Nosediving of cryptocurrencies: Beginning of a long haul?
The article has been authored by Partha Ray, a director of National Institute of Bank Management, Pune. The views expressed here are personal.
In recent times, with their prices nosediving, cryptocurrencies have attracted quite a bit of attention. What was earlier projected in some quarters as the new messiah of democratization of money was seen to have crumbled like a house of cards. Take the recent past. On April 1, 2022, the price of bitcoin (the leading cryptocurrency) was $ 46,222; it experienced a secular steep fall since then and touched $ 18,989 on June 18, 2022! Since then, it has witnessed some marginal recovery and tended to hover around $ 20,000 these days. Consequently, the global cryptocurrency market capitalisation has fallen by over $2 trillion after touching the $3 trillion mark in November 2021. But is this roller coaster transition of bitcoin, from erstwhile euphoria to a dampened mood, in expected lines? Is it an affirmation of the dictum of speculative market forces that, “what goes up comes down? Such questions seem to be blowing in the wind.
But is not such instability inherent in the nature of cryptocurrency? To go back to history, it is now widely known that a White Paper (https://bitcoin.org/bitcoin.pdf) in 2009 by someone named Satoshi Nakamoto demonstrated to the world that a secure low-cost payment can be created outside the conventional central banks, via blockchain technology. These cryptographically-verified tokens could act as a decentralised digital medium of exchange called bitcoin. Interestingly, the identity of Nakamoto remains illusory to date. Also, there had been a mushroom growth in the number of cryptocurrencies - and the number could be anything between 10,000 and 20,000 at the current juncture.
But does this usage of suffixing currency after crypto capture the letter and spirit of money? First, unlike a currency, bitcoin is not backed by the might of the State. Second, and more importantly, people are not clear as to what backs up cryptocurrency; unlike a currency, the backing of security or asset is out of the question in the case of a cryptocurrency. Thus, the term cryptocurrency appears to be a misnomer. An appropriate term could perhaps be a crypto-asset/crypto for short. But what is the nature of this asset? What backs them? Is it a combination of binary numbers, a token or a computer algorithm? Thus, for a common investor, such cryptos are difficult to comprehend as an asset. In an obvious reference to tulip-mania of 17th Holland, reportedly, Reserve Bank of India (RBI) governor commented that these have no underlying values, not even that of tulip.
But why is this recent crash? While some commentators have tried to relate the dramatic fall in prices of crypto-assets in line with the general subdued mood in the global equity markets (in the backdrop of inflationary pressure and the Russia-Ukraine war), the reasons could be far beyond this. In fact, there is a contrary view that the meltdown in the crypto market is at best a footnote to the story of subdued mood on Wall Street.
Some local/specific factors could also have played important roles. Illustratively, the one per cent TDS on the transfer of the virtual digital assets (VDAs) in the Indian case could have had some dampening role in the Indian crypto market. Besides, reports of OpenSea’s former head of product Nathaniel Chastain, being charged by the United States department of justice with fraud and money laundering, and associated data breaches have created apprehensions of the sanctity of many of these platforms. There were also reports of Coinbase selling geo-location data to the US immigrations and customs enforcement agency (ICE) and crypto lending firm Genesis facing huge potential losses on account of its exposure to over-leveraged hedge fund Three Arrows Capital Babel Finance, a Hong Kong-based crypto lender. There are also resurfaced stories of crypto queen, Ruja Ignatova, who was accused of defrauding investors for $ 4bn by selling a fake cryptocurrency called OneCoin.
All these disjoint stories of crypto fragilities tended to add up to the generic foundation of instability in the crypto market. It is not that the crypto market is unaware of such inherent threats. Hence, in search of a nominal anchor, stablecoins, (i.e., cryptos whose value is linked to some Sovereign currencies) were innovated. In fact, BitUSD, the world's first stablecoin was released as early as in July 2014. But, then stablecoins do not offer the inherent flexibility of cryptos and hence may be less attractive to a typical crypto investor.
All over the world, regulatory oversight is slowly getting extended to cryptos. In view of their largely speculative roles, the Financial Stability Board (FSB), the global club of regulators, had stepped up its surveillance, and ensuring that crypto markets are properly regulated has become a key priority for the FSB. In the US, the Securities and Exchange Commission (SEC) is reportedly moving towards subjecting the cryptocurrency markets to the full spectrum of its regulations. In India too, RBI has repeatedly warned that private cryptos continue to remain a threat to financial and macroeconomic stability. Thus, the earlier advantage of the softly regulated (in some cases unregulated) nature of the crypto market is slowly vanishing.
The line of demarcation between investment and speculation is fuzzy. By their very construction, the crypto assets would continue to remain unstable and hence it is desirable that an investor in search of a quick buck in the crypto market should be aware of this inherent property. One is reminded of Robert Shiller, the Nobel Laurette Economist, who in his 2012 book, Finance and the Good Society, commented, “We need a system that allows people to make complex and incentivizing deals to further their goals, and one that allows an outlet for our aggressions and lust for power ….(but) it must be a system that redirects the inevitable human conflicts into a manageable arena, an arena that is both peaceful and constructive.” Hope, in the days to come, the crypto market will get developed into such a state!
The article has been authored by Partha Ray, a director of National Institute of Bank Management, Pune. The views expressed here are personal.
