[Editorial Analysis] Brace up for Cryptocurrency

Mains Paper 3: Economy
Prelims level: Cryptocurrency
Mains level: Issues related to the Indian Economy

Context:

• Since the demand for Cryptos has gone exponentially, the debate about its Pros, Cons and consequences has been taking place in every domain.

• The author instead of discussing Crypto and its implication on Microeconomics, he discussed the Crypto and Macroeconomics relation.
Cryptocurrency and Microeconomics implications:

• A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend.

• Many cryptocurrencies are decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers.

• A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation.
Significance of Cryptocurrency:

• Have the potential to spur financial innovation,

• Increase efficiency through faster and cheaper payments.

• Augment financial inclusion.

• As blocks run on a peer-to-peer network, it helps keep corruption in check by tracking the flow of funds and transactions.

• It can help save money and substantial time for the remitter and the receiver, as it is conducted entirely on the Internet, runs on a mechanism that involves very few transaction fees, and is almost instantaneous.

• Intermediaries such as banks, credit cards, and payment gateways draw almost 3% from the total global economic output of over $100 trillion, as fees for their services.

• Integrating blockchain into these sectors could result in hundreds of billions of dollars in savings.
Cryptocurrencies and Concerns:

• Cryptocurrencies pose risks to consumers. They do not have any sovereign guarantee and hence are not legal tender.

• Their speculative nature also makes them highly volatile. For instance, the value of Bitcoin fell from USD 20,000 in December 2017 to USD 3,800 in November 2018.

• A user loses access to their cryptocurrency if they lose their private key (unlike traditional digital banking accounts, this password cannot be reset).

• In some cases, these private keys are stored by technical service providers (cryptocurrency exchanges or wallets), which are prone to malware or hacking.

• Cryptocurrencies are more vulnerable to criminal activity and money laundering. They provide greater anonymity than other payment methods since the public keys engaging in a transaction cannot be directly linked to an individual.

• A central bank cannot regulate the supply of cryptocurrencies in the economy. This could pose a risk to the financial stability of the country if their use becomes widespread.

• Since validating transactions is energy-intensive, it may have adverse consequences for the country’s energy security.
Cryptocurrency and Macro-economy:

• Though the microeconomy and crypto debate rages, there is much less appreciation of the macro consequence of privately-issued cryptocurrencies.
Implication on Monetary Policy:

• Widespread adoption of privately issued digital currencies as a medium of exchange will render domestic monetary policy ineffective because domestic central banks cannot set interest rates and inject liquidity in privately-owned cryptocurrency.

• The larger and greater the substitution into cryptos, the less potent will be domestic monetary policy in responding to business cycle needs and external shocks.

• Due to inelasticity and demand shocks resulting in outsized price volatility, Bitcoin became an inappropriate medium of exchange.

• However, to get around this issue, Stablecoins have been introduced whose value is pegged to a fiat currency by maintaining equivalent reserves.

• These Stablecoins hope to serve as viable mediums of exchanges and have proliferated rapidly in recent years.
• However, the risk posed by these Stablecoins to monetary policy depends on the degree of currency substitution.

• As IMF points out that to contain the implications on monetary policy, the cryptos need to be used only for niche purposes which are then quickly converted back into local fiat currencies.

• However, the central bankers and policymakers fear an existential challenge to the global monetary system.

• If the privately issued Global Stablecoins gain credibility and acceptance over time, there will be every incentive for network owners to break free from fiat currencies pegs to generate monetary discretion.

• This leads to private network owners effectively running independent monetary policy.

• This ultimately results in the Cryptoization of the Indian economy where network owners may not have any incentive to use monetary policy to smooth shocks or issue emergency liquidity when needed.

• Ultimately, the fate of economics responding to shocks would be in the hands of private firms. This would present an existential threat to monetary policy.
Implications on Fiscal Policy:

• The greater the substitution into digital currencies the more the loss of seigniorage revenues to the government from the monopoly issuance of fiat currency.

• Further, the fiscal revenues can also be adversely impacted by the increased tax evasion opportunities that crypto-currencies can facilitate.

• The increased substitution into cryptos will commensurately raise the onus on fiscal policy to respond to economic shocks.

• The crypto challenges push Fiscal policy to have the least space to act when it is most needed.
Implications for the Rupee:

• Since the cryptos are mined abroad, demand for them will be akin to capital outflows. If the cryptos begin to get mined onshore, they will induce capital inflows.

• All these dynamics will increase the capital volatility and these crossborder flows circumvent capital flow measures, they increase capital account convertibility, accentuating the policy trilemma that emerging markets confront.
Concerns with Banning of Cryptocurrencies:

• The intended ban is the essence of the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 that seeks to prohibit all private cryptocurrencies in India.

• Though, decentralized cryptocurrencies such as Bitcoin aren’t be controlled by any entity, private or public.

• However, categorizing the cryptocurrencies as public (government-backed) or private (owned by an individual) is inaccurate as the cryptocurrencies are decentralized but not private.

• The Ban of cryptocurrencies is most likely to result in an exodus of both talent and business from India, similar to what happened after the RBI’s 2018 ban. With a blanket ban, blockchain innovation, which has uses in governance, data economy, and energy, will come to a halt in India.

• A ban will deprive Indian entrepreneurs and citizens of a transformative technology that is being rapidly adopted across the world.

• Banning as opposed to regulating will only create a parallel economy, encouraging illegitimate use, defeating the very purpose of the ban.

• Ban is infeasible as any person can purchase cryptocurrency over the internet.

• At the same time, banning cryptocurrency is inconsistent with the Draft National Strategy on Blockchain, 2021 of the Ministry of Electronics and IT (MeitY), which hailed blockchain technology as transparent, secure, and efficient technology that puts a layer of trust over the internet.

Way forward:

• Regulation is needed to prevent serious problems, to ensure that cryptocurrencies are not misused, and to protect unsuspecting investors from excessive market volatility and possible scams. However, the regulation needs to be clear, transparent, coherent, and vision-centric.

• A legal and regulatory framework must first define crypto-currencies as securities or other financial instruments under the relevant national laws and identify the regulatory authority in charge.

• Instead of a complete prohibition on cryptocurrencies, the government shall rather regulate the trading of cryptocurrencies by including stringent KYC norms, reporting, and taxability.

• Record keeping, inspections, independent audits, investor grievance redressal and dispute resolution may also be considered to address concerns around transparency, information availability and consumer protection.

• To overcome the implications over monetary policy, fiscal policy and Rupee, there must exist a triangular arbitrage between Rupee-Bitcoin-Dollar market. Because changes in the Rupee-Bitcoin market will inevitably spill over into Rupee-Dollar markets.

Conclusion:

• The macro implications of widespread crypto adoption are complex and interlinked. Though there is justifiable angst about growing household attraction for cryptos as speculative assets, the true macro challenge will emerge and compound if and when unbacked private digital currencies seen as viable mediums of exchange.

• However, India is currently on the cusp of the next phase of the digital revolution and has the potential to channel its human capital, expertise, and resources into this revolution, and emerge as one of the winners of this wave. All that is needed to do is to get the policymaking right.

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Prelims Questions:

Q.1) With reference to the Global Innovation Summit of the Pharmaceuticals sector, consider the following statements:

1. It aims to bring together key Indian and international stakeholders from the government, industry, academia, investors, and researchers to discuss and strategize priorities to foster a thriving innovation ecosystem in the pharmaceuticals industry in India.

2. It is the third Global Innovation Summit of the Pharmaceuticals sector.

Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Answer: A

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