The Hindustan Times article “The Centre’s clampdown on cryptocurrencies betrays lack of understanding of the technology”, published February 13, 2018, argues that the government’s antagonism towards cryptocurrencies could result in India missing out on the biggest wave of innovation since the internet became popular in the 1980s.
A FALSE PREMISE
The article argues that India’s clampdown on cryptocurrencies and the Ministry of Finance calling digital currency investments “ponzi schemes” shows a lack of understanding of digital currencies and blockchain technology. Now this argument is clearly based on a false assumption.
In his Budget speech, the Finance Minister made it clear that while cryptocurrencies are not legal tender in India, the government is not hostile to the technology behind it per se and will explore the blockchain technology to help boost India’s own digital economy. Thus, as far as understanding of technology is concerned, the government does not seem to have a prelapsarian attitude at all.
In fact, the apprehensions of the Indian government vis-à-vis cryptocurrencies were spelled out in a statement from the Ministry of Finance on December 29, 2017. These reasons are sound and need to be seen in detail. The main apprehensions and arguments of the government are listed below for quick reference:
- Virtual currencies, or cryptocurrencies, do not have any intrinsic value and are not backed by any kind of assets
- There is a heightened risk of investment bubbles similar to ponzi schemes, which can result in sudden and prolonged crashes exposing investors
- Virtual currencies are stored in digital/electronic format, making them vulnerable to hacking, loss of password, malware attacks, etc
- As transactions of cryptocurrencies are encrypted, they are also likely being used for illegal /subversive activities, such as, terror-financing, smuggling, drug trafficking, and other money-laundering activities.
Therefore, cryptocurrencies are not backed by state fiat and, as such, are not legal tender. It follows that cryptocurrencies or virtual currencies are not really currencies. Cryptocurrencies do not have any intrinsic value and are not backed by assets in the real economy as stated above. What follows further from the above is the recognition that the value(s) of cryptocurrencies is/ are wholly a matter of speculation and this is the reason behind the volatility their prices exhibit.
The article eulogises cryptocurrencies as the biggest wave of innovation since the internet. While that is certainly a matter of opinion, below are some facts about what has been happening in the (virtual) world of cryptocurrencies of late:
- It is true that last year (2017) cryptocurrencies, especially Bitcoin, reportedly ended up rising to about $20,000 in value.
- However, over the last few weeks, Bitcoin’s value has reportedly crashed to less than 50% and is likely to fall further.
The above is evidence of the volatility and fluctuation that have scared governments and central banks across the world – and not just in India. The European Union has warned only this week that a cryptocurrency crash seems to be very much in the offing, which could burst the Bitcoin, Ethereum and Ripple price bubbles. This would leave investors at risk of losing everything.
The following is what the European Supervisory Authorities (ESAs) for securities, banking and insurance and pensions reportedly said in its joint statement on Monday, February 12, 2018: “The ESAs warn consumers that VCs (virtual currencies) are highly risky and unregulated products and are unsuitable as investment, savings or retirement planning products…” The ESAs also said: “Virtual currencies such as Bitcoin, are subject to extreme price volatility and have shown clear signs of a pricing bubble and consumers buying VCs should be aware that there is a high risk that they will lose a large amount, or even all, of the money invested…”
In other words, the warning from the EU is stark: People who have invested in Bitcoin and other cryptocurrencies could soon lose all their money. This is precisely part of the reasoning and warning from India’s Ministry of Finance too.
Again, in another example, the Global Chief Economist of UBS, Paul Donovan, in an interview to the BBC has described the Bitcoin price as “a classic bubble”. But in the most “shocking” admission, to quote the media, the CEO of one of the world’s most successful cryptocurrencies has said that he believes all digital currencies are set to plummet in value to a price of £0. Ripple CEO Brad Garlinghouse, speaking at the Goldman Sachs’ Technology and Internet Conference, said that he believes “most” digital currencies will eventually lose all their value. He warns that “cryptocurrencies are too unpredictable to be widely used due to largely being unregulated and with very volatile price markets.”
