The Reserve Bank of India (RBI) warned Indians earlier this week that virtual currencies (VCs) like Bitcoin, which is now hitting the stratosphere in terms of valuation, are risky, and hence not worthy of use or investment. In fact, this is not a new warning, for four years ago it had raised similar red flags and pointed out the risks. Unfortunately, while the risks of investing in cryptocurrencies that are now in bubble territory – Bitcoin hit $17,000 on Thursday (7 December) – are obvious, the reasons the RBI trotted out to underline the risks are almost the same as that for regular currencies.
The risks pointed out by the central bank when it first issued warnings on 24 December 2013 were the following.
Risk 1: “VCs (virtual currencies) being in digital form are stored in digital/electronic media that are called electronic wallets. Therefore, they are prone to losses arising out of hacking, loss of password, compromise of access credentials, malware attack, etc. Since they are not created by or traded through any authorised central registry or agency, the loss of the e-wallet could result in the permanent loss of the VCs held in them.”
Comment: Don’t the same risks apply to e-wallets that are legit, and internet banking or credit cards, or mobile banking? While banks are accountable for losses arising from their carelessness or mistakes, if the losses arise from your mistakes, they are not liable. So, are Bitcoins riskier than, say, credit cards or mobile banking?
Risk 2: “Payments by VCs, such as Bitcoins, take place on a peer-to-peer basis without an authorised central agency which regulates such payments. As such, there is no established framework for recourse to customer problems/disputes/charge backs, etc.”
Comment: This is a valid point, and cryptocurrencies have no courts of appeal, but that is also their attraction. They are not based on centralised databases that require you to trust the system; they are based on a widespread sharing of transaction details with everyone in the network, and thus do not require you to trust anybody. Collective responsibility obviates the need for trust in one central bank or one hackable database. You have the details of all transactions with you, and so you are your own money’s minder. It’s no different from keeping cash with yourself for safe-keeping. The risks are real, but you know you are the one responsible for it, not someone whose decisions you can’t control.
Risk 3: “There is no underlying or backing of any asset for VCs. As such, their value seems to be a matter of speculation. Huge volatility in the value of VCs has been noticed in the recent past. Thus, the users are exposed to potential losses because such volatility in value. It is reported that VCs, such as Bitcoins, are being traded on exchange platforms set up in various jurisdictions whose legal status is also unclear. Hence, the traders of VCs on such platforms are exposed to legal as well as financial risks.”
Comment: This is a bit of a joke, for it is not as if the RBI’s issue of rupees or the US Federal Reserve’s dollars are backed by major underlying asset – barring a small quantity of gold. In any case, you can’t demand gold in exchange for your rupees or dollars. These are fiat currencies, and the only reason we trust them is because we believe that at the end of the day more paper can be printed to pay us back – even if it is only in debased currency. A Bitcoin, on the other hand, has seen value go in only one direction – up. So, despite the risks, the one risk it does not face is debasement due to wanton printing on currency. The main risks relate to speculative bubbles – and this risk is real. But then hasn’t the US dollar also been in a speculative bubble since 2008?
Risk 4: “There have been several media reports of the usage of VCs, including Bitcoins, for illicit and illegal activities in several jurisdictions. The absence of information of counterparties in such peer-to-peer anonymous/pseudonymous systems could subject the users to unintentional breaches of anti-money laundering and combating the financing of terrorism (AML/CFT) laws.”
Comment: This is true, but isn’t this true for all cash transactions that leave no trail. Critics of demonetisation have discovered the virtues of fiat cash and its anonymity, so why blame Bitcoin for the same? In fact, the risk of counterfeiting is lower with cryptocurrency than national currencies.
This does not mean the RBI’s warnings on cryptocurrencies are entirely invalid. The wild swings in the prices of Bitcoin, the cryptocurrency that has caught the fancy of cyberbuffs and ordinary investors alike, indicate that it is in bubble territory. In less than two weeks, it has shot all the way from under $10,000 to over $17,000, which puts it on a par with Tulipmania.
However, the sheer size of cryptocurrencies issued and their current valuations suggest that they cannot be dismissed as mere distractions on the sidelines of mainstream money. Not anymore.
