Bit of a bubble

| Updated on November 27, 2018 Published on November 27, 2018

File Photo   -  Reuters

The latest crash underscores the unsuitability of bitcoin as an asset class for investors

As the bubble in the price of bitcoin, the most popular crypto currency, bursts, Indian regulators can rest easy that they helped protect investors from steep losses. The upward spiral in the price of bitcoin last year, with value racing from $985 in January 2017 to $18,847 by December, attracted investors by the drove, who viewed this as yet another avenue to make quick profits. While the initial leg of the rally was propelled by optimism about wider acceptance of the crypto-currency, speculators entered the ring in the second part of last year, causing a frenzy that resembled the tulip mania of the seventeenth century or the South Sea bubble of the eighteenth century. Since bitcoin prices are solely dependent on demand and supply, due to the absence of an underlying asset, it is not surprising that prices are now down almost 80 per cent from their December peak.

Indian regulators and the Centre had been maintaining a vigil on crypto-currencies and had been cautioning users from time to time. In 2013 and again in 2017, RBI issued a statement warning against using crypto-currencies. But it was the Centre which took the first step in dousing the buoyancy in these assets by stating in the Budget of 2018 that bitcoin is not a legal tender in India; thus ruling out the possibility of these currencies becoming alternative mediums of exchange. The Securities and Exchange Board of India seems to have desisted from passing any stricture against crypto-currencies as it viewed these as falling under the purview of RBI. This silence emboldened those trading in bitcoins and other crypto-currencies in various unregulated exchanges across the country. It was presumed that there was no harm in investing in these assets that promised inordinate returns. Therefore exchanges facilitating trading in crypto-currencies thrived up to the first quarter of 2018 and unfortunately, most of the naïve first-time investors would have bought these assets towards the end of 2017 or early part of this year, at peak valuations. The RBI’s move this April, to prohibit all entities regulated by it from servicing individuals or businesses that dealt in or settled in crypto-currencies, brought trading in crypto-currencies to an end.

Even though the ban was brought about in a roundabout manner, it was timely. The crash in crypto-currency prices in recent weeks makes it clear that they are highly unsuitable as an asset class for retail investors. SEBI needs to spell out its stance on these crypto assets in order to prevent a recurrence of such episodes. That said, crypto-currencies are not completely useless . But these currencies can be effective as a medium of exchange only if they are well regulated. The RBI move to constitute a committee to explore the feasibility of rupee-backed digital currency therefore appears to be a good idea. Higher adoption of the blockchain technology also needs to be encouraged.

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Published on November 27, 2018
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