Can cryptocurrencies exist as legitimate media of exchange and as digital assets, or will CBDCs take over?
Crypto was a Greek word known to few, till the launch of Bitcoin in 2009. Today, as per various estimates, we have around 4,500-5,000 different cryptocurrencies available, led by market leaders Bitcoin, Ethereum, Binance Coin and XRP.
Cryptocurrency can be summarised as a digital asset, a medium of exchange that can be used as a form of payment, exchanged online for goods and services. Cryptos use digital ledgers using blockchain technology to store the data of transactions and users.
The main debate among supporters, opponents and regulators is whether crypto is only a medium of exchange or an investable asset. If used only as a medium of exchange (company and cross company specific coins, tokens), there may not have been any issues. But the question has arisen because many companies, institutional investors and retail investors have started investing in these volatile currencies, whereas technically, it has no characteristics to be termed as an asset with a store of value. And owing to this speculative and volatile nature, one surely can’t hedge it or take any sort of insurance to protect against it.
Hackers’ attacks, ransom stories and the recent fraud of DeFi100 coins have added fuel to the debate which was already heated when recently Elon Musk announced Tesla would stop accepting Bitcoin because of the potential environmental damage Bitcoin mining resulted in, months after starting accepting Bitcoins in March 2021. This, along with China's restrictions, resulted in crypto prices going down, ranging from 30 per cent to 50 per cent. This was interesting as Musk is known as a strong proponent of crypto, with his known love and investment in several currencies.
Coming to the environmental issues, some researchers argue that enormous amounts of CO2 are emitted when cryptos like Bitcoins and Ethereum are mined, though others say actually, many cryptos are using renewable energy for mining.
Regulators have been divided on crypto as a tool for investment. China has banned cryptos twice, in 2013 and 2017, but the current decision of a tougher ban on banks and payment companies offering crypto-related services has been severe on cryptos, on top of Musk’s public pronouncements. On the one hand, European Central Bank has warned that cryptos run risk of affecting the financial system, on the other, the US Securities and Exchange Commission is in favour of regulating crypto trading. In India, RBI had restricted banks from dealing in all crypto transactions, but this was overturned by the Supreme Court later. However recently, RBI has again indirectly urged banks and financial institutions to refrain from financing these highly volatile assets. There also have been talks of India completely banning cryptos.
So, where does fiat currency and Central Bank Digital Currencies (CBDC) stand vis-à-vis cryptos? A fiat currency is one issued and backed by a government, but not backed by any physical asset. A CBDC is blockchain-based, and can be a virtual currency backed by reserves or virtual fiat currency, which is managed in a centralised manner by the currency-issuing authority, ie, central banks. Whether these currencies can only be used as a mode of exchange, or also have store value, is still being contemplated. Having said this, countries which can be early adopters include US, Canada, UK, EU, Russia, China, Japan and even India.
In short, if cryptos are only used as a medium of exchange, one might not see any major problem, but if the agenda is also speculation through price management, then we will see more heated debates for sure. In comparison, CBDCs are superior to cryptos, vis-à-vis their blockchain technology (public vs private), management (centralisation vs decentralisation), issuers (government vs private or anonymous), usage (legitimate vs the possibility of illegal use) and security (full security vs chance of data leak). So, whether cryptos and CBDCs will co-exist or CBDCs will replace cryptos, needs to be seen.
The writer is a CFA and Head, Department of Financial Markets and Fintech, ITM B School
DISCLAIMER: Views expressed are the author's own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.