Cryptocurrencies, led by bitcoin, today are most topical but also the least understood. The reason is most attempts, howsoever sincerely attempted, end up in highlighting technical aspects and, in the process, lose focus on substance. The end result: while over a thousand cryptocurrencies exist globally today, there is still no clarity with regard to their status. Arguments against these “currencies” have generally revolved around three elements. On closer look, however, none of them stands the test of logic. First, cryptocurrencies are not backed by any central bank or the government. It is indeed a myth that all “currencies” must necessarily be backed by central banks and governments. Take gold, silver, platinum or diamonds, for instance. These are not backed by any bank or government and yet, for centuries, have been accepted as “valuable” and, thus, are “currencies”. So much so that the central banks use them as “assets” backing their issued currencies. On the other hand, we all know that currencies such as Zimbabwe dollar, which were duly backed by central bank/government of Zimbabwe, became absolutely worthless and had to be actually abandoned in 2009, to be replaced by a multicurrency system. There are several such examples across the world.
In fact, the so called “backing by the central bank” is merely a matter of faith. Take a closer look at the Rs 500 note and read the printed text carefully. It says that the RBI governor “promises to pay the bearer a sum of rupees five hundred”. In other words, if you present this note to the RBI governor, he will simply replace it with another paper. Sounds pretty worthless except that we have over the years been conditioned to believe that there is value in rupee note. It is not about “backing” by a central bank, but an inherent belief that a currency is of value.
Second, cryptocurrencies are not being backed by any assets. In today’s world, there is hardly any connection between money in circulation and reserves held by a central bank as back-up assets. As per RBI, the total Indian currency in circulation as on December 15, 2017, stood at Rs 16.918 lakh crore. In comparison, gold reserves at 557.17 tonnes (including gold held in vaults abroad) as on July 20, 2016, were valued at just Rs 1.62 lakh crore (at current prices).
Another set of facts to dispel the notion about rupee being backed by “assets”—say gold: between 1990 to 2017, the value of 10 gm of gold has gone up from Rs 3,200 per 10 gm to Rs 29,000 per 10 gm—an appreciation of over 800%. However, the value of rupee in terms of purchasing power reduced by 85%, and against the dollar by 65% in the same period. It would be quite clear that centralised currencies like rupee are neither asset-backed nor do they gain much from “backing” by the central bank. Third, these currency platforms/systems are not “owned” by anyone. Bitcoins, just like internet, are not owned by anyone but by everyone using or transacting them. We are all aware that once “lack of ownership” was accepted in case of internet, the real proliferation of internet happened globally.
Today, nobody questions it. There being no “owner” ensures its worldwide acceptance with no vested interest vis-à-vis users. Bitcoin is exactly like that. It is only a matter of time that with more users, this concern will evaporate.
Below I list some of the big advantages that a cryptocurrency like bitcoin could enjoy vis-à-vis traditional currencies:
In a centralised economy, currency is issued by a central bank. The new issuances are supposed to happen at a rate which would match the growth of the amounts of goods that are exchanged so that these goods can be traded with stable prices. In practice, this does not happen. Technically, there is no limit to which a centralised currency can be issued. The data about supplies or future supplies of other “currencies” like gold and other metals in use are even more opaque.
In a fully decentralised monetary system, there is no central authority that regulates the monetary base. The bitcoin generation algorithm defines, in advance, how a currency will be created and at what rate. Any currency that is generated by a malicious user, who does not follow the rules, will be rejected by the network and is worthless. The algorithm used ensures that every time a new incremental demand “over and above bitcoins in circulation” is created, new bitcoins get created in a manner that supply is regulated with decreasing supply for extra demand or “blocks”. As a result of this pre-defined and unalterable algorithm, the maximum number of bitcoins in existence is capped at 21 million (at present, total number of bitcoins mined are approx. 17 million).
Second, today, there is no currency, including the US dollar, which is freely accepted in all parts of the world without conversion into locally accepted currency. Bitcoin, being a virtual currency, has the potential of becoming one such currency that can be truly universal across political and physical boundaries. All that one needs is access to internet.
Also, as discussed earlier, bitcoin is the only currency where total demand as well as actual supply is known at any point of time. Over time, if it becomes universally acceptable with better understanding of myths and concerns surrounding it, whereby people shed the tags like “bubble” or “ponzi” being currently attached to it, this could have the potential of an instrument whose value can be determined in the most scientific manner.
Major concerns with cryptocurrencies
Since supply of a currency like bitcoin is capped, the only determinant of its valuation in long term would be its demand. And that is where the real uncertainty vis-à-vis bitcoins lies. They have already come to a stage of evolution where increasing number of central banks are trying to figure out the level of regulation needed for bitcoins. The fear, if unregulated, arises from the following factors:
It could well become a major competitor over time to the centralised currencies issued and controlled by central bank and government of a country. As a result, the fear of a turf war may look real at some stage. Since all cryptocurrencies are based on strong encryptions, where identity of purchaser/seller are invisible, there is a serious concern of them becoming tools of money laundering without any know your customer or KYC protection prevalent in the financial world. The second concern is more serious and poses the biggest threat to bitcoins. It is already suspected that groups and individuals indulging in nefarious activities like drug trafficking, smuggling, ransom, terrorism funding and remittances/transfer of unaccounted money are now actively using bitcoins to evade detection.
The real danger for bitcoins is either a total ban in countries over its use in the absence of ensuring controls to determine legal usage of bitcoins or imposition of significant hurdles in the form of taxation or other regulations (like possible levy of GST on bitcoins transaction value in India). Such developments would lead to an induced curb on demand of bitcoins, adversely impacting its valuation relative to, say, dollar. The flip side to such a ban would be that while law abiding citizens would be deprived of taking advantage of these new world scientific and universal currencies, the outlaws would, in any case, be free to use them.
Demand, thus, would be ensured in any case unless the world effectively cracks down on such underworld and undesirable criminal activities. If that is done, there would be no need to ban such currencies anyway. It is my belief that no amount of regulation would be able to stop this brilliant concept whose time has come. However, given the uncertainties on regulations and the still evolving global acceptability of these cryptocurrencies, the valuations will remain volatile for some more time. Worth a small bet for sure.