Bitcoin’s credibility problem here to stay

Lokeshwarri SK | Updated on June 05, 2019 Published on June 05, 2019

Too dicey A currency created out of thin air can have no intrinsic value   -  Bloomberg

The cypto asset cannot be accepted as a currency on account of its misuse by speculators and miscreants

Bitcoin, the most popular crypto asset, made yet another dramatic comeback this year with prices rising 147 per cent in the five months to May 2019, when most believed that it would be unable to recover from the debilitating crash in 2018. This revival has rekindled the debate about the future of these assets.

There is no denying that bitcoin and other crypto assets, as envisaged in their original form, have great potential to transform the global payment system. But for this system to work effectively, all the users need to be idealistic, earnest, honest and trustworthy; in other words crypto assets can replace traditional currency only in a fantasy land.

There are two other categories of crypto asset users — besides the believers in an alternative currency system — who have eroded the credibility of these assets. The traders and speculators, who view these crypto assets as a new avenue to make disproportionately large profits, are behind the sharp rallies and equally steep plunges.

The other category posing a threat to the existence of these assets comprises, among others, money launderers, drug traffickers and Ponzi schemes managers. With almost no supervision, crypto assets provide an easy channel for this group to move money across borders, pay for drugs, arms, etc., and to dupe investors.

A problem with the ecosystem

The presence of speculators in the ecosystem has made the value of the crypto assets extremely volatile, rendering them unfit to serve as a medium of exchange. Sample this: In 2016, the value of bitcoin against the dollar increased 110 per cent and in 2017, the gain was 1,493 per cent. But in 2018 bitcoin price plunged 77 per cent.

This kind of volatility is fine if you are a speculator, but if you are holding it with the intent of purchasing a property or some other high value item, it would be difficult to estimate the amount you need to hold, given the gyrations in price. Similarly, it cannot be a store of value either, because the large fluctuations will make it difficult for bitcoin value to remain stable in the future.

The activities of the other set of users — money launderers and the like — have brought down the ire of central banks and governments on crypto assets. Since many investors find it difficult to understand the working of these crypto assets, many Ponzi schemes have sprung up, promising fixed returns to investors. Besides these, the crypto trading platforms are mostly unregulated, posing a risk to investors.

Regulatory action in India

The Reserve Bank of India initially restricted itself to issuing a note of caution to users of crypto assets. But the sharp rally towards the end of 2017 and the crash that followed in early 2018, made the government swing into action. The then Finance Minister, Arun Jaitley, declared in the Budget speech of 2018 that crypto assets are not ‘legal tender’.

But trading in cryptos continued on the trading platform even after this pronouncement. With SEBI unwilling to regulate these ‘exchanges’, investors’ money was at risk. Following allegations of money laundering through some of these platforms, the RBI prohibited all banks and NBFCs from servicing individuals or businesses that deal in or settle crypto assets. This has resulted in most of the crypto asset trading platforms shutting shop in India.

The right approach

For now, bitcoin and other crypto assets cannot hope to displace traditional currencies due to extreme volatility in prices. Besides, the lack of regulation and supervision is their greatest undoing as users do not have any one to turn to in case of any fraud. With scamsters abounding, crypto assets can function in the current format, only in Neverland.

Also, a currency created out of thin air, such as bitcoin, can have no intrinsic value, besides the value imputed by the demand for it. It can be argued that it is the same with other global currencies. But there is a way to arrive at the value of a typical currency — based on the external balances of a country, purchasing power, interest rates associated with the currency, and so on. Besides, the government of a country is guaranteeing the payment of the value ascribed to a typical currency. But in crypto currencies, the creator and the miners are faceless, nameless people, who will not and do not have the wherewithal to guarantee the payment in case of defaults.

That said, there is no denying the potential these assets hold to change the payment system of the future. A via media is possible if central banks can consider issuing digital currencies that can be used in certain transactions.

These could form part of the notes issued for circulation, thus addressing the other issue with crypto assets — the lack of inherent value and absence of sovereign guarantee. Yes, the transaction cost will be higher in such digital currencies, but the higher security will compensate this.

A good diversifier

Interestingly, crypto assets are much in demand of late as an investment avenue. The MSCI World Index fell from 2072 to 1794 in December 2018 and from 2185 to 2045 in May. The prices of bitcoin rose 35 per cent in December and 73 per cent in May. This inverse relation of crypto assets to equity markets makes it a good diversifier.

Both institutional as well as retail demand is emerging for these assets which are viewed as high-risk, high-reward investments. Many hedge funds and other alternate investment funds are quite active in these assets.

Should Indian investors be allowed to trade in crypto assets? Not immediately. Crypto asset trading platforms are mostly unregulated in India and are often run by fly-by-night operators. The scams perpetrated on many of these global exchanges, such as the $450 million scam in Mt. Gox, a Japan based bitcoin exchange, shows that trading directly in these assets could not be ideal.

Instead, SEBI could allow futures and options, based on crypto assets such as bitcoins, to be traded on commodity platforms such as MCX, BSE or NSE. AIFs and high net worth individuals who want to take exposure to these assets can buy these instruments. Trading on exchanges supervised by SEBI also protects investors from undue risk.

While crypto assets replacing traditional currency is quite some way away, Indian investors should be provided some way to take exposure to these assets.

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Published on June 05, 2019
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