Evolution of Money
Money, as we know of it today, is the result of a long-drawn process. At the beginning, there was no money. The barter system formed the backbone of the economy. This system involved the exchange of one set of commodities for other commodities through double coincidence of wants (for two parties in exchange, what one party wants to sell exactly coincides with what the other party wants to buy). On account of the inherent limitations of this system of exchange, money was invented to serve two major functions: as a medium of exchange and as a measure of value. Over a period of time, the forms of money underwent evolution from commodity money in the beginning to metallic money to paper money and then to bank money.
In more recent times, the financial crisis of 2008 affected the financial systems worldwide and undermined people’s faith in banks so much that a new class of asset, which did not have the backing of any formal bank, came into being. Bitcoin, the most popular cryptocurrency, was created in 2008 as a fully decentralised, peer-to-peer electronic cash system wherein the users of the currency would not need to place their trust in a central authority, such as traditional central banks. Thus, the emergence of a cryptocurrency was organically linked to the implosion of the global financial system in 2007-08, which undermined the confidence in government-controlled currencies.
What is a Cryptocurrency? How is it different from conventional money?
A virtual currency represents value in a digital form; it is both a medium of exchange and a measure of value. A cryptocurrency is a digital or virtual currency, created and stored electronically in blockchain. It uses encryption techniques, as the term ‘crypto’ implies, and this makes it almost impossible to counterfeit or double-spend. It has no intrinsic value: it cannot be redeemed for another commodity such as gold. It has no physical form as it exists only in the network. Its supply is not determined by a central bank as the network is completely decentralised. A defining feature of cryptocurrencies is that they are not issued by any central authority, so they are not controlled by one person or a government, making them theoretically immune to government interference or manipulation.
Some of the most popular cryptocurrencies are Bitcoin, Ethereum, Binance coin, Tether, Cardano, Dogecoin. In essence, cryptocurrencies such as Bitcoins are just unique pieces of digital codes that (some) people accept as ‘digital currency’.
Cryptocurrencies, unlike fiat currency such as the rupee, are not legal tender as they are not regulated by central banks and do not have the backing of a government. Cryptocurrencies are also much more volatile than fiat money. The volatility comes from the speculative nature of the trade, where investors are focussed on wealth creation quickly by booking profits. Moreover, cryptocurrencies do not require an intermediary like a bank to validate a transaction between two parties as would be required in the case of fiat money. Crypto transactions are verified using the blockchain technology, because of which all transactions undertaken are recorded permanently, enhancing the security of every exchange.
Framework behind Cryptocurrency: Blockchain Technology
Blockchain is the reason why cryptocurrency has any value. It is the underlying platform on which cryptocurrencies are built.
A blockchain is essentially a digital record of all transactions across a peer-to-peer network: every transaction undertaken is duplicated and distributed across the entire network of computer systems on the blockchain. Each block in the chain contains a number of transactions, and every time a new transaction is undertaken on the blockchain, a record of that transaction is added to every participant’s ledger. No central clearing authority is required for participants using this technology to confirm a transaction. Using this technology, a common record of all transactions undertaken is shared between multiple participants across locations. This is called Distributed Ledger Technology (DLT). If there is any sort of tampering with the record of transactions undertaken, it would be visible to all the participants. Even though anyone can join and participate in the blockchain, date on every transaction as well as data of the participants associated with it is secured using a technique called cryptography.
Being a very disruptive technology, blockchain has the power and potential to revolutionize financial services as it can provide a platform that is transparent, secure and can operate efficiently.
Cryptocurrencies can revolutionise money
Cryptocurrencies can revolutionise the way we store money, pay for goods and services, and do business. All money in circulation in an economy is owned by the central bank and commercial banks of that currency’s legal jurisdiction, except for cash in hand with the public or the money deposited in the banks as checking deposits. With cryptocurrencies, funds will be owned by those who hold the keys. The role of commercial banks would be restricted to issuing and safeguarding keys to digital wallets instead of maintaining bank accounts. The flow of funds through conventional banking and that through cryptocurrencies can differ substantially. With the former, a central bank typically goes through the banks to distribute money into the markets. However, with a cryptocurrency, the central bank can distribute directly to a consumer. This has not been previously possible as banks have played the role of middlemen in transactions.
