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Wednesday, December 1, 2021

Cryptocurrency – Is it the future of Digital Currency?

“Is Cryptocurrency going to be just another investment avenue or an alternate currency in the future?”

There seems to be growing an open mindedness in general public and financial industry about the cryptocurrencies across the globe. Bitcoin is taken as a currency to transact, companies like Tesla, PayPal and Square have been getting into cryptocurrencies in a big way with billion dollar bets on bitcoin. However, there is no fundamental basis on which cryptocurrencies are driven as their prices are thrown up or down merely by someone’s support or withdrawal.

Fin-tech companies like Facebook has launched its own cryptocurrency called Diem, Amazon is coming up with its digital currency project in Mexico and could roll out in emerging economies, and Alipay by Ant Group. This adds up to the credibility of volatile cryptocurrency, could rest the concentration of power in these few hands and could turn out to be destabilising for the emerging markets. There is also a growing challenge from China with respect to their pilot testing of digital yuan in their major cities as it aims to be a cashless society by Winter Olympics to be held in Beijing in 2022.

Considering cryptocurrency as an emerging asset class and an advancement in technologies that are prominent, many central banks decide to take a radical action by creating their own digital currencies to compensate the volatility of Bitcoin in the financial system. Many governments like United Kingdom, Hong Kong, Australia, and Sweden are exploring the ways as to how digital currencies would work. European Union bank is working with European Commission in experiments to consider benefits of Digital Euro. Even Federal Reserve is becoming serious about digital dollar and Bharat would also consider studying over the block chain technology that supports the cryptocurrency and come up with their own digital rupee.

Are these digital currencies going to be the future of finance?

Central Bank digital currencies (CBDC) is a digital form of a country’s currency operated by the central bank. CBDC is an online version of cash that central banks would issue to make everyday transactions. This would lower the cost of cross-border digital payments countering the usual high costs of sending fund transfers from one country to another through banks. CBDC would be a digital currency wallet to store safe assets with well-established central banks who are not going anywhere anytime soon and ensures the privacy of sensitive data. However, on a flip side, if there is massive power outage or hacking, it could jeopardise the entire system and could also cause a bank run during economic stability.

Hence, digital currency should co-exist with physical form of currency and allow central banks to continue to take control of economy. Nevertheless, the advocates of Cryptocurrency argue that failed government policies, rising banking defaults in central banks would be averted with decentralised approach of bitcoin and alt-coins, corruption will be lowered, entrepreneurship will be enhanced and foreign direct investment could also increase and they consider bitcoin as “digital gold.”

China is switching from paper cash to digital cash with zero transaction fees for merchants and it will work offline for one day as well. It is 100% trackable and is not based on block chain and does not involve any third party. China wants to replace all cash and coins with digital yuan. China becomes the first major economy to introduce a digital currency in the real world. This may force the foreign companies to start trade in digital yuan making it a bone of contention with respect to privacy and data issues.

Sweden has the lowest usage of cash and had launched a pilot program for its digital currency known as E-Krona in 2019. In Hong Kong, an experiment using digital currency to settle cross-border transactions between Thailand is being expanded.

How does Cryptocurrency Work?

The total value of bitcoin in circulation is worth US$750 billion in market capitalisation. Bitcoin was the first cryptocurrency that was invented by Satoshi Nakamoto as an alternate currency on block chain technology and is not controlled by any particular bank. For example, if person A wants to transfer funds to person B, the miner would verify the bitcoins available with A. Every transaction has a unique variable that is worked through their algorithms with high processing computers. The transaction is confirmed with the help of other network of computers and then transaction is added to the public ledger and goes into the chain that builds up like blocks. Transactions once added to the block cannot be reversed and generally it is difficult to hack. Every block has its fingerprint called hash and distinguishes itself from other blocks and if anyone attempts to tamper any block, the hash changes and the entire block chain is destroyed. Since this is very expensive affair and require a lot of technical capabilities to code hence miners are rewarded with Bitcoins as they make sure the transactions are verified. If we want to create a cryptocurrency/coin, then a new block chain has to be created but a new crypto can also be created based on existing block chain technology called as Token.

Why are Cryptocurrencies trending across globe?

