EDITORIAL ANALYSIS: The Reasons behind the crashing crypto Market – INSIGHTSIAS

 

Source: The Hindu

• Prelims: Indian Economy, Cryptocurrency, Blockchain
• Mains GS Paper III: Fiscal policy, Monetary policy, Impact of crypto on fiat currencies.

ARTICLE HIGHLIGHTS

• Bitcoin and many other cryptocurrencies have been crashing since they hit an all time high late last year.
• Bitcoin has lost more than two thirds of its value since it hit a peak of around $69,000 in November last year and is currently trading at around the $22,000 mark.
• Ethereum,another cryptocurrency popular among investors, has lost almost 80% from its peak.
• The overall market capitalization of cryptocurrencies has dropped under $1trillion for the first time since January 2021.

 

 

 

Puucho ON THE ISSUE

Context

Cryptocurrency:

• Cryptocurrency, sometimes called crypto-currency or crypto, is any form of currency that exists digitally or virtually and uses cryptography to secure transactions.
• Cryptocurrencies don’t have a central issuing or regulating authority, instead use a decentralized system to record transactions and issue new units.
• It is supported by a decentralized peer-to-peer network called the blockchain.

 

Benefits Associated with Cryptocurrency:

• Fast and Cheap Transactions: Cryptocurrencies are way cheaper to use to execute international transactions because the transactions don’t have to be handled by a series of intermediaries before they reach their destinations.
• Investment Destination:

1. There is a limited supply of cryptocurrency – partially like gold.
2. Moreover, the last few years have seen the price of cryptocurrencies rising faster than other financial instruments.
3. Due to this, cryptocurrencies can become a preferred investment destination.

• Anti-Inflationary Currency: Due to the high demand for cryptocurrency its prices have largely remained on a growing trajectory. In this scenario, people tend to hold more cryptocurrency than spending it. This will cause a deflationary effect on the currency.

 

Drawbacks associated with Cryptocurrency:

• Extremely Volatile: Cryptocurrencies are highly volatile assets and have acquired popularity for their unregulated nature and the risk of volatility has established concerns over the potential impact on a country’s macroeconomic stability, especially those with weak socio-economic fundamentals.
• Unregulated Nature: International Monetary Fund (IMF) had also urged El Salvador to limit the scope of unregulated assets as there are large risks associated with the use of Bitcoin on financial stability, financial integrity, and consumer protection, as well as the associated fiscal contingent liabilities.
• Paying Taxes in Cryptocurrencies: For countries like CRA, risks associated with paying taxes in cryptocurrencies would be exposed when taxes are paid using crypto assets but expenditures remain in local currency.
• Not a Definite Mechanism: Unlike equities or currencies, cryptos are not subject to a definite mechanism and are speculative assets, therefore, central banks would not have any reference point to devise their interest rates in accordance with their domestic requirements.
• Counterproductive Utility: Blockchains may help trace the transactions but not the parties involved. Hence, it could potentially be used for money laundering, terrorist financing, or other illegal activities.

 

How do governments view cryptocurrencies?

• Many Countries have taken several steps to discourage the widespread use of cryptocurrencies.
• While countries such as China and Russia have opted to impose outright bans on cryptocurrencies, India has tried to tax and regulate them heavily.
• In India, while the government has not imposed an outright ban on cryptocurrencies, the Reserve Bank of India Has been quite vocal about the need to ban them completely.
• Central banks are wary of private cryptocurrencies since they challenge the monopoly that central banks currently enjoy over the money supply of an economy.
• If Cryptocurrencies became widely acceptable,it would affect the control that central banks possess over the economy’s money supply.
• It would also affect the ability of governments to fund their spending by creating fresh money as citizens could then opt to switch to alternative currencies.

 

Why are cryptocurrencies crashing?

• It is not possible to pinpoint the exact reasons why investors are fleeing cryptocurrencies at the moment.
• Most Analysts believe that the fall in the price of cryptocurrencies is in line with the fall in prices of stocks and other assets as central banks such as the U.S’s Federal Reserve tightens monetary policy to fight price rise.
• Others believe that the crash could also mark the popping of the bubble that has driven the prices of cryptocurrencies to stratospheric levels.

 

Will cryptocurrencies rise again?

• Cryptocurrency enthusiasts argue that Cryptocurrencies such as Bitcoin have always been subject to extreme price swings and that the current crash is a good time to buy these virtual currencies at a tremendous bargain.
• Many crypto enthusiasts have been handsomely rewarded in the past when they bought cryptocurrencies during times of panic selling.
• Skeptics, however, believe that the current crash could very well be the end of the road for cryptocurrencies. Even if cryptocurrencies manage to recover from the current crash, they may still not manage to hold on to their gains, because cryptocurrencies possess no fundamental value as money.
• In fact, some have argued that the real value of cryptocurrencies is somewhere close to zero. They point out that even the most popular cryptocurrencies such as Bitcoin are still not used very much in the daily purchase and sale of goods and services in the real economy.
• Crypto enthusiasts, however, argue that while cryptocurrencies may not be widely accepted as a currency, they still represent an independent asset class like gold that can help investors protect their wealth from central banks.

 

 

Way Forward

• Regulation is the Solution:

1. Regulation is needed to prevent serious problems, to ensure that cryptocurrencies are not misused, and to protect unsuspecting investors from excessive market volatility and possible scams.
2. The regulation needs to be clear, transparent, coherent and animated by a vision of what it seeks to achieve.

• Clarity on Crypto-currency definition: A legal and regulatory framework must first define crypto-currencies as securities or other financial instruments under the relevant national laws and identify the regulatory authority in charge.
• Strong KYC Norms: Instead of a complete prohibition on cryptocurrencies, the government shall rather regulate the trading of cryptocurrencies by including stringent KYC norms, reporting and taxability.
• Ensuring Transparency: Record keeping, inspections, independent audits, investor grievance redressal and dispute resolution may also be considered to address concerns around transparency, information availability and consumer protection.
• The fact that precious metals are limited in supply definitely helped boost their value.But limited supply alone cannot make cryptocurrencies like Bitcoin a valuable asset like gold and silver.

 

QUESTION FOR PRACTICE

Countries such as China and Russia have opted to impose outright bans on cryptocurrencies, India has tried to tax and regulate them heavily. Critically analyze.

(200 WORDS, 10 MARKS)