Already, the move towards a cashless economy based on digital transactions has disrupted the physical cash market, and the emergence of cryptocurrencies will further accentuate the disruption. The real driving force will be central banks as they develop their own more stable forms of digital currencies (central bank-backed digital currency).
The meteoric rise of cryptocurrencies and the subsequent growth of a cryptocurrency industry has immense potential. Being a disruptive innovation, cryptocurrencies possess the ability to transform the global financial ecosystem. Individuals, businesses, banks, and governments will all be affected. In all likelihood, there would be more efficiency, greater flexibility, and more market access, especially those without access to formal financial services. Concurrently, the rise of cryptocurrencies poses a challenge to the sovereign function of the State, i.e., currency and coinage. There is need for governments across the globe to provide for enabling regulation, formalising the industry and lowering the risks associated with such investments.
Advantages of Cryptocurrencies
The principles underlying transactions using cryptocurrencies make it a democratic alternative to the commercial banking network. Decentralisation is the primary tenet of a cryptocurrency.
Cryptocurrencies, being based on blockchain technology, will go a long way in eliminating fraud related to digital transactions.
Though wire transfers and bank-to-bank transfers have become fast and efficient with time, there is a time lag involved, especially in case of international transfers. Money transfers using cryptocurrencies can be instantaneous without any transaction fees, and they can be tracked and stored in blockchain.
With e-commerce gaining pace, use of cryptocurrencies can make it safe and secure for both buyers and sellers as it eliminates fraud associated with digital transactions because of transactions being permanent.
Account keeping becomes easier in a system using cryptocurrencies as accounting is done using a decentralised online ledger without the possibility of any sort of manipulation, as compared to a system using money.
Because blockchain-enabled cryptocurrency transactions do not require a third party or a central authority, this paves the way for business transactions to become more decentralised. This will provide anonymity as nobody will be able to monitor mutual information between two parties. Only the sender and receiver will be involved.
Risks Associated with Cryptocurrencies
The aspects of cryptocurrencies that are of concern are speculation, volatility, and erosion of savings. Fortunes may be made and lost in a matter of weeks on account of tremendous volatility in the value of a cryptocurrency. For example, Bitcoin was selling at $60,000 per coin in April 2021 but its value was halved in June 2021. In a country where lakhs of traders get involved in such currencies, this could have huge implications.
The anonymity of transactions undertaken through private digital currencies makes them vulnerable to money laundering and terror funding while making law enforcement difficult. The element of anonymity makes it hard to track the origin of transactions undertaken through a cryptocurrency digital wallet.
These virtual currencies are challenging the sovereign function of the State, i.e., issue of currency and coinage. If private cryptocurrencies are allowed to function as legal tender, the central bank would lose control over the monetary policy and financial stability, as it would not be able to keep a hold on the money supply in the economy.
Transactions in cryptocurrency being outside the purview of regulation, the government is deprived of legitimate tax revenues (capital gains tax on profits made through speculation in the virtual currency market).
As the cryptocurrency exchange websites operate outside the purview of supervision, there is no grievance redressal mechanism in case of a redress.
As cryptocurrencies are not based on any real economic activity, unlike a sovereign currency, they do not inspire much confidence.
Cryptocurrencies and India
Pioneered by Bitcoin, there has been a phenomenal rise in the price of cryptocurrencies as well emergence of a number of new virtual currencies in the market. In this background, since 2013, the Reserve Bank of India (RBI) has been issuing multiple notifications regarding the risks associated with virtual currencies. In 2018, it went to the extent of prohibiting banks, non-banking financial companies (NBFCs), and payment system providers from either dealing in or providing services pertaining to virtual currencies. However, the RBI directive was set aside by the Supreme Court on March 4, 2020. An inter-ministerial committee (IMC) that was set up in 2018 to assess the viability of virtual currencies has recommended that India should ban private cryptocurrencies such as Bitcoin. The IMC recognises the potential of DLT and Blockchain, However, the IMC has recommended a ban on ‘private’ cryptocurrencies, though it is open to a cryptocurrency that the RBI may unveil. The IMC’s view is that it “would be advisable to have an open mind regarding the introduction of an official digital currency in India”. The union government has sought policy intervention in the form of the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 which seeks to ban all private cryptocurrencies while providing the RBI the power to develop a central bank digital currency (CBDC). The bill remains to be tabled in Parliament. An apprehension on the part of the government in providing regulatory directions with respect to cryptocurrencies might lie in the fact that regulation may be seen as providing legitimacy to what is currently ambiguous and may further boost its speculative valuation, thereby contributing further to the investment bubble.