Satoshi wanted the supply of bitcoins to be limited in such a way that only 21 million bitcoins are available in the market hence it’s less supply would allow the prices to rise and make bitcoins more valuable. 90% of bitcoins have been mined and it is believed that last bitcoin will be mined in the year 2140. As the bitcoins are mined, it makes difficult to mine new bitcoins further. However, in order to address the challenges of bitcoin, the alt-coins like Ethereum, Ripple and Litecoin and many more came into being. The execution speed of transactions of Bitcoin is 10 minutes compared to Litecoin, Ethereum that takes 2.5 min, 25 seconds and Ripple takes less than 4 seconds per transaction. Alt-coins provide unlimited supply of coins unlike Bitcoin.

On 14th April 2021, Bitcoin made its all-time high at US$ 65,000 and currently stands at US$ 32,000 with a market capitalisation dominance of 43%. Bitcoin has given 246% returns over 1 year.  Ethereum, Tether and Litecoin, have given returns of 407%, 179% and 160% over the last 1 year.

A global perspective on Cryptocurrency

There is a lot of research going on in the world about cryptocurrency as an alternate currency.

  • El Salvador (in Central America with 64 lakh population) has announced it would soon make Bitcoin cryptocurrency a legal tender. This country relies heavily on remittances sent by Salvadorians from abroad which is 20% of their GDP and currently uses US dollar as their official currency. 70% of population does not have bank accounts and crypto will generate jobs for people in informal economy as they believe. El Salvador is handing out up to $117 bitcoins to its citizens.
  • Cryptocurrencies in Japan are treated as legal tender and the exchanges are required to register with Japan’s financial services agency (FSA). They have stepped in to regulate trading and exchanges.
  • The Treasury in United States has not accepted Bitcoin as a legal currency but as a money services business.
  • Canada views Bitcoin as a commodity and income generated is treated as business income.
  • Australia does not consider bitcoin as a currency or money instead just an asset and treats its income under capital gains.
  • Finland treats bitcoin as a commodity and not any legal tender.
  • Bharat had frozen out the crypto industry from the banking system in April 2018 to ensure financial security after the media reported about illegal activities and money laundering taking place. But after various developments, the government has decided to revisit the plans to launch its own digital currency. Bharat does not treat bitcoin as a legal tender. After the positive news filled in for crypto investors, crypto banks like Vauld, EasyFi Network and Cashaa have stepped in for their lending operations in Bharat.
  • Countries like China, Russia, Vietnam, Bolivia, Ecuador and Columbia have said no to bitcoin.

Is Cryptocurrency Safe?

Probably not. In the dark web of internet, people had started accepting payment in bitcoins for buying weapons and drugs. It became difficult for law enforcement agencies to track such people outside the financial system. Hacking issues also surfaced. Lot of bogus companies took money from public with a promise that once trading started in that particular cryptocurrency, the value of their money would double/ triple, as anyone can make their own cryptocurrency. Elon Musk, the CEO of Tesla had even tweeted saying cryptocurrency mining process consumes enormous amount of electricity and this tweet had a direct impact on valuation of cryptocurrency globally. There have been cryptocurrency scams worldwide known as Pump and Dump strategy, wherein people create new cryptocurrencies based on some existing block chain technology and launch it with hype. People start buying giving a bull run to the prices, the founders sell the cryptocurrency at higher prices, get money and escape the game.

These cryptocurrencies are highly volatile and their prices change too frequently. Currency value should be more stable hence stable coins like gold, US dollar are preferred as they are reserve backed currencies. They derive their value from underlying asset like government money or gold. Hence digital currencies may emerge to give more stable values to investors and consumers compared to private and public cryptocurrencies. In 2021, 90% of the world’s central banks said there are experimenting with digital currencies compared to 18% in 2019. However, surveillance and privacy risks still pose challenges for the central banks.

Conclusion

A few countries like Cuba, Venezuela, Mexico and El Salvador are either dependent heavily on remittances or suffering from hyperinflation and they are inclining towards cryptocurrencies to increase financial inclusion in their countries and there could be a significant growth in their GDP. Digital currencies should be a fraction of paper currency in circulation considering the volatility of cryptocurrencies but if we expect that digital currency could ever replace paper currency or may replace banking system, is simply an exaggeration! Because it is the conventional global banking industry that plays a big role in driving economy in a more sensible manner.


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Criti Mahajan
An MBA graduate in finance with 5 years of working experience in the financial services space. An enthusiastic research writer inclined towards understanding economics and policy making with an experience of diversified writing on professional platforms in economics. A self-starter, perseverant and an ardent learner.

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