Governments must realise that cryptocurrencies were created as a reaction to neoliberal policies and wholly strive to understand how the state can build better outcomes for citizens.
By Shashidhar K.J. and Srinath Sridharan
Headlines have been awash with Bitcoin’s 15 percent crash last week as the price of the cryptocurrency fell below US$ 49,000.
Consequently, other cryptocurrencies like Ether token saw its price fall by 20 percent. The fall in price came coincidentally with two key statements.
• The first from Janet Yellen, the current United States treasury secretary, who called Bitcoin an extremely inefficient way of conducting transactions and called its price highly speculative.
• The second came from Elon Musk, CEO of Tesla Motors and generally considered bullish on cryptocurrencies, who tweeted that Bitcoin might be overvalued.
Predictably, there have been sharp reactions from proponents of cryptocurrencies, as well as from those who oppose it or politely advise caution. Calmer minds need to prevail to understand the situation deeper.
Bitcoin’s history has seen much worse. There have been about 13 major crashes since 2011 and the crash in December 2017 saw the price of Bitcoin to plummet by 83.7 percent. These crashes were faced by individual investors called “Bitcoin-whales,” who hoarded the asset and drove up the value. These whales hyped other retail investors to participate and eventually cashed out at a peak. And one must remember that correlation does not mean causation and that Janet Yellen and Elon Musk’s statements might not have contributed to the fall in price. It is more likely that this was profit-booking by some investors and a price correction.
Bitcoin’s price is falling but believers in the community are still ‘hodl’-ing and waiting for the day when the price ‘reaches the moon.’ Volatility and speculation must be considered while dealing with cryptocurrencies. This is not a game for the faint-hearted.
Bitcoin’s rally has been aided by an increasing interest by institutional investors who are now taking the cryptocurrency more seriously as an asset. Companies like Tesla, MicroStrategy, Massachusetts Mutual Life Insurance Corporation and Square are holding Bitcoin as part of their treasury operations (as assets) while companies like MasterCard have announced that they would enable payments using select cryptocurrencies (as a currency). Tesla also says that it will allow users to purchase their electric cars using Bitcoin. Further, a survey of 774 institutional investors by Fidelity Investments says that 36% of them have cryptocurrencies as part of their portfolio.
Broadly, the interest of institutional investors in cryptocurrencies is a good thing and will act as a bulwark against retail whales in the cryptocurrency market and bring more accountability on the trades. But with more institutional investors taking an interest in cryptocurrencies, it becomes crucial that there is prudent-risk-management as asset management companies (AMCs) invest people’s savings and pensions in volatile cryptocurrencies. The government’s hands-off approach/hostile approach to cryptocurrencies cannot work here and they will have to build in protections for investments in cryptocurrencies, in the case of unforeseen externalities.
However, institutional investors coming into the picture also puts additional pressure on cryptocurrencies to find a purpose for themselves.
Yellen, yelp and yelling
Janet Yellen is right — cryptocurrencies are not a viable currency due to their volatility. Companies like Stripe and Valve’s Steam games marketplace, which did accept Bitcoin as a form of payment have reversed their position considering the volatility of the Bitcoin while processing a transaction.
Cryptocurrencies like Bitcoin do not work securities as they do not make a promise of a fixed return. The former United States Securities and Exchange Commission (SEC) chairman Jay Clayton explains well why Bitcoin cannot be considered a security since it never sought public funds to develop its technology, but what it does is replace the value in fiat-currency and, therefore, it works a “store of value.”
The SEC said the same cannot be said of cryptocurrencies like Ripple’s XRP token where there was an initial buy in by early adopters who were given tokens that were already mined. Further, the token was advertised that it would give guaranteed returns on the buy in. This led to an investigation by the SEC, which filed a case against the company and its promoters for running an unregistered security. Since the XRP tokens were already mined and some were held by the promoters, it presented an information asymmetry allowing them profit as more people bought the token driving up its value. Therefore, cryptocurrencies have largely been operating akin to a commodity like gold, considering the limited number of tokens that can be mined or acquired.
Commodities too are subject to an immense speculation over their usage and its subsequent trading reflect that. During the COVID-19 pandemic, oil futures collapsed since all economic activity ground to a halt and the price of crude oil at one time was zero. However, oil’s usage would return and, therefore, it still held value. Similar speculation can be done with other commodities like steel, coffee, aluminum etc.
Gold is an interesting commodity since its real-world applications are limited. It derives its value due to its rarity and its non-corrosive properties. Therefore, it functions as a store of value and medium of exchange during uncertain times. But more importantly, now that the world has abandoned the gold standard for the convertible fiat-currency system after the Second World War, it now functions as a “hedge against other financial bets” in an investment portfolio for investors. If there is a crash in the equities market leading to a broad fall in the stocks invested, the value of the gold investment offsets the losses in the portfolio.
