• Citation: Shri T Rabi Sankar, ‘Cryptocurrencies – An Assessment’. 14th February 2022. https://rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=1196
• Wiki topic: Crypto Asset

Overview

• In this address Sankar argues that:
  • Cryptocurrencies have specifically been developed to bypass the regulated financial system.
  • Cryptocurrencies are not amenable to definition as a currency, asset or commodity; they have no underlying cash flows, they have no intrinsic value; and that they are akin to (or even worse than) Ponzi Schemes.
  • They undermine financial integrity, especially the KYC regime and AML/CFT regulations and at least potentially facilitate anti-social activities.
  • They can (and if allowed most likely will) wreck the currency system, the monetary authority, the banking system, and in general Governments’ ability to control the economy. They threaten the financial sovereignty of a country and make it susceptible to strategic manipulation by private corporations creating these currencies or Governments that control them.
  • Banning cryptocurrency is the most advisable choice open to India. None of the arguments proffered by those advocating that cryptocurrencies should be legalized and regulated stand up to basic scrutiny.

Summary

• In this address, Sankar gives an introduction to the basics of cryptocurrencies. Sankar then engages in a critical assessment of cryptocurrencies.

What are Cryptocurrencies?

• While cryptocurrency is designed to be a currency, it does not fulfill the function of a currency: Cryptocurrencies do not have an issuer, they are not an instrument of debt, or commodities nor do they have any intrinsic value.
• Cryptocurrencies are not financial assets. Cryptocurrencies are neither any person’s liability nor do they have any underlying cash flows and are therefore by definition not financial assets.
• Cryptocurrencies are not a commodity: they are not tangible and have no utility.
• Concludes that cryptocurrencies are not currencies, financial assets, nor commodities. They are rather “an electronic code (with no practical use) which has created enough hype such that people are willing to pay money to buy ownership rights to that electronic code, seemingly on the hope that someone else would buy it at a higher price in future… Cryptocurrencies are very much like a speculative or gambling contract working like a Ponzi scheme.”
  • It has been argued that the original scheme devised by Charles Ponzi in 1920 is better than cryptocurrencies from a social perspective - even Ponzi schemes invest in income earning assets.¹

What useful social or economic role does a cryptocurrency play?

• Can cryptocurrencies perform the functions of a currency? “The volatility of many cryptocurrencies precludes them as an efficient medium of exchange.”
• Are cryptocurrencies useful as a store of value? “Stores of value are either currencies, or financial assets or commodities which are tangible and have intrinsic value… Cryptocurrencies are none of these… if a threshold number of people decide to opt out, the entire values can easily collapse to nothing.”
• “For all the hype about a revolutionary innovation, cryptocurrencies themselves do not appear to be designed to meet any need in the finance space that is currently not being met or to meet existing needs more efficiently.”

What, if any, are the risks posed to a society or an economy?

• 1: They are intended to be private currencies and therefore come with the associated risks.
  • Historically, private currencies have resulted in instability and therefore have evolved into fiat currencies over centuries.
  • With one or more private currencies being allowed, there would be parallel currency system(s). Thus, increased acceptance of cryptocurrencies would result in effective ‘Dollarization’ of the economy.² Dollarization would undermine the ability of authorities to control money supply or interest rates, as monetary policy would not have any impact on the non-Rupee currencies or payment instruments → ability to control inflation would be materially weakened.
  • If private currencies are permitted, the banking system’s ability to mobilize deposits in Rupees, and consequently, the ability to create credit, would be diminished.
  • There are already indications that private cross-border flows are taking place in cryptocurrencies.
    • If this trend is legitimized, a part of the flows related to trade payments, personal remittances or cross border investments would be made in these cryptocurrencies. As they are non-reserve currencies, this could have adverse implications for India’s foreign exchange reserves, which lend stability to the external sector.
    • Such cryptocurrency payments can take place outside the ambit of capital account regulations. This would adversely affect the integrity of the capital account regime, as policy control on capital flows would be eroded. The consequence of this on foreign exchange reserve accretion and exchange rate management raises serious macroeconomic stability issues.
  • Stablecoins (which are simply cryptocurrencies that are less volatile) are being promoted globally, because they are more stable than, say, Bitcoin. We should be more concerned about stablecoins because they would be more effective as currency than volatile cryptocurrencies. FT: “Stablecoins pegged to official currencies would increase, rather than dampen risks, if assets and liabilities were mismatched.”³
• 2: They are structured to evade Government control with respect to financial integrity standards such as KYC, AML/CFT etc.
  • The raison d’etre of cryptocurrencies is that they bypass established intermediation and control arrangements that ensure integrity of financial transactions, such as Know-Your-Customer regimes, Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT) rules etc.
  • Cryptocurrencies are particularly attractive to illegal/illegitimate transactions which have been largely filtered out of the formal financial system.
  • Since valuation is largely based on beliefs, and not on underlying value, it is bound to have a destabilizing effect on monetary stability of a country through large-scale wealth loss to investors (if it is adopted widely), even if not allowed to be used as a currency.
  • Wasteful energy use of crypto infrastructure.
• Sankar thus concludes “there does not appear to be any case to allow cryptocurrencies to be legitimized in India.” He then goes on to address arguments for permitting cryptocurrencies when subject to close regulations.

Should cryptocurrencies be permitted and regulated in India?

