we should be thinking about virtual currencies and how we should be thinking about regulating, if we should be regulating at all, these currencies — if you like, the perimeter of regulation. As we think about our payments system, we don't capture them in today's regulatory framework.

Second, the economic action plan announced the government's intention to introduce legislative amendments and new regulations to strengthen Canada's anti-money laundering and anti-terrorist financing regime. These amendments include emerging risk such as virtual currencies, including bitcoin. These proposed regulations would extend the act's requirements for money services businesses to entities in the business of dealing in virtual currencies.

We would aim, in these regulations, to cover virtual currency exchanges, but not individuals or businesses. We think that this approach will allow for financial innovation, which we see to be one of the interesting markers behind this. Again, there will be an opportunity for public consultation on both these initiatives.

Finally, as we think about this, as I think I noted at the beginning, this is a rapidly evolving marketplace in virtual currency. We're running hard to try to keep on top of it and will continue to monitor and respond to market developments and also to your questions.

In conclusion, I thought that I might provide our take, if you will, on what commentators and analysts are saying about bitcoins specifically. We have noted three ways that people are thinking about these currencies.

As a currency, there is skepticism of using it as a currency for the long term. That's particularly because of its volatility and its, frankly, not yet widespread use. As a commodity it continues to have some interest, but it has significant investor issues. It will be interesting, for example, if they are able to have an ETF come to the market. I think that will be a challenging thing to do, but we will follow those developments.

It's a little too soon to say how it will fare as a commodity, but as a payments innovation, we think there are some interesting lessons there and that there is some potential that we will follow with interest.

Mr. Chair, that would conclude our early views on what is a broad and deep topic and one that we're not experts in, as I say.

The Chair: Mr. Murchison, I know I speak for every member of the committee when I say that those were outstanding opening comments, and we greatly thank you for kicking off our study on this subject.

If I may step back a bit and ask you this first question, do you think virtual currencies are going to grow and thrive, or do you think perhaps we're witnessing a passing fad?

Mr. Murchison: The number of calls that I'm getting and from the interest we're seeing in the marketplace — I'm relatively recently into my job but David Karp would spend some portion of every day following this — all of that has done nothing but go up in the past year. There has been more, not less, and I have no reason to think that that will diminish.

Senator Tkachuk: What creates the demand for the virtual currency? You can use American dollars basically worldwide in exchange for products, goods and services. What created the demand for the bitcoin?

Mr. Murchison: I'll look to my colleagues if they have a better answer, but I think it's been driven by a number of things. One is as a mechanism for payment and transfer of value at zero cost. That's one aspect of it. Much of the early work, frankly, was done by what I would categorize as libertarian people who were seeking to avoid government, if I can put it that way. The mythological individual who invented bitcoin did so, as far as I can tell, in part for those libertarian values of getting out from under government and the government's thumb on the money supply.

Senator Tkachuk: It is a creative thing.

Mr. Murchison: A very creative thing.

Senator Tkachuk: It's a supply side thing almost.

Mr. Murchison: Correct.

Senator Tkachuk: You build a TV set and there is no demand, but you build it and somebody buys it.

Mr. Murchison: That's right.

David, would you add to that?

David Karp, Economist, Financial Crimes - Domestic, Financial Sector Division, Department of Finance Canada: I think that covers it off pretty well. It started on the supply side — you are right — where individuals who had a libertarian philosophy would want to use these virtual currencies. Then, because they want to use them, you see merchants uptake because they are happy to receive this form of payment, because it's revenue for them. As the supply side picks up, the merchant side is also picking up.

Senator Tkachuk: I was thinking about this because of our discussion here, sort of like points. We kind of have currency in points with AMEX or Aeroplan, all of these different cards. We actually take these points and buy stuff with them. They are stored virtually and digitally. You just process them and you don't know where it goes. I know where it comes from. Someone is issuing it.

Who is issuing this? When I buy, say, an airplane ticket and I receive so many points, or on a credit card I receive so many points, a decision is made. Someone is making a decision about how much to issue. Who decides how many bitcoins to issue? If you issue too many, it will have no value. How is that decision made?

Mr. Murchison: I will let David answer that question because it's about mining and the fact that one of the attributes the earlier adopters liked was that no one had a thumb on the money supply, and there is a finite amount of bitcoin that is available. David will take you through how that works.

Mr. Karp: It is essentially an algorithm for the decentralized virtual currencies that have no central authority. It is predetermined by an algorithm. It's predictable. People who use the currency know how many units are going to be issued. I believe it will cap out at 21 million bitcoins, if I'm not mistaken. The new bitcoins are issued as transactions are verified. They're essentially a reward for people who have successfully verified transactions, to give people an incentive to verify bitcoin transactions.

Senator Tkachuk: I'm trying to understand it.

Mr. Murchison: One of the reasons the transaction takes the 10 minutes that it does is because of the computing power to verify the transaction through a long chain of previous people who have transacted, and that's done through a network of people. To incent that network of people to verify that transaction, they are compensated by getting a bitcoin, which is, if you like, mined. That is the process.

Senator Greene: There are 21 million of them. Within the 21 million, each time there is a transaction and new bitcoins are generated, they are generated with respect to the cap, so what you're receiving is a slice of the total; is that right? More slices?

