Commentary on “The Cryptocurrency Deception”

The following article is my commentary on the article titled — “In the garb of Crypto”/”The Cryptocurrency Deception” written by Shri Yogesh Gupta ( Additional Director General of Police, Kerala) and published in The Indian Express on Jan 17, 2022.

Link to the article: https://indianexpress.com/article/opinion/columns/cryptocurrency-bitcoin-litecoin-ethereum-7726701/

Special thanks to Bhoomeendra, Nitesh & Samarth for their inputs.

Disclaimer — The encompassed information is true to the best of my knowledge and belief. Since cryptocurrency is an evolving area, there is a possibility that some errors might have crept in as a result of my ignorance. Do let me know, along with the corrections, if you find any.

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Mr Gupta in his article argues that cryptocurrency is neither a currency nor an asset.

He writes that for any instrument to qualify as a currency, it must have the following features:

1. It is a promissory note, wherein the issuer is promising the bearer or holder a value.
2. It is backed by a sovereign nation.
3. It is backed by a tangible asset such as gold or a basket of goods.

He writes that since a cryptocurrency doesn’t exhibit any of these features, therefore it can never be a currency.

Let us examine each point on a basic level. Let’s start with the third point. There was a time when paper currencies used to be backed with gold. However, as time progressed, gold was replaced by “full faith in the government”. These currencies which are not backed by any commodity but only by the citizens’ trust in the government are called “fiat currencies”.

Fiat currencies allow the central banks to have greater control over the supply of money in an economy, thus paying way to control inflation and other desired macroeconomic indicators. ( The Central Bank can’t achieve all of its objectives with the limited tools available to it and there are often trade-offs involved.) Most of the currencies in today’s era are fiat currencies, including the Indian Rupee and the US Dollar. So it will be unfair to single out only cryptos then.

We expect the authorities to make positive use of the trust we placed in them for the greater good. However, what happens when it is misused. What happens when the sovereign nation mints money recklessly? Hyperinflation. This had been witnessed in Post World War 1 Germany and continues to be witnessed in Zimbabwe and Latin America.

The premise for cryptocurrency is to avoid placing our trust in a few powerful institutions — Central Banks, Commercial Banks and other financial institutions. Rather the founders of cryptocurrency aim to decentralize and democratize this trust. Hence, point 2 is the principle that the cryptocurrency, instead of complying with, seeks to directly challenge and attack. It promises to build a future that allows seamless transactions within and across borders without the need for any middlemen.

Now let us come to point 1. Why do we necessarily require the currency to be a note only? We have coins too. Considering notes and coins synonymous for a while let us examine the issue further. With time and the availability of technology, the form of currency has evolved. Civilizations began with the barter economy — people trading for and exchanging their goods. As time progressed we had the introduction of currencies. The currencies were of diverse forms — for instance, in the Ancient Chinese civilizations — food grains, textiles and metal coins all were different forms of currency. The usage of a particular type of currency depended on practical feasibility. E.g. Farmers paid taxes in food grains, small payments were made in coins and bigger payments in textiles.

Today we use paper currencies or transfer money digitally. And we know this piece of paper is valuable because the entire society deems it to be. Thus, the currency that we use today has evolved from having an intrinsic value to having a relative value or a market value. In other words, digital money is intangible and hence of no use per se. Similarly a Rs. 2000 note has very limited intrinsic value — origami, scribbling, burning to produce heat — all of these are considered to be acts of insanity. We still value the Rs. 2000 note because we know that the market and society value it, and hence it is a store of value. Similarly, a cryptocurrency can also exhibit a market value if society deems it to be valuable.

A point to remember over here is that, unlike the traditional fiat currencies, a cryptocurrency does not derive its value from trust in a particular government or a central bank. Rather it derives its value from the trust placed in the entire system made up of a large number of computers. It is open to everyone and anyone can associate oneself with that network. The assumption is that the network is sufficiently large enough to prevent one actor or a cartel of actors to influence or manipulate the collective decision making in a fraudulent manner.