Central Bank Digital Currency (CBDC)
A CBDC is the digital format of a fiat currency for a particular country. It will be a legal tender issued by a central bank in a digital format. It would be fiat currency and exchangeable one-to-one with fiat currencies. According to T. Rabi Shankar, Deputy Governor of the RBI, “CBDC will be a positive step in India, which is seeing a surge in cryptocurrency investments”. The RBI is working towards a phased launch of a CBDC.
Advantages Some of the advantages associated with CBDC are as follows:
- The cost of issuing digital currencies will be far lower than that of physical currencies (which involve printing and distribution cost).
- A digital currency would enable smoother international settlements.
- The RBI-backed digital currency will protect people from the volatilities associated with private cryptocurrencies.
- With a CBDC in place, governments will be enabled to control illicit payments and tax evasion as the transactions in CBDC will have a digital footprint. This will help in combating money laundering and terror financing.
Concerns The idea of a digital currency, however, raises some
- With their popularity, people may be tempted to withdraw money from their bank accounts.
- With money withdrawn by people, banks will lose deposits over time and that will constrain their ability for credit creation. Thus, CBDCs may weaken the modern banking system in the long run as banks’ access to deposits and revenue gets constrained.
- The most worrying aspect is that of low financial and digital literacy in the country: dependence on a digital form of payment could render a large proportion of population vulnerable to fraud and financial crimes.
With a CBDC in place, its success will depend on its efficient integration with the existing banking and payment applications to ensure a flawless operation.
Way Forward
Even in the absence of clear regulatory directions, the investment in cryptocurrencies in India is already growing. The cryptocurrency revolution has already arrived in India, as evident from the amount invested by Indians in cryptocurrencies which stood at ₹ 49,161 crore ($6.6 billion) in May 2021, as per information available in the public domain. In these circumstances, there is a need for the regulatory authority to accept this and re-examine the policies in the larger interest and reality. The leading economies of the world are taking a broader view of the virtual currencies. After the RBI ban on cryptocurrencies in 2018, there was an exodus of both talent in blockchain industry and business from India. In case of a blanket ban, blockchain innovation, which has uses in governance, data economy, and energy, will come to a halt in India. It will be counterproductive for the blockchain industry in the country, hampering the growth of technocrats and software professionals related to this disruptive innovation. Moreover, a ban ineffectively implemented might result in the development of a parallel economy involving cryptocurrencies.
Conclusion
The idea of a virtual currency came into effect due to dissatisfaction with the existing financial system. These cryptocurrencies were intended to be used for peer-to-peer transactions without having to trust a third party like a central bank. However, over time, these virtual currencies have turned into as asset rather than a currency. As an asset, cryptos are feared for their speculative tendencies. This makes the case for regulation. However, the absence of regulation is the most appealing aspect of a cryptocurrency as well as the most dangerous. To address serious concerns associated with cryptocurrencies and to prevent cryptocurrencies from being misused, government regulation is the need. Concurrently, there is need to spread awareness about the risks associated with such investments so as to protect the unsuspecting investors from excess market volatility and possible fraud. But the regulatory framework, like all effective regulations, has to be clear and coherent, and transparent, and must project a vision of what is sought to be achieved.
“This crypto, blockchain technology, the public interest in it right now is being driven by a kind of speculative fever,” says Dr. Richard Smith, executive director of the Foundation for the Study of Cycles. Cryptocurrencies may go up in value, but that will be the result of mere speculation, and not any real investments. One cannot profit from the use of cryptocurrencies unless someone else pays more for the currency than what the previous party did. As of now, the jury is still out on the future of cryptocurrencies.
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