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GS Paper 3:
Topics Covered: Effects of liberalization on the economy
Context:
International Monetary Fund (IMF) Chief Economist has made a strong case for regulating cryptocurrencies, saying it will always be a challenge to ban them as they operate from offshore exchanges; and feels it to be more attractive to adopt cryptocurrencies and assets in emerging economies than in advanced economies
What is a Cryptocurrency?
A cryptocurrency is a digital asset designed to work as a medium of exchange wherein individual coin ownership records are stored in a ledger existing in a form of a computerized database.
It uses strong cryptography to secure transaction records, to control the creation of additional coins, and to verify the transfer of coin ownership. It typically does not exist in physical form (like paper money) and is typically not issued by a central authority.
Cryptocurrencies typically use decentralized control as opposed to centralized digital currency and central banking systems
Significance of Cryptocurrencies
- Corruption Check: As blocks run on a peer-to-peer network, it helps keep corruption in check by tracking the flow of funds and transactions.
- Time Effective: Cryptocurrencies can help save money and substantial time for the remitter and the receiver, as it is conducted entirely on the Internet, runs on a mechanism that involves very less transaction fees and is almost instantaneous.
- Cost Effective: Intermediaries such as banks, credit card and payment gateways draw almost 3% from the total global economic output of over $100 trillion, as fees for their services.
- Integrating blockchain into these sectors could result in hundreds of billions of dollars in savings.
Concerns of Cryptocurrencies
- Sovereign guarantee: Cryptocurrencies pose risks to consumers. They do not have any sovereign guarantee and hence are not legal tender.
- Market volatility: Their speculative nature also makes them highly volatile. For instance, the value of Bitcoin fell from USD 20,000 in December 2017 to USD 3,800 in November 2018.
- Risk in security: A user loses access to their cryptocurrency if they lose their private key (unlike traditional digital banking accounts, this password cannot be reset).
- Malware threats: In some cases, these private keys are stored by technical service providers (cryptocurrency exchanges or wallets), which are prone to malware or hacking.
- Money laundering: Cryptocurrencies are more vulnerable to criminal activity and money laundering. They provide greater anonymity than other payment methods since the public keys engaging in a transaction cannot be directly linked to an individual.
- Regulatory bypass: A central bank cannot regulate the supply of cryptocurrencies in the economy. This could pose a risk to the financial stability of the country if their use becomes widespread.
- Power consumption: Since validating transactions is energy-intensive, it may have adverse consequences for the country’s energy security (the total electricity use of bitcoin mining, in 2018, was equivalent to that of mid-sized economies such as Switzerland).
The Pros and Cons of Cryptocurrency need to be weighed in before going ahead for regulation aspects:
Advantages
- Potential for high returns – with compounded annualised growth rate of 14.5%
- Some have cited cryptocurrencies as an alternative hedging instrument to gold in a portfolio context
- Protection from debased currencies and the threat of rising inflation
- Growing acceptance and usage
Disadvantages
- High volatility and potential for large losses
- Whilst it is true that the number of bitcoins produced will eventually be capped at 21 million and many other cryptocurrencies also have limited supply built into their protocols, there is currently nothing to stop an ever-growing number of new cryptocurrencies from being launched
- Whilst bitcoin and some other cryptocurrencies are now accepted across a growing number of payment platforms, the number of places where one can exchange cryptocurrencies for real goods or services remains very limited
- Cryptocurrencies are wide open to being exploited by criminals as a means to scam unwary investors
- Money Laundering, Drug Trafficking, Terrorist Financing, Weapon Proliferation, Cyber Crime and Sanction evasion are some of the activities for which Virtual currencies are susceptible to misuse.
India considering ‘Middle path’ on cryptocurrencies
- India is not going for an outright ban of cryptos is not being found feasible, in view of large investments in such instruments by Indians, and these unregulated virtual currencies are also unlikely to be allowed as a legal tender
- While India is already saying no to cryptocurrency, possibilities of how fintech can help maximise its potential need to be explored yet
Things to consider before regulating Cryptocurrencies
- Should digital currencies be taxed as an assets, commodities or capital gains?
- Countries across the globe have come up with rules and regulations to include the firms dealing in these cryptocurrencies under their RADAR.Balance need to obtained in relevance to this aspect
- What constitutes a security is that a financial asset which can be traded. But it is still not clear if cryptocurrencies fall into the category of assets without casting any doubt. Government may utilize the existing definition of security or may have to amend the existing laws to include cryptocurrencies into the definition of security
Way forward
- Due to lack of regulations, there is enormous growth of crypto currencies.
- There are risks of over regulating. There is a misconception in the minds of authorities that the transactions of cryptocurrencies cannot be traced.
- This is a complete misconception as every transaction forms part of the currency packet.
- Hence there is a need for educating authorities at every level to understand and prevent misuse of cryptocurrencies.
- People in India are currently hesitant to invest in cryptocurrencies as there is no regulation in place.
- However the recent announcement of its government to introduce Central Bank Digital Currency has given a ray of hope to those looking to invest into cryptocurrencies. The sooner its usage is regulated the better for the country
Insta Curious
The Governments across the world today, are all moving towards Cryptocurrency regulation. Hence the highlight on India now.
InstaLinks:
Prelims Link:
- About Cryptocurrency
- The actions being taken across the Globe
- The need for its regulation
Mains Link:
- Weighing in the aspects related to Cryptocurrency, discuss the need for its regulation in India.
Sources: The Hindu
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