Mr. Karp: Not exactly. The 21 million is the maximum that will be reached, and we are not there today. Today we are in the neighbourhood of 15 million bitcoins or so. You actually do get new bitcoins when you successfully verify transactions. You would get, I believe, 25 bitcoins right now if you successfully verified a transaction.

Senator Ringuette: Can we go to your slide 26 and the example there? Am I to believe that 0.27 bitcoin is equal to C $186?

Mr. Karp: That's correct, yes.

Senator Ringuette: That's correct. So not only does it have its own value market, it also assigns a value to a regulated currency, Canadian dollars.

Mr. Karp: The dollar figure there shows what people are willing to pay for a bitcoin on bitcoin exchanges. I'm not sure which exchange that number comes from, but bitcoin doesn't specify what its price is. It is really dictated by supply and demand, and it depends on the price people are willing to buy and sell it at on an exchange.

Senator Ringuette: In this example on slide 26, the people who were willing to exchange 0.27 bitcoin were willing to exchange it for C$186; is that right?

Mr. Karp: That's correct, yes.

Senator Ringuette: For instance, a merchant selling, let's say, a barbecue will say, ``Okay, it's online. You can buy it for C$270 or 0.30 bitcoin.'' Would that work like that? Because then the merchant will be setting the exchange rate —

Mr. Karp: Yes.

Senator Ringuette: — not the system.

Mr. Karp: It would work like that in many circumstances. Some websites would only sell products denominated in bitcoin and would not accept other currencies, but many merchants would accept both and they could set the price in either currency.

Senator Ringuette: I know everyone wants to question. Does this have potential to become universal currency then?

Mr. Murchison: Given the length of presentation, I omitted a description of how bitcoin works in the process of a transaction, but given the questions I wonder if I might take a few minutes to read it? I think that would clarify some of these issues.

Senator Ringuette: Can you just answer if it has the potential to be a universal currency?

Mr. Murchison: Sure, yes, I think it has potential.

A bitcoin isn't a file. It's not something that can be downloaded or deleted from your computer. In that sense, it's abstract. A bitcoin is just a number that is associated with a bitcoin address, which is a little bit like a bank account.

Bitcoin, as we've noted, uses a decentralized peer-to-peer network that allows for the proof and transfer of ownership without the need for a trusted third party. This network facilitates the verification of transactions, which is one of bitcoin's most innovative characteristics. It is important to be able to verify transactions to ensure that once someone sends a bitcoin to another person they don't try to double-spend that same bitcoin by trying to send it to a second person. With traditional payments, this verification is done through a central authority. For an online payment, like a bill payment, my bank verifies to the payee that there are enough funds in my account to pay the bill. With the bitcoin, the verification process is decentralized.

When I send a bitcoin to someone else, I broadcast that transaction to everyone else who uses bitcoin. It's like posting a transaction on a public bulletin board for everybody to see. Because all the transactions are public, you can see the history of each bitcoin to ensure it is not double-spent. This is the true technological innovation behind bitcoin, its ability to cut out the traditional middlemen — including governments, by the way — that have traditionally played a role in the payment system by performing such functions as verifying payments, determining money supply and creating rules of use. These middlemen typically add to the cost of payments, so by eliminating the middlemen, decentralized virtual currencies can lower the payments and their cost.

Mining, which is the point we're getting to, is also an important part of the transaction process. Computers involved in the mining process solve math problems to ensure that the private keys for each bitcoin are legitimate. Once the math problem is solved, the transaction is verified and is included in the public record for all bitcoin transactions.

This brings me to another interesting point, which is how transactions can be tracked. All bitcoin transactions are publicly recorded and you can view them online. You can type in any bitcoin address, which is a little like an account number, and you can see all the transactions associated with that bitcoin address. A bitcoin address is nothing more than a collection of letters and numbers, so often you don't know what person is connected with a particular address.

Some people post bitcoin addresses on the Internet if they want to raise money. You see charities doing this. If you're sending bitcoins to someone you must know their address, thus in some cases it's possible to link a bitcoin address to a particular person or business. That's why these bitcoins are considered to be pseudo-anonymous. As noted before, there is more transparency in the bitcoin transaction than in most other types of payments, and certainly much more than cash payments.

I don't know if there is anything else I would say here. A bitcoin is convertible, which is why we are interested in it into Canadian dollars. I don't know if that helps a bit; it may just pose more questions on it.

Senator Tkachuk: I have a bit of a supplementary on the math equation. If you have one bitcoin worth $186, and you are buying something worth around $100, what is the exchange? Here we give back change. How do you give back change in a bitcoin? Do you have fractions in a bitcoin and it's marked that way on the transaction?

Mr. Murchison: You will see on slide 26, the fraction of a bitcoin, 0.2766.

Senator Black: Thank you for that helpful presentation.

I would like to start with the assumption I'm making, as this is our first go at this. This is the assumption I'm going to make unless you correct me. I will assume that virtual currencies are reality that will enhance, not diminish, and our challenge is to figure out how to protect, regulate and tax them. Do you agree with that analysis?

Mr. Murchison: Would you mind repeating that?

Senator Black: I'm questioning whether or not I should assume that virtual currencies are a reality. The genie is out of the bottle.

Mr. Murchison: Sure. That's fair.

