- The Finance Ministry recently issued a statement warning against investing in bitcoin and other cryptocurrencies (CCs). Likening CCs to ‘Ponzi schemes’, it linked them to terror-funding, smuggling, drug-trafficking, and money-laundering. The stern advisory came after three other warnings issued by the Reserve Bank of India.
Why the distrust?
Two aspects of the bitcoin phenomenon have attracted great interest:
- the challenge it poses to states and central banks; and
- the potential of its underlying technology to unleash a new wave of creative destruction.
Central Bank Digital Currency:
- A CBDC is a complex tool whose functionality is still being researched.
- But there is one flaw endemic to any CBDC: the contradiction between the centralising tendency of a CBDC and the decentralising technology that underpins cryptocurrencies.
- What economists conveniently forget when discussing CCs such as bitcoin is the trigger for it: distrust of bankers.
- A man (or a group of people) named Satoshi Nakamoto provided an answer: a peer-to-peer, ‘trustless’ electronic cash system based on a technology called blockchain.
Why is it attractive?
- In order to be functional, a virtual currency must solve the problem of double spending
- Given that anything digital can be copied, how do you prevent someone from spending the same unit of currency twice?
- The creator of the bitcoins has solved the double spending problem by designing a decentralised ledger that bundles data about transactions into blocks, timestamps them
- And links each new block of transactions with the previous one in an immutable chain of blocks that are copied, authenticated, and updated continuously, and publicly
- This is done on thousands of computers — the blockchain.
- A major reason for which people find bitcoins attractive is its deflationary nature, which makes it inflation-proof
- Since there can only ever be 21 million bitcoins, unlike a fiat currency, it cannot suffer a loss in value due to inflation
Blockchain & Fiat Currencies:
- The blockchain uses economic incentives (payment in the form of bitcoins or other CCs) to motivate members of the network to do the work of validating every transaction
- It does away with the bank’s role as an intermediary, and this is what differentiates CCs from (the digital version of) fiat currencies.
Market capitalisation of cryptocurrencies:
- Coinmarketcap.com, a website that tracks the market capitalisation of cryptocurrencies, lists 1,379 currencies.
- Away from the hysteria around bitcoin, lesser known cryptocurrencies such as Omisego, TRON, Golem, and Storj are attracting investments that are helping to set up an entire decentralised ecosystem and payments infrastructure on blockchain platforms that could radically transform the way businesses transact with each other.
The fundamental value:
- The fundamental value proposition of the blockchain is that it eliminates the need for trust — a commodity without which exchanges of value (transactions) cannot happen.
- This means that individuals and businesses can do away with a whole bunch of intermediaries whom they pay for managing trust.
- For instance, on Ethereum, a blockchain platform that calls itself “the android of the cryptocurrency world,” you can set up an application that enables people to rent out idle storage space on their laptop.
- Programmable money is another example of a decentralised blockchain-based application.
- Since digital currencies are software programs, one can program a particular CC such that, say, it cannot be used to buy the product of a company that uses sweat shop labour.
Artificial Intelligence and Internet of Things:
- Two domains that would gain immensely from blockchain applications and CCs are Artificial Intelligence and Internet of Things (IoT), since in an IoT world, thousands of devices would need to rapidly and seamlessly transact with each other in real time, without the devices’ owners having to dig into their wallets every time.
The Way Forward:
- Of course, as happened in the early days of the Internet, some of the claims being made about blockchain are plain silly.
- It is true that the technology’s peer-to-peer orientation renders it more democratic.
- But it is not about to usher in a socialist paradise.
- Even the World Wide Web was supposed to be a decentralised, democratic space where everyone was equal.
- Clearly, technological innovations cannot substitute for the hard job of reducing socio-economic disparities through political mobilisation.
- If blockchain is getting traction, it is because it works with, rather than against, market logic.