Figuring out risks posed by cryptocurrency
On April 6, 2018, the RBI issued a prohibition on all dealings in cryptocurrency by regulated entities. Recently, the Supreme Court has annulled this circular of the RBI.
How cryptocurrency is different from normal currency?
- The money we use (fiat currency) is a product of lending by institutions (commercial banks). What makes it credible or trustworthy is that it is backed by the state through its central bank. What makes its usage ubiquitous is the law, which establishes that our taxes can only be paid in state-issued fiat currency.
- Although the ‘virtual currency’ (or ‘cryptocurrency’) is intended to function as a means of payment, unlike fiat currencies, they lack a sovereign guarantee and their source of value is not quite clear.
Risks involved –
- Crypto-assets indeed pose several risks, including anti-money laundering and terrorism financing concerns (AML/CFT) for the state and liquidity, credit, and operational risks for users.
- Particularly for consumers, the pernicious effects of cryptocurrencies are heightened by the striking paucity of information on their design, use and operation and indications of market manipulation.
Fixing the loopholes –
Concerns are heightened when there are linkages between the crypto-asset economy and the formal banking and payments sector — grey areas in regulation can allow for malaise in the former to be transmitted to the latter.
- First, in the face of growing technological innovation in the financial sector, it is critical to strengthen the supporting regulatory frameworks that operate regardless of the nature of an instrument. Emerging technologies are characterised by steep information asymmetries among the innovators, regulators and users, which limits the potential for preemptive action. Re-examining and strengthening the complementary framework allows for, to a certain degree, the creation of a safety net which operates irrespective of the regulatory arbitrage sought to be exploited by new players.
- Second, the RBI must set clear parameters on functional grounds to evaluate the appropriate course of action. Realigning regulation along functional lines allows regulators to draw more meaningful perimeters and expand oversight to cover the system’s current blind spots. Striking at function, rather than just form, will help to minimise the risks involved.
- One of the more useful takeaways from the crypto storm, apart from the popular distributed-ledger technology, is the worldwide proposal for central-bank digital currencies, which could allow for money to be transferred between users without the involvement of a third-party (commercial bank). If implemented, it is not entirely certain what the implications for the financial system will be, although it is possible that the business models of commercial banks may be seriously disrupted. In determining the course of action, the RBI must carefully study the implications before changing status quo.
- Like electric vehicles and the Internet, money has also evolved with time. Changes to systemic architecture are iterative and so, the rules must be carefully calibrated.
Source – The Hindu Business Line
QUESTION – With respect to the emerging trends of cryptocurrency in the market, discuss the concerns attached with them and suggest a way forward to fix such loopholes in the system.