Senator Black: If that's the case, our challenge is figuring out how to, among other things, protect consumer protection, regulate and tax?

Mr. Murchison: That's broadly right. Our interest is perhaps whether they should be regulated.

Senator Black: Lots of questions around it all.

Mr. Murchison: I don't think it's necessarily that they will be regulated. We have identified, certainly in our anti- money laundering and anti-terrorist financing legislation, that they should be captured at least on the money services business side. But at the same time, I've tried to highlight to this committee some of the innovative aspects, which I think frankly should be promoted for a more competitive economy.

Senator Black: This is helpful so we can set the rules of engagement. But if I took the initial assumption of ``Look we've got to stop this wave right now,'' you would look at me and say, ``What are you thinking?''

Mr. Murchison: I think there are enough advantages to suggest to you that we should not automatically jump in and regulate.

Senator Black: Thank you very much. I have three specific questions on your deck, if that's appropriate.

In respect of the description you gave on pages 4 and 8, I think I understood — and could be wrong — that the transactions between parties are not able to be certified or verified. My very rudimentary understanding was that there is, in fact, a way through miners to verify a transaction. Did I misunderstand what you said?

Mr. Murchison: They are verifiable, and that's the central ledger, which is really central.

Senator Black: That is very important.

Mr. Murchison: Very important.

Senator Black: There is a way somehow to capture this and therefore potentially regulate, expose or recognize that there are problems. I wanted to understand that point.

Mr. Karp: I think the distinction on slides 4 and 8 was between the centralized and decentralized virtual currencies. It depends who verifies it. With the centralized virtual currency there is a central authority that verifies it, and with the decentralized virtual currency, it's the network. It's everybody who is using it, the miners that verify it.

Senator Black: There is a verification?

Mr. Karp: The verification occurs in both cases.

Senator Black: I wanted to make sure I didn't misunderstand that.

Can you talk to us for a moment about the role of an exchange here? I'm referring to slide 11. I understand a stock exchange and how that works, but what is the role of an exchange in this world with the virtual currency?

Mr. Murchison: It's really playing the same role that a stock exchange plays or a foreign exchange plays. In this case it's converting bitcoins into fiat currency — Canadian dollars.

Senator Black: The only time I would use an exchange, or anyone would use an exchange, is to convert bitcoins to currency or vice versa?

Mr. Karp: Yes, more or less. You can exchange other types of virtual currency besides bitcoin, and I believe there are some exchanges that allow you to exchange one type of virtual currency for another, but more or less, yes.

Senator Black: When you say there are 100 globally, are these exchange facilities?

Mr. Murchison: They are almost all virtual exchanges. It's not like a stock exchange floor of old.

Senator Black: I have a technical question on slide 21. How could a bitcoin be a commodity of any value if it wasn't used as a currency? How are those two points separated? You're saying that as a currency there is skepticism on its long-term viability, fine, but perhaps there is value as a commodity because of significant investor issues. How could it be a commodity if it didn't have a use?

Mr. Murchison: A commodity as in an asset that one might imagine buying, much like one might imagine buying gold or zinc or silver.

Senator Black: What if the commodity had no use? In other words, if it wasn't a currency it wouldn't be a very valuable commodity.

Mr. Murchison: Correct.

Senator Black: Are you aware of Khan University lectures on bitcoin?

Mr. Karp: I've heard of Khan University, but I wasn't aware they had any lectures on bitcoin.

Senator Black: You might check those, and if you thought they had value I'd recommend them to the committee. You sit down with your iPad and there is a very clear person talking about the properties of bitcoin; it is really helpful. However, I would like to know whether you would bless it. If you bless it I'm going to recommend it to the committee. I did it and I thought it was interesting and I understood it more or less.

The Chair: We'll ask the clerk to receive the information to that effect.

Senator Black: My office can point this out, and it might be helpful to the committee. You might have a look though, too, and if you think it's not helpful or baloney you should let us know that.

[Translation]

Senator Hervieux-Payette: You mentioned a number of names. Besides bitcoin, are there other names associated with game currencies? In other words, are there other names used only for games, electronic games that youth play, and nothing else? Are bitcoin and litecoin the only ones that have monetary value and can be exchanged for money? Do the others, like Liberty Reserve, have monetary value?

[English]

Mr. Karp: Any virtual currency that is convertible can be converted back for fiat currency, be it Canadian dollars, U.S. dollars, et cetera. Those currencies, Linden Dollars, Pecunix — Liberty Reserve is now defunct — could absolutely be converted back into real currency, so they have a monetary value attached to them.

[Translation]

Senator Hervieux-Payette: It is not worth billions like bitcoin. It is less, right?

Mr. Murchison: Yes.

Senator Hervieux-Payette: There is the taxation issue, the GST in particular, payable on the purchase of goods and services. Are AIR MILES reward miles taxable?

[English]

Mr. Murchison: Honestly, senator, I actually don't know the answer to the question, but in any case I would be inclined to duck it.

[Translation]

Senator Hervieux-Payette: In bitcoin transactions, that would be the first major advantage for bitcoin users, since the GST, and the QST in Quebec, is charged on goods and services.

I come from a small community. When I was young, the doctor came to people's homes to deliver babies. His fee was two chickens. So I was thinking that this is a bit like the good old days. People do not have to pay taxes; that is where the benefit lies.

