Changing risk appetite towards Crypto currencies


With more and more countries entertaining cryptocurrencies (CCs) a social view is emerging in favor of regulating them rather than staying away from them. Though some forms of digital coins were in use even earlier, the marked debut of CCs can be traced to the entry of bitcoin software developed and brought into use in 2009 based upon blockchain technology. It enabled the safe, secured tamper-proof recording of transactions that led to a massive upsurge in the number and volume of CCs. Since its data is stored across the network, every user of the network needs to authorize the transactions lending credibility to its security.

The risk and vulnerability of the financial system stem from the fact that there is no central governing authority or controlling body or issuing authority with sufficient capital buffers and risk management systems like a bank, licensed non-bank or any regulated intermediary in administering CCs. Hence, imposing self-regulation to make every user responsible for storing and safety of their funds within the wallet is the essence of an operational modicum of CCs.

1. How do CCs work:

They work on four distinct operating platforms. (i) Proof of work (POW) basis where a unit of CC must show proof of completing the predefined task to exist, based upon blockchain technology that is incorruptible distributed ledger system. The most popular CCs based on POW is Bitcoin and Ethereum. (ii) Proof of Stake (POS) where the concept of providing proof of legitimising a CC unit is needed. It is fundamentally different from POW to overcome the challenge of scalability. Dash, Eos and Tron are some of the examples of CCs operating on POS method. (iii) Tokens is a basis on which CCs are designed with specific, limited purpose use like for example digital gaming assets such as weapons and extra lives and are not meant for wider usage. They are usually built around using blockchain. Popular tokens are Tether and BAT. (iv) Stable coins are a class of CCs that function as assets storing value that doesn’t fluctuate as is the case with popular CCs such as Bitcoin. Tether, Gemini, Paxos and TrueUSD are examples of stable coins. The basis of CCs is confidence drawn from the secured operating platform and it is about its money value and not about who issues or who sells.

Since there is no need of centralized authority to float the CCs, there has been a massive rise in their numbers. The latest information indicates that there are currently more than 7,800 CCs in circulation today, of which close to 2000 is defunct with many more on the verge of stagnation or exit. They range in aspects such as type, use, and value. Many of them are not popular on a large scale, and the most popular CCs account for more than 80% of the industry.

2. Changing global stance on CCs:

Since its quick ascent in popularity with the increase in tech-savvy users with higher risk appetite, the world is widely divided on treating them and so are the regulators. It is estimated that 16.36 percent of countries have banned, 16.36 percent are hostile to it, 25.45 percent are on the fence or neutral, the perception is improving in 22.73 percent of countries. 19.09 percent of countries have either recognised or promoted them aggressively. But in India, given the financial literacy level and risk management limitations, RBI has been reiterating its concern.

The apex court set aside the RBI direction to banks issued on 6/4/2018 banning them from facilitating cryptocurrency-related transactions. The judgment marks an important milestone both in India and globally and helps in bringing a positive perspective towards the crypto trading activity. But RBI continuous to be apprehensive about the multidimensional risks in CCs, more importantly about consumer protection and financial stability. Fear of money laundering and security concerns with widespread risks cannot be ruled out. It terms of dimensions of risks; it is like, if cashback tokens/scratch coupons provided by digital wallets are to be regulated. At least they are of low value and do not fluctuate.

3. Regulatory concerns:

Though many countries have permitted trading in CCs and even some have legalized it but its risk sensitivity continues. In the absence of a lack of control on issuers and volatile money value, it is difficult to track the flow of funds and its end-user. Authentication of KYC and enforcing anti-money laundering laws would be difficult.

Bank for International Settlement (BIS) that works on guiding central banks across the globe in institutionalizing a stable financial system does not find any constructive role of CCs. In its recent Annual Economic Report – June 2021 while referring to several recent developments that have placed a number of potential innovations involving digital currencies, it observed that “By now, it is clear that cryptocurrencies are speculative assets rather than money, and in many cases are used to facilitate money laundering, ransomware attacks and other financial crimes”.

However, the regulatory cue can be taken from large countries like US where CCs are not legal tender but CC exchanges are legal and considered money transmitters. US continues to make progress in developing federal-level cryptocurrency legislation. China has recently banned all private CCs and is not a good host. Taking these risk factors, if regulations can ensure customer protection and is adequately able to track end use of funds from CCs changing hands, then safety can be ensured. But in the current level of financial and digital literacy when protecting consumers from cyber-attacks is a challenge, it is necessary for policymakers to introspect if the financial ecosystem be able to create a safe pathway for CCs that are relatively riskier and less understood as a financial product. While global consultations in articulating regulatory and legal framework can be useful but customising them to the individual needs of economies will still be a tough challenge, more so for large and diversified country like – India. The point to ponder by policy makers – will the financial ecosystem be able to cope with the nuances of risks coming from CCs – recognising the merits in the RBI way of looking at it.

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Disclaimer

Views expressed above are the author’s own.



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