• Pro: Blockchain or Distributed Ledger Technology is a promising technology where Indians might have a global edge. Banning cryptocurrencies would affect the absorption of DLT technology in India.
  • Rebuttal: Creating native cryptocurrencies⁴ is just one way of implementing a blockchain. It should be possible to maintain a blockchain without any native cryptocurrency if transactions are authenticated centrally.
• Pro: Most advanced economies (AEs) are not banning cryptocurrencies, but are considering some kind of regulation.
  • Rebuttal: India is not similarly placed as advanced economies. If some private currency substantially replaces the Rupee, the corporation which manages that cryptocurrency (or the country which has control of that corporation) can practically control India’s economic policy. There are a number of other reasons why it might be in the interest of AEs to not ban them:
    • Almost all cryptocurrencies are priced in terms of Dollars (or potentially any of the freely convertible currencies). Wider adoption would result in wider use of these currencies. So cryptocurrencies are not a threat to convertible currencies as they are to the Rupee, which is not an international currency.
    • Most cryptocurrencies are owned by businesses of AEs; therefore, better adoption of cryptocurrencies would add to their growth and employment.
    • AEs have more mature markets which can withstand the potential disruption from cryptocurrencies. They are, therefore, in a better position to wait and watch.
    • AEs have quicker legal systems therefore concerns of misuse of cryptos can be addressed through the legal systems. In India, none of the major instances of consumer exploitation have been redressed legally (e.g. the mis-selling of derivatives in mid 2000s).
    • AEs have the political power to control the crypto companies. The recent instance where the US recovered Bitcoins from the hackers of the oil pipeline in the US is an example that AE Governments wield enough power to access the records. India or most other countries would lack such advantages.
• Pro: Many Indians have already invested in cryptocurrencies and banning it may lead to wealth loss for them.
  • Rebuttal: Banning in India does not mean investors would lose money, because they can be provided with a reasonable exit.
  • Rebuttal: Persons who have invested in these instruments are fully aware of the risks involved. Reserve Bank has been warning investors of the risks for nearly a decade.
  • Rebuttal: There is no data to justify how many investors have invested in these instruments and what is the amount of investment. Data informally gathered in November seems to indicate that crypto investments by Indians is nowhere near to being significant.⁵
• Pro: Banning is unlikely to be effective because by its very nature cryptocurrencies can be acquired and traded in an anonymous manner.
  • Rebuttal: Could argue that drug trafficking is a rampant phenomenon despite a ban, and therefore drug trafficking should be legalized and regulated. If cryptocurrencies are banned, the vast majority of investors who are law abiding would desist from investing. Those few elements who would continue to invest will be carrying out an illegal activity.
• Pro: Some argue that private currencies should not be allowed as legal tender but should be allowed as an investment asset.
  • Rebuttal: Not allowing them as currency would still amount to cryptocurrencies being used as a store of value. ‘Store of value’ demand is a more substantial source of demand for a currency than transaction demand. If a cryptocurrency is used as a store of value the same concerns arise again.
  • Rebuttal: Unlike the value of Rupee, which is anchored by monetary policy and its status as legal tender, the value of crypto assets rests solely on the expectation that others will also value and use them. Since valuation is largely based on beliefs that are not well anchored, it is bound to have a de-stabilising effect on the monetary and fiscal stability of a country, even while it is not permitted to operate as a legal tender.
• Against: It would be futile to regulate cryptocurrencies as cryptocurrencies are not currencies, or financial assets or real assets or even digital assets. Therefore, it cannot be regulated by any financial sector regulator - it is not possible to regulate something that one cannot define.
• Against: The Financial Stability Institute of the Bank for International Settlements identifies difficulties in regulating cryptos – such as the international nature of crypto transactions, absence of technological solutions to ensuring FATF’s ‘Travel Rule’, the problem of ‘unhosted wallets’, the fact that P2P transactions do not involve any entity subject to AML-CFT regulations, etc.
• Against: As it is not always possible to know of the persons who are the management for cryptocurrencies (e.g. Bitcoin), at whom would the regulatory action be directed?

Conclusion

• Cryptocurrencies can (and, if allowed, most likely will) wreck the currency system, the monetary authority, the banking system, and in general Governments’ ability to control the economy. They threaten the financial sovereignty of a country and make it susceptible to strategic manipulation by private corporations creating these currencies or Governments that control them.
• Banning cryptocurrency is perhaps the most advisable choice open to India. We have examined the arguments proffered by those advocating that cryptocurrencies should be regulated and found that none of them stand up to basic scrutiny.

References and Notes

1. McCauley, Robert. ‘Why Bitcoin Is Worse than a Madoff-Style Ponzi Scheme’, 22 December 2021. https://www.ft.com/content/83a14261-598d-4601-87fc-5dde528b33d0.
2. This could be actual dollarization if stablecoins linked to the US Dollar become widely used, and there is good reason to believe that that they would be popular if permitted.
3. Guthrie, Jonathan. Where Crypto ‘anarchy’ Will End | Lex Megatrends, 2021. https://www.ft.com/video/ccb48782-82f9-44ef-97c7-dcfa02431123.
4. Bitcoin is native currency to Bitcoin Blockchain, Ether to Ethereum
5. The Reserve Bank does not vouch for the reliability of this data as it was collected informally and has not been validated. These conclusions may only be taken as indicative, subject to correction if better data is made available.