You said there are benefits from an innovation standpoint. Will the G20 look at this issue to find an international formula that could work, since right now it is all over the map?

[English]

Mr. Murchison: I'm not aware of this being on the G20 agenda. It's certainly an active agenda item on the FATF, the Financial Action Task Force, internationally, but that's the only forum I know of where it's had much currency.

[Translation]

Senator Hervieux-Payette: What about the OECD?

Mr. Murchison: No.

Senator Hervieux-Payette: That is a bit surprising. If I am in Italy and I buy something worth 250,000 lira, that is not worth much, while I would have how much in bitcoin? Say 0.0010 bitcoins, because every currency has a different value. Does bitcoin change in value depending on the country? When we exchange Canadian money for euros or American dollars, we get 88 or 90 cents American and $1.53 for a euro right now, so how does it work if I want to buy, say, a work of art in Europe? Will they give me a price in bitcoin?

[English]

Mr. Murchison: If you were in Italy you would go to an exchange in Italy, and if you wanted to convert to a local currency they would give you a price to do that in the same way that we've quoted to you some numbers in Canada. I don't actually know if there is an exchange in Italy, but there are 100 globally so my guess is there probably is one.

[Translation]

Senator Hervieux-Payette: I am starting to understand the purpose and especially the fact that both money launderers and people who do not want to pay income tax or sales tax can benefit. I am trying to see other benefits.

Senator Bellemare: Thank you. It is very interesting to learn all this. How does bitcoin work? It requires machines, computers, that sometimes break. So people are needed to fix them. There is a workforce and there are people in the background who make money from this.

Banks charge interest and collect service fees to cover their costs and make a lot of money. Who earns income from this initiative, and how are these services paid for? Is it just fees? Are there people who make money from bitcoin? Do the profits come from the volatility? Are profits generated, who receives them and how are the costs paid for?

[English]

Mr. Murchison: I don't actually know the full answer to that question.

Clearly, we talked about the verification of the transaction. Those people involved in verifying the transaction through the use of computing power have compensation in the form of a bitcoin, or fractions of a bitcoin that are paid back to them during that process, so they are compensated at that time. Otherwise, the compensation is in the form of the commodity and whether that appreciates. If I was smart enough to have taken a bitcoin from a vending machine a year ago and held on to it, I would be a much wealthier man today than I am. I didn't do that, actually.

Equally, there will be people who have lost money in that commodity trade.

The network wasn't envisaged as a business that was to generate profit. I think that would be the point that I would make. It was generated by someone who was interested in math and in the ability to make it and not in its potential as a business.

Senator Massicotte: Like the Internet.

Mr. Murchison: That is exactly right.

[Translation]

Senator Bellemare: Money is made from the user fees, and profit can potentially be earned from the fluctuations in the value of bitcoin. Is that right?

[English]

Mr. Murchison: I should clarify. So we have the network, what we have been calling capital B Bitcoin. But much like the Internet in the early days, if you will recall, there is this protocol language. It wasn't until, in my case, Google came around and allowed me to have an interface that allowed me to access that in a reasonable way that it became useful for me. In the same way, we have a variety of businesses that are popping up to give you that interface and the exchanges of providing that interface as well; they are all in business to make money. So they are charging. When I choose to take my bitcoin and convert it into Canadian dollars, I am being charged a transaction fee for that. I think we suggested it ranges between half a per cent to 1.5 per cent.

Those people are in the business to make money. The network itself was much like the Internet, as one of the senators said. It is a network.

Senator Massicotte: Being conscious that we are being televised — am I correct in saying that?

The Chair: That is correct.

Senator Massicotte: I must explain to the public that we must appear naive and ignorant but I want to tell the public that we know all the answers to the questions. We are just trying to make sure our witnesses know.

Mr. Murchison: Thank you very much.

Senator Massicotte: I will go back to the basic question that Senator Tkachuk and Senator Greene asked — we were all trying to get it — how is this created? We have $8.4 billion in circulation. It is simplistic. It seems to me at the very beginning someone says I will create this money. I will put in $100 or $100,000 and then create this. Someone has to be a sponsor because eventually those bitcoins will be converted to merchandise and the fellow selling that merchandise wants cash. Am I correct in saying if there is $8.4 billion out there, collectively they spent $8.4 billion? Forget the currency speculation and conversion; there is that kind of money sponsoring that system. Is that correct? Is it a bit like the central bank would do? There are seigniorial rights; money is sitting there some place. Is that right?

Mr. Murchison: I think the numbers on daily transaction values would suggest about $375 million is being transacted every day.

Senator Massicotte: But what is the amount of bitcoin sitting out there today?

Mr. Murchison: We have an outstanding number of bitcoins of — how much is it?

Mr. Karp: It is around $7.3 billion now.

Mr. Murchison: It is $7.3 billion and today the market value is $700 and some odd dollars.

Senator Massicotte: If you forget the appreciation value, the speculation aspect, is it correct to say there is $7 billion of currency of some country that was put in the system to support that?

Mr. Karp: No, because I think the value that bitcoin gets is from what people are willing to pay for it. At the current price that people are willing to pay for one bitcoin, if you multiply that by the number of bitcoins in circulation, you would get $7.3 billion. But that could potentially change tomorrow.

