Removing RBI’s restrictions on digital currencies like Bitcoin could give them a fresh lease of life
By: Tavaga Research
Just before the death knell on Yes Bank was rung, there was another news electrifying the financial circuit. On March 4, the Supreme Court overturned a cautioning move from RBI that prevented trading in cryptocurrencies.
Now, the inner workings of the world of finance may seem cryptic to the uninitiated. But their mystery is no match for the one around cryptocurrencies. Yet, the digital forms of currency have an aggregate value of $214 billion.
What is a cryptocurrency?
Cryptocurrency is a digital currency that uses encrypted algorithms and techniques to generate its units and verify the transfers of units by its miners, and secure the network in which they exist, completely independent of a regulating or central body.
We could call a cryptocurrency a new-age digital asset, so named because it owes its existence, traits and security to the encryption algorithms and techniques in its network universe.
Cryptocurrencies are at once the units and the overall system/network that sustain them.
The most common use of a cryptocurrency is for secure online transactions, in its units or denominations that are called tokens.
Some of the encryption algorithms in use are public-private key, hashing function and elliptical curve.
For those who have heard of cryptocurrency, the term is almost synonymous with Bitcoin, the sector’s poster-child. But there are thousands of other cryptocurrencies which have emerged, some copies or extensions of Bitcoin such as Ethereum, some completely different from Bitcoin, new currencies like Ripple’s XRP and some more private than Bitcoin such as Dash.
The value of a Bitcoin is derived from the heavy computing power required to create a unit or token.
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Transactions with cryptocurrencies
Cryptocurrencies are tradeable units that exist solely in digital form and are not regulated by any authority, save for the universe they exist in.
Central banks don’t have jurisdiction to regulate them. No authentication is needed when we trade in (buy or sell) a unit. The system accepting and dispensing cryptocurrency does not require us to furnish any KYCs or other identifiers that the regular financial world demands.
Besides trading and speculation, another usage of cryptocurrency networks is the transfer of money or value. It is usually done peer to peer (not on exchanges). A user’s account has a public key as an identifier and a private key for enabling transactions. Fund transfers are done with the help of such keys.
To understand how they work, we need to know the following phrases.
Phrases telling us how cryptocurrency works
Token: These are the units of the cryptocurrency. For example, a unit of Bitcoin will be called a token in its universe.
The tokens are what are transacted and are the assets or hold value.
Blockchain: Blockchain is the name of the technology that fires up the universe of cryptocurrencies. Cryptocurrencies’ foundational technology can be traced to military technology.
Blockchain refers to a data structure or organization that maintains a ledger for all transactions and the creation of units of a cryptocurrency.
The ledger created through blockchain is maintained by a mind-boggling number of energy-glugging computers that comprise the network of the cryptocurrency. Each computer has a copy of the ledger and the computers are known as the nodes.
Blockchain technology is expected to be disruptive in industries like fintech (payments systems, crowdfunding), general finance, and law.
Block: Each tranche of transactions using tokens is known as a block to be recorded by the blockchain technology.
Each new block generated has to be verified by each node of a cryptocurrency universe before being confirmed and committed to the ledger. This makes it near impossible to fake transaction records as there are innumerable nodes that cannot be controlled or even known by all at once.
Exchange: It is a digital marketplace for these digital assets enabling buying and selling of a cryptocurrency like Bitcoin using fiat currencies (recognized by a government).
The number of exchanges is difficult to ascertain as none are registered in any way. In India, there used to be 20-30 cryptocurrency exchanges with the most common cryptocurrencies being Bitcoin, Ethereum and XRP before the 2018-RBI circular. Now there are around seven exchanges still standing. Some of the exchanges around are WazirX and Matic Network.
Mining: It is the process that verifies transactions of a cryptocurrency through blockchain technology, after which the block of transactions gets added to the highly secure digital ledger.
Anyone with a powerful enough computer and infrastructure may open a mining center at home.
Income from cryptocurrency
Returns from speculation and trading on a cryptocurrency’s value remain the main source of income. It has been reported that some 5 million traded in cryptocurrencies in India before 2018, and one of every 10 global trades were from India.
Cryptocurrency’s anonymity for its users unnerved the purveyor of all things money in our country, ie. our central bank.
In 2018, RBI had banks sever relationships with individuals and businesses dealing in cryptocurrencies in 2018. This meant lenders could not enable banking transactions for the digital currencies’ exchanges and traders.
In the eyes of the central bank, these were illegal and it was moving to secure the financial system from misuse by way of money laundering and consumer fraud.
Though RBI did not impose an outright ban on cryptocurrency trading, it meant cryptocurrency traders had to use the only peer to peer networks for transactions.
The startups and companies offering services such as those of exchange platforms etc were forced to wind up, as a result.