Cryptocurrencies function in a similar manner as gold right now, where its main use seems to be a hedge against other financial bets and the current inflationary regime. Asset managers who are not averse to decentralised finance advise investors to keep 1-2 percent of their portfolio in cryptocurrencies as a thumb rule.
Various “isms” and crypto
However, on the flip side, a more bearish view on cryptocurrencies is worth keeping in mind. In the event of catastrophic events like war or climate-related calamities where electricity and Internet connectivity goes down, gold still has value as a medium of exchange. Bitcoin stored in a digital wallet will be useless in this scenario (of no electricity or internet access). This scenario, therefore, works as a sharp critique of the anarcho-capitalist philosophy the cryptocurrencies base themselves on. It becomes very crucial for regulators to understand the underpinnings of this philosophy.
This idea blends elements of the political philosophies of anarchism and capitalism.
Anarchism promotes the notion of stateless societies and no hierarchies in the power structure. While there are no power structures or governments, it doesn’t mean that there is no governance. Anarchism promotes self-governance (however good, bad and ugly) and the notion of non-aggression; it requires all individuals to act as rational actors, where competing self-interests will maintain order.
Anarcho-capitalists support the idea of a stateless-society, but also promote the idea of owning private property and support free-markets. All functions of society will be fulfilled by competing private companies and enforced by voluntary contracts.
Bitcoin’s creator Satoshi Nakamoto developed the first cryptocurrency as a critique on the inefficiency of central banks and monetary authorities, which debased currencies and criticised banks as they held people’s money but lent indiscriminately with very little reserve. Coupled with neo-liberal policies adopted through the the 1980s to the present time — which advocate for economic growth through debt — we saw the rise of income inequality where ordinary people were unable to generate wealth for themselves and move up the socio-economic ladder.
Bitcoin presented itself as a solution where the limited number of tokens that could be created would limit indiscriminate lending. Thus, people or entities who could contribute processing-power for mining Bitcoin would be rewarded with tokens and its value would only be dependent on “supply and demand dynamics.” The blockchain technology decentralised finance by keeping an immutable record of tokens mined by users and their subsequent transactions. In contrast, central banks control the production and issuance of money and centralise finance through monetary policy. It solved trust-issues with transactions in a limited way, as the blockchain was an immutable record of transactions which needed to be authenticated by all nodes in the system.
However, for this system to work, it requires a wholesale-rejection by citizens on the role of central banks and governments. Governments are loathe to give up power, particularly something as powerful as money.
Goods and is crypto good?
Cryptocurrencies also relies on public goods provided by governments such as cheap electricity for mining and are beholden to corporations that provide Internet connectivity that must abide by rules set by the government. In countries such as India where the Internet is frequently snapped, the operation of cryptocurrencies is frequently disturbed.
Cryptocurrencies are also curtailed by the state in a much simpler manner: Bans through legislation. The Indian government is getting ready to pass a legislation which bans all cryptocurrencies, save for a virtual currency backed by the government. The Reserve Bank of India is reportedly working on building a central bank digital currency (CBDC) using many of the properties of cryptocurrencies including the blockchain technology.
CBDCs are uncharted waters again and there are several questions that need to be answered for acceptance, including state overreach and privacy where it would have a complete view of all transactions, the role of banks in this scenario, and if it really needs a decentralised system of money.
CBDCs conducting centralised finance operations is at odds with the idea of blockchain which seeks to promote decentralised finance. Permissioned-blockchains will limit the number of nodes, but the question remains: Who controls those nodes and what would be their objectives?
State reigns supreme
Despite varying views on policies, political power reigns supreme and it will be better to accept this reality. The State will want to have its influence in the society, especially in a socialist-democracy like India. It will have to take care of larger sections of the population, especially the vulnerable segments. Hence, the narrative of what’s good for the economy could be the prerogative of the State at its own discretion and decision.
However, the relationship between governments and cryptocurrencies need not be so antagonistic. Decentralised finance offers a great opportunity for better financial outcomes for people and addressing income inequality needs fresh ideas. The Indian government also needs to understand that cryptocurrencies have been regulated in other jurisdictions globally by applying existing frameworks to regulate them in some fashion.
Cryptocurrencies, on the other hand, must realise that they gain legitimacy as more governments and markets are accepting of them. Governments, ultimately, must realise that cryptocurrencies were created as a reaction to neoliberal policies and wholly strive to understand how the state can build better outcomes for citizens. And accept new processes, however inconvenient it is politically.
The opportunity is now — to show how much transparency we can build, as we develop our policies of digital-finance, in this century dominated by the 4th Industrial Revolution.