Senator Massicotte: Forget the fluctuation. When you first started off, I went to some bank or to some place and put cash in. I know there's fluctuation. It looks like they went up in value a lot. If you presume it went up by 100 per cent they take half the amount, but that means someone put up a lot of cash, no?

Mr. Karp: The value wasn't always as high as it is now; it used to be a fraction of the dollar. The initial bitcoins were created by mining. People didn't necessarily put money in. They would have verified transactions using their computer, and then they would have sold those bitcoins to other people. That is where the cash first comes into the system.

Senator Massicotte: Is there the same risk like the bank when there is a run? Let us say we all say we want to cash in our bitcoins. Someone has to pay these merchants if you all spend that money, no? And you can't run out.

Mr. Murchison: The way I think about it — and, David, correct me if I am wrong — it is much like an initial public offer, IPO. If you are a company and you come to the market with an IPO, I might offer my shares out for $10 and I have 100 shares. That is $1,000 that I get into my company, less any fees. Those same shares can then trade in the secondary market.

Senator Massicotte: But I'm trying to avoid the depreciation. I know it went up and down, but besides that?

Mr. Murchison: Those could go up to $100 but the company only ever saw $1,000.

Senator Massicotte: It appreciates, but other than appreciation, the fundamentals — that is, the gas, or the liquid, or the energy — cash went in, no? Otherwise, how do the merchants get paid?

Senator Ringuette: No, no.

Senator Tkachuk: If you went to the bank, and everyone asked for their money, the bank could go broke.

Senator Massicotte: Agreed, but that is why central banks are there. That means there is a guarantor.

Senator Tkachuk: Let us see what would happen if everybody did it and see how long the central bank would last.

Senator Massicotte: Our central bank makes over $1 billion a year because someone put in cash for that currency. I am saying that somebody put in cash for this currency also — maybe not the same amount.

Senator Ringuette: No. It is an artificial value.

The Chair: What is the question you want to ask here?

Senator Massicotte: I am trying to understand, chair. If I understand well enough, I will do it again and again and again, before all you guys do!

Senator Tkachuk: The bank prints it.

Mr. Karp: Bitcoins come into creation when they are mined. You verify a transaction; you are awarded with 25 bitcoins. You are not putting money into that directly. You have to buy your computer, the computing power and the electricity, but you are not putting money into those bitcoins.

Senator Massicotte: But that money only comes to that party that did the transaction. Not everyone is on the network, right? It is just like a rebidding requisition on your purchase price, no? Is it a percentage of your purchase price? If you spend 100 bitcoins you get how much back? If you spend 200 you get twice as much back?

Mr. Karp: No. You only earn bitcoin for free if you are able to successfully verify transactions.

Senator Massicotte: It is based on transactions.

Mr. Karp: It is not based on the value of those transactions or anything; it is a flat rate.

Senator Massicotte: So every transaction you get a certain amount of bitcoins back?

Mr. Karp: Correct, yes.

Senator Massicotte: It must be an insignificant amount; otherwise, it would make the whole thing inefficient if it is too large relative to the transaction.

Mr. Karp: That is how all new bitcoins are generated. That is why the number is increasing and will eventually hit $21 million.

Senator Massicotte: You are saying that the $8.4 billion is just electronic stuff in mid-air? That is, there is no cash supporting any of that?

Mr. Murchison: Yes.

Mr. Karp: Yes.

Senator Massicotte: I would get out of there pretty fast.

The Chair: You've got it!

Senator Greene: I have one technical question and one probably stupid question.

If there is a 21-million cap in bitcoins, and we have about 14 million or 15 million in circulation now, what happens when we reach the cap, and when are we likely to reach it?

Mr. Karp: To answer your first question, when you reach the cap, instead of having new bitcoins being given to you as an incentive for verifying transactions, users would specify a transaction fee. They would say, ``If you verify my transaction, I will give you this small fraction of a bitcoin.'' I am not sure of the exact date that the cap is expected to be reached, but I think it is in about 10 years or so.

Mr. Murchison: I think I have seen 2030 as one date.

Senator Greene: Second, I am reluctant to ask this, actually, because on one level, to me, it sounds a little ridiculous, but we all know that inflation is part of the currency system we have now. Some governments inflate their currencies for a reason and they do it on purpose; others at other times try to get rid of it and keep it as low as possible, et cetera.

Is there any inflation, as we know it — as we can define it — in relation to traditional currency? Is there any inflation in the bitcoin? If there isn't — and I tend to think there isn't — then isn't that another advantage of a bitcoin?

Mr. Murchison: Yes.

Senator Greene: Okay. Thank you.

[Translation]

Senator Maltais: You repeated several times that the people who created the bitcoin network were minors. I am wondering if I understood you correctly, because Newsweek does not agree with you. It claims that it was someone named Satoshi. This month, in March 2014, it published a long article revealing that the creator of these precious coins is apparently a 64-year-old naturalized American of Japanese origin named Nakamoto. Do we really know who created bitcoin? Who is right here?

[English]

Mr. Karp: That is a good question. The paper that created bitcoin, and it is actually on our last slide, slide 28 — it was by an individual or a group of people with the pseudonym Satoshi Nakamoto. I am familiar with the Newsweek article, and it has been disputed somewhat. I want to clarify that.

