In Focus: Cryptocurrencies

  • About:
    • 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 defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to governmentinterference or manipulation.

  • Types of Cryptocurrency:
    • Bitcoin: Launched in 2009, the first blockchain-based cryptocurrency was Bitcoin, which still remains the most popular and most valuable. Today, the aggregate value of all the cryptocurrencies in existence is around $1.5 trillion (60% Bitcoin).
    • Others: Some of the competing cryptocurrencies spawned by Bitcoin’s success, known as “altcoins,” include Litecoin, Peercoin, Namecoin, Ethereum, Cardano and EOS.

  • Advantages of Cryptocurrency: Easier means to transfer funds, Secure, Minimal processing fee, Promotes privacy etc.
  • Disadvantages: Well suited for illegal activities, such as money laundering and tax evasion; Highly volatile; Entire ecosystem (including exchanges and wallets) is not secure; Absence of regulation etc.

News Summary:

  • The Central American country formally adopted the virtual currency (first country in the world to do so), after its Parliament approved the move announced by the President Nayib Bukele.

  • Reason behind such decision:
    • El Salvador depends heavily on remittances sent by Salvadorians from abroad (around a quarter live in the US and send more than $6 billion in remittances, making up more than 20% of the GDP).
    • A big chunk of these remittances is lost to intermediaries. By using Bitcoin, the amount received by more than a million low income families will increase.
    • It will also help increase financial inclusion in El Salvador, where 70% of the population does not have a bank account and relies on the informal economy.

  • Reaction to the decision:
    • It is seen by some as an innovative step, in a time (pandemic) when the world is looking for new ventures of economic recovery.
    • It is also seen as good news for cryptocurrencies in general, as it will improve the appeal for Bitcoin, which has witnessed major fluctuations this year.
    • However, some crypto experts have criticised the move saying that El Salvador could have looked at other crypto options, as Bitcoin’s transaction rate is too slow compared to other virtual tenders such as Bitcoin Cash or Monero.
    • The lack of a central regulating authority, potential for fraud and money laundering, high energy costs and extreme volatility, further increase skepticism about the private currency.

Understanding El Salvador’s decision in Indian context:

  • From the prism of monetary policy:
    • El Salvador has no monetary policy of its own and hence no local currency to protect. The country was officially ‘dollarized’ in 2001 and runs on the monetary policy of the US Federal Reserve.
    • In India, the Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy. By this, RBI controls the supply of money in the economy by its control over interest rates in order to maintain price stability and achieve high economic growth.

  • Not merely currency but technology: The overall use of Bitcoin appears less motivated by its use as a currency and much more by the image and investment boost this could give the country towards innovation.
  • Potential shift in remittances: The impact Bitcoin has on remittance inflows would be worth monitoring for India, which is home to the largest remittance market in the world.
  • Necessary oversight measures: The implication of this move for illegal activities such as money laundering is unclear at the moment. India may face challenges on this front unless there is a rapid push to put in place the necessary oversight measures.
  • The overall takeaway for India:
    • While deliberations continue in India on the monetary and financial regulations around cryptocurrency, it is important to incentivize Indian developers working on key innovations in the space.

Other countries where the use of cryptocurrencies is fast gathering pace:

  • In many parts of the world that are plagued by economic uncertainties, the use of cryptocurrencies is fast gathering pace.
  • In Cuba, virtual money is being used for making payments for utilities, cross-border transactions as well as for remittances from abroad.
  • In Mexico, where also remittances from the US form a huge source of income, the crypto market has boomed.
  • In Venezuela, which is undergoing an economic and humanitarian crisis, many are adopting crypto money as spiralling hyperinflation has harmed the official currency (Bolivar).
  • The US took a decisive step towards issuing its own central bank digital currencies (CBDC).
    • CBDCs are being touted as a means for extending financial services to those who have remained underserved by traditional banks, while mitigating the risks of unregulated private tokens such as Bitcoin.

  • Recently, China rolled out pilot testing for its home-grown digital currency and issued major curbs on private cryptocurrency transactions.
  • In India, the government has floated The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, which will prohibit all private cryptocurrencies and lay down the regulatory framework for the launch of an “official digital currency”.