The European Commission has warned in a draft motion that virtual currencies and distributed ledger technology (DTL) have the potential for money laundering, terrorist financing and tax fraud. European legislation such as the Markets in Financial Instruments Directive will apply to activities carried out irrespective of technology, the economic and monetary affairs committee said.

According to the draft motion, some DTL applications such as bitcoin create uncertainty, and limited regulatory capacity in new technology makes it difficult to define safeguards. The proposals, to be voted on in April, could lead to a recommendation for legislation, a Commission spokesman said.

The move comes just as the UK Treasury has confirmed its intention to bring anti-money-laundering regulation to digital-to-fiat currency exchange firms in its response to the European Commission's call for evidence on EU regulatory framework in financial services. A HM Treasury spokesman said that no timetable existed, but the regulation could happen this year. The UK concerns are about money laundering/terrorist financing risk at the point where users cash in and cash out of the digital currency network.

The perceived European risks, as discussed in the draft motion, are based on pseudonymity and "mixing services" in the relevant services, and limited regulatory capacity may make it difficult to define safeguards. The absence of reliable governance structures, especially in some distributed ledger applications such as bitcoin, create uncertainty and consumer protection problems, especially in challenges unforeseen by the original software. 

The sometimes limited capacity of regulators in new technology may make it difficult to define appropriate safeguards in a timely manner, ensuring the reliable functioning of distributed ledger technology applications when or before they grow so large as to become systemically relevant, the draft motion said. EU legislation such as MiFID and the Alternative Investment Fund Managers Directive is likely to apply in line with activities carried out irrespective of the underlying technology.

The report suggests that to address the risks will require enhancing regulatory capacity should some distributed ledger technology applications get much more use. There is legal uncertainty around new applications of these applications, and legislation may sometimes be ill-suited. Appropriate regulation may still be lacking. Distributed ledger technology might prove transformational for clearing and settlement, but will raise new regulatory challenges.