Miners don't create bitcoin. It is a network. It's a protocol, and that was created by an individual or a group of individuals calling themselves Satoshi Nakamoto. Miners verify the transactions, and in exchange for verifying the transactions, they earn new bitcoins, so as new bitcoins, new individual units of the currency are created.

[Translation]

Senator Maltais: Is there a way to find out how many bitcoins are in circulation? Who prints them? Who controls their circulation?

[English]

Mr. Karp: That number is publicly available. You can find it on the Internet. I'm not sure what the exact number is, but we can get that for you.

[Translation]

Senator Maltais: Who can print them in large quantities? Who controls that? You say they are worth $7 billion, but if I ask someone else, I might hear that they are worth $21 billion. No one controls that.

[English]

Mr. Karp: I guess the best way to explain it is that there is a protocol, an initial set of rules designed by Satoshi Nakamoto to govern how this system works. Everyone knows the rules, and the system is governed by these rules. If people want to change the rules, there is a democratic structure through which they can be changed by all bitcoin users.

[Translation]

Senator Maltais: The American tax authorities have looked at this issue a little bit. Fifteen days ago, the American financial market regulator, FINRA, which you know, stated that bitcoin is one of the riskiest investments out there and that it facilitates fraud and scams. Is this true?

[English]

Mr. Murchison: I think it has a lot of risk attached to it, yes.

The Chair: I will conclude with a question from round one because we have a number of questions on round two.

Mr. Murchison: Oh, good.

The Chair: I started by asking if you thought this might be a fad, to which you responded quite clearly. I am interested in this whole concept of converting from real currency to virtual currency, virtual back to real currency because, certainly, in money laundering, terrorist financing, et cetera, you can't pay in bitcoins. You need hard, cold currency to pay salaries, whatever it may be.

At the other extreme of its being a fad, can you imagine a world where virtual currencies actually achieve large-scale adoption and you are not into the conversion situation? Looking way out in your crystal ball, is that a potential issue?

Mr. Murchison: As I tried to conclude on the last page — and this is really just summarizing other analysts and commentary I have read — I think that would be appear to be unlikely at this time.

I would point to, in the references that we have left at the back of that deck, a comprehensive piece by Goldman Sachs which covers a wide swath of views on this. I think you will have a good sense, if you read that, of what the prevailing views are of both those advocating and those who think it's a silly thing.

The Chair: Thank you. That concludes round one, so we will now commence with round two.

I am sorry; I have a question in round one.

[Translation]

Senator Rivard: We find ourselves in the era of virtual currency, but there have been earlier attempts to create common currencies. We know that, well after the creation of the European Community, the euro was established. In or about the 1970s or 1980s, a number of European countries wanted to have a common currency they called the ECU. Does that sound familiar? It disappeared after a few attempts to establish it.

I remember, for example, that in some European countries like France, to get us used to the idea, menus listed the price in French francs, at the time, and the equivalent in ECUs. The Europeans were very hopeful that this would become the currency of all European countries and eventually of the entire world. But it failed.

Now we are talking about a virtual currency, bitcoin, that might have a future. Of course, we are in another century and things are different, but the ECU did not last; it was never a common currency, but people tried to implement it. Are the two comparable?

Now, in the digital age, it is much easier, printing-wise, to exchange currencies than in the 1970s. Printing ECUs and then starting to distribute them to every country would have been much more complicated then.

This is more of a comment than a question, but do you remember when the Europeans tried to make the ECU their common currency?

[English]

Mr. Murchison: I don't, senator.

[Translation]

Senator Rivard: You are too young.

Mr. Murchison: Yes, perhaps.

[English]

I don't remember the ECU, the European Currency Unit. Was it the 1970s?

[Translation]

Senator Rivard: Senator Hervieux-Payette remembers that time, I think.

Senator Hervieux-Payette: The euro replaced the ECU.

Senator Rivard: Exactly.

Senator Hervieux-Payette: Only the name gained some traction.

[English]

The Chair: Thank you. That now concludes round one, and we will move to round two.

[Translation]

Senator Bellemare: I would like to return to the issue of the convertibility of bitcoin into money. If I understood correctly, if you want bitcoins, you have to buy them. They do not just fall out of the sky.

You have to go to a machine to open a bitcoin account, and it is a virtual currency that you cannot see. The machine does not give you any currency, but you have to put in Canadian currency or withdraw some from your bank account.

In the era of the first kind of fiat money, which was put into circulation and was convertible into gold, people would deposit gold and receive currency from the various banks. The banks printed more than the value of the gold in order to lend and make money. When large withdrawals were made and the banks did not have enough gold, they collapsed.

With bitcoins, to ensure they can be converted, they need to be backed by something, since an automaker will not sell a Tesla to someone who wants to pay in bitcoin, given that Tesla does not necessarily pay its employees in bitcoin. Those who are paid in bitcoins cannot buy milk and bread with them, as bitcoin is not in widespread use, so they need monetary backing in a currency that people trust.

That does not mean there is $12 billion in cash somewhere, but there has to be a way to convert bitcoins. So there is money somewhere. Could you expand on this a little?

[English]

Mr. Murchison: The vision of bitcoin presumably as a currency would be to replace what we know as dollars today. That would be the reach objective.

