Be aware of bitcoin, other cryptocurrencies

Before debating whether to ban private cryptocurrenies, it is prudent first to understand what cryptocurrencies are

Virtual currencies created using blockchain technology have been the subject of great speculation and discussion in recent times.

Legendary investors Charlie Munger and Warren Buffet have gone as far as to call Bitcoin and other cryptocurrencies ‘rat poison.’

Before debating on whether to ban private cryptocurrency, it is prudent first to understand what cryptocurrencies are.

Cryptocurrencies are digital encrypted tokens that can be transferred between two parties without the need for a centralised regulator.

The facilitators of the transaction work to verify a transaction individually and maintain a public ledger open for anyone to see.

No intrinsic value

The elimination of a centralised entity is why we see the word ‘decentralisation’ being thrown around very often. Cryptocurrencies are not ‘untraceable’ as most believe; in fact, it happens to be more traceable than currency notes due to the public ledger leaving a clear trail.

In addition, when discussing the merits of cryptocurrencies, one must understand that it possesses no intrinsic value. Stocks provide partial ownership of a firm that produces goods and services, bonds provide a steady source of income, and gold has inherent metal value. Cryptocurrencies are non-productive assets that are merely traded because there is demand for it.

Ex-RBI Governor Raghuram Rajan had stated recently in a TV interview that “a lot of cryptos have value only because there is a greater fool out there willing to buy”.

Cryptocurrencies are eerily similar to the tulip mania of 1636, when tulips were being traded for the sake of turning a profit. Another essential point to note is that although theoretically there is a scarcity of Bitcoin and other cryptocurrencies, that does not mean anything in terms of economics because there needs to be a particular purpose that will sustain demand for the asset.

Some claim that Bitcoin and other private cryptocurrencies are a new revolution in currencies and the monetary system. No central bank or government around the world would be interested in relinquishing power over the money supply. Private cryptocurrencies being adopted as a legitimate currency in the nation will spell the end of regulation and economic intervention by the central bank. This is because central banks require the ability to manipulate the money supply to intervene during a crisis. Private cryptocurrencies strip the central bank of this power, leaving the central bank effectively unable to set interest rates and control the money supply efficiently. In a crisis such as the COVID-19 pandemic, it would become challenging for monetary regulators to step in and aid a wounded economy.

Therefore, it is improbable for any notable government to favour and encourage private cryptocurrencies for these reasons. Moreover, due to speculation, cryptocurrencies ensure that they can never act as a measure of the value of goods and services. For a cryptocurrency such as Bitcoin to be accepted as a currency, it has to price goods. Bitcoin, an extremely volatile cryptocurrency (like its counterparts), cannot act as a currency in a stable economy.

Ban on cryptos

Although a particular country can choose to ban private cryptocurrencies, that this does not mean anything to the asset as a whole is untrue. The significant advantage which cryptocurrencies pose, which is decentralisation, leads to its downfall. Any government with large enough pockets can decide to take down the cryptocurrency by destroying its monetary value. The incentive for miners and other participants to maintain the system is financial.

If the price of a cryptocurrency such as Bitcoin were to drop to 0, it would be devastating. The act of a significant government announcing its intention to take down cryptocurrencies would leave a considerable dent in the price. Additionally, cryptocurrency mining takes up a substantial amount of a country’s resources which could be put to more productive uses.

It is crucial for governments worldwide to decide on a course of action regarding this growing technology and equip themselves accordingly.

The longer it takes for regulators to implement a plan, the greater there is to lose as the amount of money being channeled into the asset grows further. Unfortunately, all bubbles come to an abrupt end leaving many financially distraught.

Those who invest in cryptocurrencies need to understand that they are speculating rather than investing. It follows that while speculating, one takes comprehensive care to know what they are getting into. Therefore, it is vital that an individual does not stake their financial security upon this novel asset.

(Anand Srinivasan is a consultant and Sashwath Swaminathan is a research associate at Aionion Investment Services)

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