RBI says that it has been cautioning users about the pitfalls of cryptocurrencies since 2013.
Difference between cryptocurrency and virtual currency
Virtual currency would be any currency without a physical form. One could argue that all our money, except for cash in our hands, is virtual as they are not physically being stored anywhere but are notional, ready for a transaction. But the virtual currency can be transformed into its physical form if needed (albeit to an extent).
Cryptocurrencies have another attribute. They don’t have any representation in the physical form and are not rooted in any material goods (gold etc.) or guaranteed by any government. It is a private and decentralized form of currency/exchangeable commodity for trade, beyond the purview of any authority.
But is cryptocurrency a commodity?
The apex court’s order was a result of a plea filed by a group including the Internet and Mobile Association of India (IMAI), which is a not-for-profit body representing India’s digital industry. Its members were largely among the heavy users of cryptocurrencies, transacting among themselves.
IMAI had argued the digital currencies to be a kind of commodity and hence, outside of RBI’s jurisdictional reach.
IMAI’s members contended the RBI’s restrictions scuttled business activity facilitated by cryptocurrencies.
The absence of a law on cryptocurrency in the country meant that there were no grounds for prohibition.
Supreme Court on cryptocurrency
The SC bench headed by Rohinton Nariman said that the rules governing cryptocurrencies would be decided by the Parliament based on the imminent Cryptocurrency Bill.
The SC clarified that RBI and the government would have a monopoly to create and circulate an official digital currency if needed.
Yet, it would be a tall task as it would need heavy investments to build a similarly fortified and encrypted payment gateway, exchanges, and user interfaces for an official cryptocurrency.
Regulations in other countries
Cryptocurrencies had a dream run in 2017 and early-2018, but after depreciation in a fluctuation, retail traders and speculators petered off. Some countries where it had caught on more than others such as China came up with regulations. y
In 2017, one of the developed economies, Japan, on the other hand, accepted Bitcoin as legal currency and gave its exchanges official recognition.
Advantages of cryptocurrency
- The records of dealings in cryptocurrencies are irrefutable and tamper-proof, making it one of the most transparent money systems, albeit for the knowledgeable.
- Cryptocurrencies make transferring even astronomical sums (think, millions of dollars, for example), that take days a matter of minutes and at charges that are a pittance (less than 1 percent of the transfer value!) compared to regular banking transfers. As these don’t need a trusted third-party or intermediary like a bank, the fees are really low compared to wire transfers.
- The transfer of value using cryptocurrency units or tokens is secure like no other system, comprising public and private keys.
- Because of blockchain technology, it is difficult to forge the creation and trading of cryptocurrencies.
- Given their decentralized identity, government interference mostly kept at bay, especially in markets without laws on them.
- No authority or company has access to our funds or personal information.
- Cryptocurrencies may also have the ability to preserve their value against inflation.
- The digital asset class is easy to transfer and divide unlike physical commodities
Cons of cryptocurrency
- RBI’s worries are not unfounded despite the network of cryptocurrencies being super-secure. Exchanges and wallets or user accounts are not always as secure as blockchain ledgers. That is why the theft of cryptocurrency already generated is not unheard of.
- The security and secrecy characterising the cryptocurrencies make it difficult to detect fraud, money laundering, and tax evasion.
- Not stored on a central server but held across a wide, anonymous network, physical damage to any of the computers’ storage could erase valuable units if there is no backup of the private keys of these computers’ memories.
- It is said the design of a number of cryptocurrencies results in scarcity of their availability (liquidity). The complex technology is not easy to delegate and it takes firepower to mine them. Hence, there are situations where supply is short of demand. The rate of exchange of a cryptocurrency against a fiat currency gets determined by this and there have been wild fluctuations with even the most popular Bitcoin.
Bitcoin remains the most well known among cryptocurrencies.
Bitcoin’s founder(s) remains mysterious to this day, going only by the nom de plume, Satoshi Nakamoto. Launched in 2009, it is rooted in open-source blockchain technology.
According to Investopedia, there were more than 18 million Bitcoins in circulation till the end of 2019, worth a market value of $146 billion. But wild fluctuations in its market price continue to pose a challenge to its legitimacy in the regular financial world.
Bitcoin in India
Bitcoin as seen comprises around two-thirds of the market cap of cryptocurrencies and in India, has a trading volume of around Rs 1 crore daily.
Other major cryptocurrencies which tend to move in correlation with Bitcoin have also gained this year; while Ethereum has more than doubled, Ripple’s XRP is up over 75 percent.
Cryptocurrency for us?
With the looming bill on the sector that could regulate them to an extent, cryptocurrencies may seem not worth our time or too hard to decipher but in them lies the key to a lot of disruptions.
Sending money across geographies could get revolutionized and financial inclusion could get a huge boost if they are integrated into the mainstream in the future.