I would concur with you. I think your point is whether that seems unlikely for the reasons that you've put forward. I would agree with you, yes. I don't think it will hold a value of exchange and be widely accepted enough to provide the service of what we commonly think of as a currency.

[Translation]

Senator Bellemare: Could you describe what happened when you used this machine to complete the transaction?

[English]

Mr. Murchison: That would be you.

Mr. Karp: You're talking about a bitcoin ATM specifically?

Senator Bellemare: Yes.

Mr. Karp: You go to the machine and you type in how much bitcoin you want to buy in Canadian dollars, and then it takes money into a slot like a vending machine, the exact amount. It then sends the money to your cellphone. You can get an application for your cellphone, which is actually what's on slide 26. That's a screen shot from a bitcoin application.

In the top right corner is what is called the QR code. The machine will scan the QR code on your cellphone so it knows which address to send the bitcoins to, and then it will send the bitcoins to that address.

[Translation]

Senator Bellemare: And the machine takes your money?

Mr. Karp: Yes, exactly.

Senator Massicotte: And where does the money go?

[English]

Let's continue with that. I would actually ask the same question that I asked on the first round, but I'll make as if I understood and go to the second question.

Let's follow the money. The machine has this money. What does it do with it?

Mr. Karp: It's revenue for the company that owns the machine.

Senator Massicotte: Okay. How do I buy that machine? I like that idea. How do I get that machine?

Mr. Karp: There are two or three companies that manufacture bitcoin ATMs that you could buy from them.

Senator Massicotte: What I don't understand is, I've got a machine, I'll put it in a shopping centre someplace, I collect the cash and I can keep the cash?

Mr. Karp: Yes. You would still have to buy the bitcoin from someone. You have to supply the bitcoin.

Senator Massicotte: So I've got to take the cash I got from you and pay it to somebody?

Mr. Karp: Now you're getting to an area that's a bit beyond my expertise. I believe some of the machines partner with the bitcoin exchange.

The machine owner, on the back end they're working with a particular exchange that has bitcoin or has people coming to the exchange that are willing to sell their bitcoin, and then the ATM will collect the cash. Some of that cash will go to the exchange to pay for the bitcoin, and then the ATM owner would keep a cut as a transaction fee. That's my understanding of it.

Senator Massicotte: Let's go to the exchange. Where does the cash go? What does it exchange to?

Mr. Karp: There are two models of bitcoin exchanges. One operates like a stock exchange, so you have buyers and sellers that come with fiat currency and virtual currency and they post bid and ask prices.

Senator Massicotte: Where is the cash, though? Now the cash is down to the exchange, let's follow the cash. Where does that cash go?

Mr. Karp: Into the bank account of the exchange, presumably.

Senator Massicotte: Therefore, with the exception of what I call rebates, that percentage when you do a transaction. With the exception of inflation, it's like currency. When countries issue too much currency there is inflation and it goes up and down. With the exception of that, there is largely cash supporting a large percentage of the amount of bitcoin supposedly out there. I guess that relates back to my first question. It seems to me there must be cash someplace, a very large amount of it.

Mr. Murchison: Certainly there's cash in the system. However, it's not the case that you only get to have bitcoins by putting cash into the system, which I think is the question —

Senator Massicotte: But there's a percentage of rebate.

Mr. Murchison: There's a minor —

Senator Massicotte: It has to be extremely minor, because if it's significant then the system is inefficient, totally contrary to the objectives of the founders. That's like a commission cost. It's an inefficiency of a payment system. It has to be very minor. A very large portion must be cash.

Mr. Karp: If you're not mining bitcoin, if you're exchanging it, certainly you're exchanging it presumably for cash or for goods and services. There is a lot of cash behind it, absolutely.

Senator Massicotte: Can I go to my real question? That was a supplementary question.

The Chair: We'll let you ask the real question.

Mr. Murchison: We do know that daily transactions are in the order of $375 million to $400 million per day. Those are going to be largely cash transactions, or cash will be a major component of those transactions. That's a reasonable amount of money.

Senator Massicotte: You said in your report that you've got how many billions? What is that number? Was it $8.4 billion?

There are two concepts here. How is it created? As you've probably noticed, I'm having trouble understanding that.

One of the major motivations of this currency is not only the efficiency but the anonymous nature of it, if you look at Silk Road and all of that. You said in your presentation that it's pseudo-anonymous but it was not very anonymous.

Mr. Murchison: That's correct.

Senator Massicotte: What is the fact? If it isn't very anonymous, how do all the drug dealers and so on get away it with it? You say every time you do a transaction there's a ledger. That means on my iPad, given it's not centralized, every computer has it. But that ledger only says ``transaction'' and with some code, maybe 15 digits, identifying the person. But you said they can use that information to find out who the person behind that is. Then I am lost. Is it anonymous or is it not?

Mr. Murchison: My own view is that it is not very anonymous.

Senator Massicotte: So all those drug dealers made that mistake?

Mr. Murchison: I think actually we had some estimates of what the illicit activity would be on bitcoin today. It's a relatively small number as a fraction of the total value, actually.

Senator Massicotte: It's erroneous to think that it is anonymous. People are making that mistake.

Mr. Murchison: I think that's right, in much the same way as when the Internet came in and there were lots of concerns about email being untraceable. We have since discovered that those things all leave a pretty good trail.