From our discussion so far we can conclude that cryptocurrency has the potential to be used as a currency. Their relevance is only set to increase with the evolution of Metaverse. But should it be used as a currency in the physical world as we know it today? We will come back to this question later.

Mr Gupta writes that for anything to be considered as an asset, it must have some tangible value. Eg. Bonds yield interest, Gold can be used for ornamentation, or Real estate could be developed for personal or commercial use. But as we have discussed earlier that cryptocurrencies have no intrinsic value, those can’t be treated as assets.

However, an interesting thing is to note is that most of the people involved in Crypto have “invested” their money as if those were assets. The sole purpose of investing in crypto is limited to trading — buying at market prices with the hope that its market value (since it has no intrinsic value) will increase over time and they will book profits.

Only a handful of different cryptocurrencies are expected to gain worldwide recognition and trust and thus in turn remain valuable. Mr Gupta rightly cautions about increasing the awareness around crypto, so that people, disillusioned by the flashy advertisements in an unregulated market, do not blindly invest their hard-earned money in purchasing crypto which can very well, in the future, turn out to be worthless.

He compares cryptocurrencies to be like points generated when you play a ludo game. However, there is a stark difference between these gaming points and cryptocurrencies. You can virtually play any number of games and go on winning more and more points. On the other hand, the total number of a typical cryptocurrency is limited. The total number of Bitcoins to get ever mined will fall a little short of 21 million and will saturate by the year 2140. But how are bitcoins mined? And how did the Bitcoins come into being in the first place?

In 2008, the world witnessed a financial crash (housing market crash) in the US which impacted the whole world — attributed to the systemic fraud committed by the financial institutions and deliberate oversight by the regulators. This posed a philosophical question whether should we place our trust in a few big and centralized institutions? This led to a/ a group of researchers under the pseudonym of Satoshi Nakamoto to publish a research paper that led to the conception and actualization of blockchain and Bitcoin. The underlying concept was that instead of allowing a few powerful institutions to govern a transaction, it should be decentralized. In other words, if person A has to transfer some money to person B, instead of asking the bank to carry out the transaction on his/her behalf, the person should directly write this transaction on “a public ledger”. Now all the participants/peers/members (read computers present over a worldwide network) can access this transaction and validate whether this transaction is possible or not. When a majority of participants validate the transaction to be genuine — the transaction gets validated — the transaction has indeed taken place. (Note that the money transferred over here is not in Dollars or Rupees but Cryptocurrencies — Bitcoins in this case) This transaction along with a large number of other transactions forms a “block”. And similarly, there are a large number of blocks. Each new block is linked to the previous block thus forming a “chain”. Hence — Blockchain. The first miner who correctly does the Proof of Work computation for a block is rewarded with a certain number of Bitcoins. (After each increment of 210000 blocks to the blockchain, the number of Bitcoins mined for a block as the reward is halved. And hence, there is a limit to the number of Bitcoins that can be mined.)

Let us come back to the question we previously put forward — Should cryptocurrencies be used as currencies? Even though I do not necessarily agree with Mr Gupta over the reasons, I do concur with him over the outcome. I believe that these should not be allowed to be used for two reasons:

1. By the Indian Law, the RBI is mandated to keep a check on inflation within the 2–6% band. Cryptocurrencies directly challenge the grip that the RBI enjoys over the money supply in the economy. Hence, it would be difficult to ascertain a stable world around us. There would be no assurances regarding inflation, growth or other macroeconomic indicators.
2. Cryptocurrencies can not only be traded but also mined. It means one can mint his/her own money. This warrants further debate and deliberation.

There are also concerns about how mining cryptocurrencies, being an energy-intensive process, is not eco-friendly. Or how this can further exacerbate the divide between rich and poor — given the inequality in access to the required resources. While these are indeed valid concerns, those are not limited only to Cryptocurrencies, but form a part of a bigger picture, developing solutions and policies for which would require deliberations on higher and more comprehensive levels.