Cryptocurrency is a highly disruptive technology, with a high carbon footprint, that can affect many stakeholders in today’s trust based financial system. The Reserve Bank of India (RBI), its currency issuing power and its supervisory role in the payments system domain are first casualty because blockchain is completely decentralised and anonymous.
But if we place cryptocurrency in the larger picture of digital economy then the list of casualties become even larger. As fintech move closer to banks on the credit side, cryptocurrency can replace the current legal tender in which case the central bank can lose control over money creation or, so to speak, the money undergo a compositional transformation. Thus, the possibility of blunting the power of monetary policy signal cannot be ruled out.
Cryptos do not just affect the banks. They also disrupt the capital markets just as crowdfunding has done. The method of raising funds through the initial coin offerings (ICOs) bypasses the entire paraphernalia of primary markets and stock exchanges.
Furthermore, the way ICOs are typically designed the investor in ICO does not acquire any economic right or voting right in the business that issues ICOs. Thus, cryptocurrency also disrupts the idea of joint stock or limited liability company, 170 years after it was first conceptualised in Europe.
The basic course on monetary economics always starts with the idea of ‘money’. What is money, why it is important – with the most vital concepts often being ignored and over time forgotten by most economists.
The importance of money can be understood in relation to a barter. Supposing there are ‘n’ commodities, each of which can serve as a medium of exchange, then there will be a large number of exchange rates to deal with.
However, if one of the commodities out of ‘n’ is fixed as a medium of exchange, the number of exchange rates would fall dramatically. Eventually this chosen commodity will also become a ‘store of value’ and a ‘unit of account’. The choice of this unique commodity, its supply, is vital to stability of the system at large.
Initially it was precious metals that served as money, but in modern times it is fiat paper money, or its digital format issued by central banks which serves as money.
It is from this basic story of elementary monetary economics that most of India’s cryptocurrency dilemma can be understood. This dilemma has many dimensions. With the government and the RBI on one side and computer scientists on other, crypto discourse in India reminds us of the title of the famous book Men Are from Mars, Women Are from Venus.
The idea of digital currency has existed for quite some time. But Satoshi Nakamoto who created the famous Bitcoin made cryptocurrency a reality. Nakamoto solved the double spending problem inherent in a digital currency by proposing a blockchain (or distributed ledger) based recording of all transactions.
At the core technology level, a cryptocurrency uses blockchain and cryptography to ensure no double spending and completely secured transaction. This arrangement does not require a central issuing/supervising authority like a central bank. The total number of bitcoins that can be issued is also fixed. Cryptos can also be backed by an asset such as gold.
However, it must be kept in mind that while most of the cryptocurrency is based on blockchain, all blockchains are not cryptocurrencies. That is why even if cryptocurrency is banned in India, the main technology blockchain is not.
RBI has excluded cryptocurrency from its guidelines on regulatory sandbox but permits testing of innovative uses of blockchain in other domains such as trade finance.
As things stand today, cryptocurrency has achieved the status of a medium of exchange or a payment medium. Limited supply and high valuations make cryptos a probable asset for store of value. But at the same time their stretched valuation increases their appeal for chit fund like frauds and money laundering.
No Consumer Protection
The existing arrangements have rudimentary consumer protection mechanism. The plethora of cryptocurrencies that have sprung up has given rise to a number of crypto-to-crypto and crypto-to-fiat crypto-exchanges with considerable regulatory blind spots.
What cryptocurrencies so far have not achieved is the status of a unit of account which is intrinsically linked to price stability or inflation targeting. Till this is achieved, the disruption caused to a central bank status is only partial and not full. The ongoing research to achieve the goal of price stability using cryptocurrency on a blockchain will pave the way for stable coins.
The monetary policy signal will then be transmitted over the blockchain; a stable coin will directly challenge the current legal tender and become a full substitute. It is for this reason that some of central banks, notably in China and India, have contemplated issuing sovereign cryptocurrency and prevent the emergence of a parallel financial infrastructure impinging of the exchange rate, financial stability and sovereignty.
Countries across the world have taken diverse positions on cryptocurrencies. While some are accommodating this new form of digital asset, others have been more circumspect. In the US, Congress has asked Facebook to pause the development on its Libra cryptocurrency. Some international financial centres have allowed innovations in cryptos in their regulatory sandboxes. Thus, how flexible a country’s sandbox is will decide its future attractiveness. Flexibility of sandboxes may become a parameter for ease of doing business in a digital economy. Thus, unless this crypto dilemma is resolved quickly, even Gujarat International Finance Tec-City Co Ltd (GIFT City) has a bleak future competing with more forward-looking financial centres in the digital finance space.
In conclusion, with the Supreme Court set to hear crypto related writ petitions in 2020, the stage is all set for a lively debate in the domain of law and constitutional law. It needs to be seen how some of the dilemmas narrated above are viewed from the standpoint of law making when the Banning of Cryptocurrency & Regulation of Official Digital Currency Bill is tabled in the Parliament. On the economic front there is so much to discover and debate, yet there has been a deafening silence.
(The author is an economist and works the banking industry. Views are personal.)