Senator Massicotte: The IRS declared yesterday that they will treat it like property. When you buy bitcoins and convert them to merchandise, any depreciation or appreciation of that asset would be a taxable transaction. You have to pay sales tax and so on. The amount of accounting is immense, not like with a currency. Will that not kill the whole thing?

Mr. Murchison: No idea. I would imagine it will put a damper on it.

Senator Greene: I'm interested in your answer to a question that Senator Bellemare posed. It seemed to me that you were not completely convinced that it would make a good medium of exchange to purchase goods. It would not be a currency in that sense. Yet, in the past couple of weeks I've read articles that indicate some restaurants in New York accept bitcoin. Do you think that's a temporary thing? The more it's used, the more it will be used.

Mr. Murchison: Well, I suspect that subject to IRS treatment, perhaps, and some regulatory actions being taken, I think we'll see more of that, not less. The question I thought I was answering was, did we imagine that this would replace the Canadian dollar at some point? I suppose it could. Commentators that I've read seem to think it's unlikely, but it could develop into that, maybe.

Senator Greene: Okay.

Mr. Murchison: One thing that people point to as a strong advantage is the decentralized nature of the virtual currency. I point to the fact that as we think about currency, we recognize the important tool that governments have in controlling our economy. We do that in part through the control of our money supply; and we do certain things to it fiscally and monetarily. That's an important lever that governments would be concerned about losing in this world.

Senator Greene: This is probably a naive question, but in terms of the discussion about the future of bitcoin and whether it could replace a national currency, do you see it in some ways as a more efficient transaction method than the currencies we have around the world?

Mr. Murchison: I wouldn't think of it on the currency side as much as a payment system. It has some interesting potential as a payment system. It has the prospect of being cheaper than the way many of us pay for goods today through Visa and Mastercard transactions, including bank transfer fees. It has that possibility, which is interesting and innovative.

At the end of all those transactions, there is a conversion to a currency and a transaction cost attached to it. That's exactly right.

Senator Bellemare: I want to conclude on the convertibility of the system.

[Translation]

There are 100 exchanges worldwide, and when you put money into the machine, you are opening an account, and so forth.

Regarding convertibility, can the rate vary from one exchange to another? Does it depend on what is in the machine? So, when you insert money, you are opening an account, and if someone else wants to convert bitcoins into dollars, it depends on the number of people who have purchased bitcoins and those who want to exchange them. Is that how it works?

[English]

Mr. Murchison: It's a marketplace, and currency values go up and down.

[Translation]

Senator Bellemare: There are 10 exchanges in Canada?

Mr. Murchison: Yes, 10 exchanges.

Senator Bellemare: So the exchange rate can be different at each exchange?

[English]

Mr. Murchison: Yes.

[Translation]

Senator Bellemare: I understand how it works.

[English]

Mr. Murchison: It works in the same way as a currency exchange on the corner here or at the airport. The rate fluctuates minute by minute on world markets; and it depends of course on the transaction side.

[Translation]

Senator Maltais: If I wanted to pay my taxes in bitcoin, as Senator Bellemare just said, and to do that I went from my exchange to yours, at the Department of Finance, and there was a difference of X dollars, would you send me a bill for the difference? Yet, I acted in good faith and paid you in valid money. It is not the customer's fault if the exchange lost value in the meantime. What happens in such a case?

[English]

Mr. Murchison: At this point, we wouldn't take your bitcoins to pay your taxes.

[Translation]

Senator Maltais: Why? You do not trust me?

[English]

Mr. Murchison: The government has a fiat currency, which today is the Canadian dollar. One of the underpinnings to that, as I understand, is the payment of taxes in that currency.

The Chair: I will take the liberty as chair to direct a question to Ms. Grasham, whom we have not heard from. What question do you think we should have asked that we did not ask? That will be the concluding comment of the day.

Rachel Grasham, Chief, Financial Crimes - Domestic, Financial Sector Division, Department of Finance Canada: Just from listening to the discussion about the convertibility and so forth, it would be interesting to ask Canadian merchants who accept bitcoin: To what extent are they treating it as a currency? When they receive the bitcoin, do they pay their suppliers in bitcoin, or are they immediately turning it around and converting it to Canadian dollars and treating it like a gimmick?

At the beginning of this about a year and a half ago, the news stories were all about merchants now accepting bitcoin. It seemed like a gimmick to get some media attention and advertise their businesses. I'd be interested to know what percentage of those merchants are buying into it as a currency versus just accepting it and trying to avoid the volatility of risk by immediately cashing out.

Senator Tkachuk: And the answer is?

Ms. Grasham: That would be my question.

Senator Massicotte: That is a complicated subject, but it is not complicated compared to what Senator Greene said. I am having trouble understanding what he said: ``The more it's used, the more it will be used.'' That's a heavy statement, and I'm trying to understand it clearly. But it's true.

The Chair: This is the just the outset of our study. I suspect we have a long way to go.

To our panel today, I would like to express the great appreciation of every member of the committee. It is one of the most stimulating discussions we've had before this committee. In all my days on a committee, I have never heard more senators start by stating, ``This may be a very naive question but . . . ``

I think that's an indication of the great interest you have stimulated. To each of you, we appreciate your presentations today and the work you have put in. Thank you very much.

This meeting is adjourned.

(The committee adjourned.)