The underlying tech may be transformative, but cryptos’ impact on financial markets needs clarity
Reserve Bank of India (RBI) Governor Shaktikanta Das is absolutely right in saying we need some more debate and discussion before cryptocurrencies are adopted in India. Since the mandate of ensuring financial stability rests with the central bank, RBI must be allowed to steer the discussions, and to have the last word.
Depending on what form cryptocurrencies take on in India, there could be an adverse impact on monetary policy, possibly on the currency and fiscal stability. So, while an outright ban would probably deprive the country of a promising technological avenue and may also foster an illegal market, we need a top-class regulatory framework to ensure private cryptocurrencies do not end up becoming a fertile ground for nefarious activity like drug trafficking, terror financing or money laundering.
From all accounts, it would appear that RBI is best placed to regulate cryptos and to make sure the many use-cases are not misused. Those that argue there are risks associated with other asset classes too must understand that investing in gold or stocks, for instance, is not a new phenomenon. On the other hand, cryptocurrencies are relatively new and their impact on financial markets little understood. RBI’s objective is to understand the magnitude of the impact trading in cryptos could have on financial markets, not to thwart the advent of new technologies nor choke innovation. To be sure, there is no immediate demand to give cryptocurrencies the status of a digital currency; in other words, they are not becoming legal tender. Media reports say the government is planning to legalise trading in cryptos as assets on exchanges.
It is instructive to know what experts think. Professor Eswar Prasad of Cornell University points out that as Bitcoin came into the mainstream, it has not delivered on its promise as a medium of exchange because the prices are volatile, unstable; it turns out to be quite slow, expensive and cumbersome. However, it has, paradoxically, become a financial asset, with investors believing the value will gain.
Prasad wonders where the value of Bitcoin comes from if it is does not have intrinsic value as a medium of exchange; investors believe it could come from the scarcity value—like gold—but Prasad cautions that everything that is scarce need not appreciate in value. He believes people have been taken in by the razzle dazzle of the new technology and that it may end well, for retail investors. However, he says the technology underlying the Bitcoin is truly transformative.
Central banks around the world are justifiably concerned about what new cryptos can mean for financial stability given they can be used to manipulate markets. Some countries are allowing cryptos because they could lead to innovation. The new lot of cryptos—Stablecoins—are seen as more stable in value because they are backed up by stores of fiat currencies like the US dollar and other hard currencies. However, while stable coins may appear to be risk-free, it is not clear who is going to audit the portfolio and whether the asset portfolio is liquid enough to withstand large redemptions in a short time. China does not allow trading of cryptocurrencies though there is no ban on ownership. Like China, other nations are concerned about cross-border transactions; while this can mean more efficient, faster and cheaper transfers of remittances, for instance, without adequate controls, it could also mean transfer of illegal money. However, it is clear cryptocurrencies can’t be ignored even if they cater for a very small class of affluent people. Perhaps the RBI committee’s report, expected next month, will shed light on the risks and rewards of these virtual assets and how we can go about regulating them.