NOT JUST INDIA
We have just noted above how concerned the EU is about cryptocurrencies and the warnings emanating from both the EU regulators, and at the behest of the European Commission too, as well as the statements from within the cryptocurrency industry. So, India is certainly not alone in its apprehensions, nor is it the only country taking action.
No. India is certainly not the only country apprehensive of the damage cryptocurrencies can do. Japan and China have cracked down on cryptocurrencies. The Japanese cryptocurrency exchange, Coincheck Inc, was stung by the theft of $530 million of digital money in January. The theft has exposed flaws and dangers of cryptocurrencies and, in fact, has forced Japan’s crackdown on them.
South Korea has been thinking of closing its domestic bitcoin exchanges. In fact, only last month, South Korea reportedly put in place new cryptocurrency rules. While these new rules do not proscribe cryptocurrencies, they bring in certain strictures which go a long way to validate the apprehensions. As per South Korea’s new regulations, the country is to allow trade in cryptocurrencies only via “real-name bank accounts” from January 30.
Other countries like Germany and Singapore are uncomfortable about the fact that investors do not have any regulatory safeguards. In the US, there are privacy problems about cryptocurrencies.
In Canada, recently the head of the Central Bank of Canada, Stephen Poloz, was quoted as saying (January 25, 2018): “I object to the term cryptocurrencies because they are crypto but they aren’t currencies… they aren’t assets for the most part… I suppose they are securities technically… There is no intrinsic value for something like bitcoin so it’s not really an asset one can analyse. It’s just essentially speculative or gambling.”
CRYPTOCURRENCY M.O. & RISKS INVOLVED
Now let us look at the M.O. of cryptocurrencies to understand the danger they may likely pose to investors, governments and economies:
- Cryptocurrencies adhere to a peer-to-peer electronic payment system. As such, the transfer of money in terms of cryptocurrencies takes place without going through a banking system, outside any regulatory framework.
- Cryptographic proof, instead of old-fashioned “trust”, to validate the transactions or establish their authenticity, may seem new-age and state-of-the-art. But the very cryptographic evidence that “validates” the transactions in the virtual world and is meant to ensure the security and integrity of the mechanism, consists of the same cryptographic algorithms that enable anonymity for users. Therein lies perhaps the biggest headache for governments and, ultimately, for the public at large.
- Therefore, the very nature of cryptocurrencies as decentralised digital currencies becomes the fundamental problem. The “mining” of the ledger which is public is also decentralised naturally and while it may be championed as its strength, again, we run into the same problems as above.
As such, the very virtual and decentralised system in which cryptocurrencies operate, which is touted as its greatest strength and attraction, is also perhaps its greatest weakness. Unlike the intrinsic value of a currency, backed by assets, as in banking systems, whereby users/ customers can be compensated in case of loss or theft, in the world of cryptocurrency, there is no such guarantee as the “coins” themselves are stored in complete digital/ electronic format without any intrinsic value as pointed out earlier.
Thus, cryptocurrency users are especially vulnerable to theft and attacks targeting the “money”, passwords, malware, hacking, etc. And unlike theft or loss from a banking system, whether digital or otherwise, the loss of money in the case of cryptocurrencies would be permanent and total.
Let us conclude with a brief look at the real danger to countries and economies, to governments and the public, that cryptocurrencies pose: Given the encryption of transactions and anonymity for users/ investors, cryptocurrencies are enablers for illegal and subversive activities, for terror-financing, goods- and people-smuggling, drug-trafficking and other money-laundering acts. Very importantly, a chief criminal activity that cryptocurrencies are seen to encourage and enable is tax evasion.
In the end, of course, the immediate threat that cryptocurrencies pose is to their users, as the Finance Ministry has correctly said: “There is a real and heightened risk of investment bubble of the type seen in ponzi schemes which can result in sudden and prolonged crash exposing investors, especially retail consumers losing their hard-earned money.”