Cryptos are speculative but underlying tech has merits
Reserve Bank of India (RBI) Governor Shaktikanta Das, speaking at the Business Standard BFSI Insight Summit on Wednesday, was unequivocal in underlining the risks in cryptocurrencies. He went so far as to say that private cryptos — originally conceptualised as a way to disrupt regulated fiat currencies — might set off the next major financial crisis. These presented a danger, he said, as they were not anchored to anything and were “100 per cent speculative”. The crypto universe may indeed have started to unravel. The collapse of the FTX exchange is a cautionary tale. Other major cryptocurrency exchanges, including Binance, are now under regulatory scrutiny. There’s no doubt that cryptocurrencies are speculative instruments: The original white paper on Bitcoin by somebody using the pseudonym Satoshi Nakamoto, who was disenchanted by the 2007-08 financial crisis, explicitly stated these were designed to break the fiat system. That paper and its ideas spawned thousands of cryptocurrencies. The fact that most people, including central bankers and “big four” accountants, have problems understanding cryptos, has made regulation difficult and exacerbated the problem.
There has been a huge collapse in crypto prices in the past year. Whether this dramatic unwinding will trigger a financial crisis is a different matter. That would depend on the extent of the contagion in the conventional global financial system. Did crypto holders or exchanges take a massive leverage in fiat currencies? If they did not, the conventional banking system will not be badly exposed. The case of El Salvador, where Bitcoin is considered parallel legal tender, will be of special interest. However, whatever the intentions, the launch of Bitcoin, and later Ethereum, did shake up the financial system in ways that might eventually be beneficial. The design of cryptocurrencies incorporated several innovations, which will live on even if the assets evaporate. Bitcoin conceptualised the blockchain technology, an electronic ledger with an excellent, sophisticated, decentralised method to verify authenticity of transactions while maintaining privacy. Blockchain has since been adapted for multiple purposes, including judging the provenance of designer jewellery, art, vintage wines, feeding refugees, and so on. It is used by investment banks as a strong safeguard against internal fraud. It is also being used to create “trustless contracts” by municipalities in Estonia and Finland. It has been used in China to bypass censorship (a recorded blockchain transaction cannot be deleted). India is also encouraging the development of blockchain-related uses, even if it is against the use of cryptocurrencies.
Additionally, with their ease of use in cross-border transactions, cryptocurrencies have ensured that central banks smooth out the process for such transfers by launching their own digital currencies. Bank charges for cross-border transfers dropped once it was realised, for example, that converting the euro into Bitcoin and selling it in US dollars incurred a lower cost than conventional bank transfers. This was first observed when people in Cyprus opted to bypass currency controls in this way. Removing frictions in the global remittance market is big in itself. It is worth noting that cryptos are still legally usable in many countries, including the US, Canada and Australia. While cryptocurrencies and the blockchain technology have resulted in changes in both financial and real worlds, they remain speculative instruments for individuals. Tightening of global financial conditions would further affect these instruments adversely.