According to www.coinmarketcap.com, the total value of Bitcoins issued is now more than $280 billion, which is bigger than the GDP of our rogue neighbour Pakistan. The 1,000-and-odd cryptocurrencies now in existence are collectively valued at more than $430 billion, which would collectively put them in the global top 30 by GDP.
A CNBC report notes that start-ups have already raised $3 billion in virtual currencies, and The Economic Times says some Indian start-ups too are contemplating initial coin offerings (ICOs) to raise money. Nasdaq may start trading in them from next year.
Ethereum, the No 2 crypto, is valued at over $40 billion. Others with quaint names like Ripple and Dash have lower values, but are rising still. These values may be dwarfed by the size of the US economy or the global one, but sooner than later they will be a threat to the orderly conduct of official monetary policy. If people own a lot of their monetary savings in cryptocurrencies, it will no longer be easy for the US Fed or any monetary authority to control the ownership or supply of money in the economy.
Of course, the whole purpose of having a cryptocurrency – a form of value exchange that rests on millions of computers and which cannot be manipulated by anyone – is to keep it away from government control or regulation, which means its supply cannot be politically mandated. Value thus flows from the predictability of supply, unlike gold, which too is a form of money and value, but whose supplies can be more easily manipulated and controlled by governments and monetary authorities.
The very existence and rise of cryptocurrencies is a commentary on the non-durability of fiat currencies, where governments can endlessly print notes and debase citizens’ money. Bitcoin and cryptocurrencies will thus stand as constant reminders to law-makers about how much they have destroyed purchasing power of their own official currencies through politically-driven expediency.
The problem for monetary authorities and governments is not just the embarrassment of the official currency losing value to a form of cybermoney. It is the possibility that ordinary people, without understanding the risks, may end up thinking this is some kind of get-rich-quick stock and then losing a lot of savings when cryptocurrencies crash all of a sudden. The other worry is about the use of this money to pay for illegal activities, including drugs and human trafficking. There is thus the possibility that some countries may just ban it, and criminalise the ownership of cryptocurrencies.
That would be a mistake, for what would then happen is to drive cryptocurrency trading underground. Rather than shooting the messenger, governments and monetary authorities should be issuing their own cryptocurrencies, and throwing open the door to other forms of private currencies, including gold, so that the monopoly of central banks over the issue of currency is well and truly ended.
The idea of a central bank monopoly on money, where a bunch of wise men (and the occasional woman) will decide issues relating to supply and interest rates, is past its sell-by date. We would never accept the idea that one good should be produced by only one company so that we derive maximum economies of scale; we expect competition in every other area of trade and exchange, but somehow stand wedded to the idea that only in currencies we must make an exception. This is nothing but giving politicians ultimately authority on how they will spend or mis-spend our tax revenues, and when they will just print money to get themselves re-elected. Fiat money, despite the excess love Keynesians have for its ability to moderate recessions, now needs to compete with non-fiat money so that we give ordinary people and savers leeway to tell their government what they think about their ability to manage public funds.
Once multiple currencies are created, including some by private parties, it will be possible for monetary authorities to suggest guidelines for how these crypto and other currencies are to be accounted for in monetary policy and in the banking system, what kind of basic safety features need to be built into them, where they can be used and exchanged, and generally create a degree of accountability around them, etc.
It will never be possible to control all cryptocurrencies, and many will surely stay outside regulation. Which is fine. What we need is a recognition that multiple currencies may serve the interests of the public better simply by giving them the right to vote with their feet if they start losing faith in official money. Consider just one example of how lack of alternatives distorts the values of official currencies. The US dollar is strong despite running current account deficits for years on end. It is strong because countries who accept payment in dollar fear their wealth will crash if they sell. Its strength is thus illusory, emanating from the fear that propping it is in the holder’s self-interest. Shouldn’t the world be enabling the creation of alternatives to break this piece of fiction and end the dollar bubble? Points for us to ponder.
(A part of this article was first published in DB Post)
Jagannathan is Editorial Director, Swarajya. He tweets at @TheJaggi.
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