By: Tavaga Research
A cryptocurrency is a form of virtual money that is designed to be secure and anonymous. This form of digital money uses decentralized technology for letting users make secure payments without using the bank as an intermediary and by staying anonymous.
The Central Government of India is planning to take another jibe at cryptocurrencies by introducing a legal framework that will ban the trading of cryptocurrencies.
The central authority’s stand has been consistent on the matter as indicated by a previous ban in 2018 on virtual currencies by RBI and another inter-ministerial committee inspection in 2019. However, the ban was recently overturned in March by the Supreme Court in the favor of cryptocurrency exchanges, which led to a 450 percent surge in trading in just two days. A law prohibiting cryptocurrency trades will put India in a league apart from other developing Asian economies, who have regulated the virtual currency market instead of outright imposing a ban.
Cryptocurrencies presently thrive in unregulated markets. The Government has raised concerns regarding the lack of regulation in cryptocurrency markets. Several scams post-demonetization also helped the Government’s case to lobby against the presence of a cryptocurrency market.
Cryptocurrencies work differently than traditional currencies in that traditional currencies function in the capacity of fiat money. Traditional currencies come under the purview of the Central bank and are heavily regulated. The Central bank resorts to a conjunction of monetary policies to ensure the smooth flow of the currency throughout the economy.
Virtual currencies, such as cryptocurrencies, are not regulated by a central authority and function on the concept of peer-to-peer networks. The existence of a virtual currency is limited to the digital space. For the lack of authority and reserves to back the currency value, cryptocurrencies are subject to extreme price fluctuations. A digital asset with such high levels of volatility, if adopted in the regular stream of the economy, holds the potential to cause systemic failures, unless regulated.
Why does the government want to ban cryptocurrency?
- The threat of virtual currency developing into an alternative currency will pose a severe risk to the users of such currency. Virtual currencies, due to their volatility factor, considerably add to the risk profile of the users.
- Virtual currencies are not backed by a sovereign entity. Essentially, the holder of virtual currency stands to lose all of its value in the case of defaults.
- Cryptocurrencies are not considered legal tender in most economies. Therefore, there is no sort of recourse available for the users. In case of fraud, the victim loses the right to appeal to a judicial authority.
- Cryptocurrencies have no underlying intrinsic value and variable nominal value. Such a property hinders the ability of cryptocurrencies to serve as the ideal store of value or medium of exchange.
- Cryptocurrencies aid the growth of shadow economies and may be extensively used to fund terrorism and other illegal activities.
- Susceptible to fraud related to money laundering and hacks despite complex systems of encryption involved in executing a payment.
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What is the alternative to imposing a ban on cryptocurrency?
Despite highlighting the valid concerns of accepting cryptocurrency, the Government received criticism from the proponents of virtual currencies. To publicly store and record transactions on several networks, cryptocurrency uses progressive technology such as that of blockchain. The Government’s think tank (Niti Aayog) is open to ideas surrounding the use of blockchain networks to modernize their public database. An open-minded approach to virtual currencies can take shape in weighing alternatives such as:
- Regulating the cryptocurrency markets like other Asian economies and developed economies will serve as the middle ground. For example, Singapore requires the cryptocurrency businesses to obtain a license from the central monetary authority before commencing business. The laws on anti-money laundering can also be expanded to bring cryptocurrencies under their purview. Comprehensive KYC norms placed on the holders of cryptocurrency will eliminate the anonymity in transactions and enable better tracking of suspicious activity.
- Adoption of Global Stablecoins (GSCs) will enable the Government to reap the benefits of efficient payments while ensuring regulated financial inclusion. GSCs are crypto-assets that derive their value from an underlying asset, say sovereign currencies. GSCs are stable in value because the volatility is limited to the price fluctuations of the underlying asset.
- To overcome issues around legitimacy, the Government can introduce Central Bank Digital Currency (CBDC) under the oversight of the Reserve Bank of India. The digital currency will enable the public to access liquidity without putting additional stress on the banking system. A digital currency can support the vision of a cashless society. CBDCs, due to sovereign backing, will stand a fair chance to compete against cryptocurrencies such as Bitcoin. CBDCs combined with blockchain technology protocols will increase transparency in the financial system, if adopted in the mainstream. For example, the use of CBDCs in the real estate sector could refine the maintenance of land records denying manipulations and swift developments due to improved liquidity. The presence of such a digital currency incentivizes foreign investment and businesses.
Global trends in cryptocurrencies
As per a report from Business Wire, the global cryptocurrency market is estimated to grow at a compounded annual growth rate (CAGR) of 32 percent from 2019 to 2024. According to Dune Analytics, decentralized exchanges witnessed a massive 160 percent surge in August trading volume. Aggregate trading volume in August stood at $11.6 billion, up from $4.5 billion in July.
Following the recent increase, decentralized exchanges reached their third consecutive monthly record high.
The cryptocurrency suffered a fall in volume in April due to the onset of the pandemic caused due to Covid-19. However, the cryptocurrency market swiftly claimed their upward trajectory on the back of positive trends in the global virtual currency market such as:
- Bitcoin halving, an event that occurs every four years, cuts the rewards for mining Bitcoin transactions in half and reduces the rate at which new Bitcoins enter the circulation. This is similar to a stock split.
- Facebook’s Libra was announced in 2019 as a means to enter the blockchain-based digital payment system. Facebook intends to focus on both existing Government-backed currencies and Libra tokens and combine their utility.
- Crypto-lending is a recent development allowing the borrowers to use their crypto-assets as collaterals to avail a loan in fiat money or stablecoins (crypto-currency with an underlying asset).
- Crypto-friendly regulations in several economies have contributed to the wide-scale popularity of cryptocurrencies.
A legal framework prohibiting cryptocurrencies in India will be detrimental for cryptocurrency exchanges, investors, and other stakeholders. The Government is likely to exercise caution in the coming days on the matter of publicizing the pros and cons.