Is it an alternative currency? A technology? A venture capital investment? A specious bubble?. Cryptocurrency is decentralised digital money, which works based on blockchain technology.
In the past six months, cryptocurrencies have seen their prices skyrocket on the back of tweets, comments on social media, and advice from random people some of who barely know anything about how cryptocurrencies work. There are now over 4,000 in Crypto currencies in circulation in 2021 vs 180 sovereign currencies recognized as legal tender in United Nations (UN) member states.
As the price kept moving up, everyone felt the FUD (fear, uncertainty, doubt), and started pumping even more money in a typical action that every retailer takes, not just in cryptocurrencies but in every asset class. The result is that over the recent past, many retail investors found themselves trapped in a situation they’ve been in before.
In the long run, bitcoin still makes for a unique asset class for portfolio managers seeking growth. While regulatory uncertainties still have a significant role to play, cryptocurrencies over the past decade have proved potent enough to be called an investable asset. Bitcoin is still an emerging asset class and will continue to experience large price swings. It’s here because people in the market want something other than just the traditional currencies that we’ve had and whether that’s right or wrong, it’s clearly something that the market wants.
A key reason bitcoin and the cryptocurrencies that followed it were embraced—they have no central point of failure because the blockchains they are built upon are distributed on thousands of computers spread all around the globe.
The current generation was too young to catch bitcoin, and is now on the hunt for the next big thing that offers more upside on their investing budget. Though dogecoin launched in 2013 based on the “Doge” meme, which portrays a shiba inu dog, and its creators didn’t intend for dogecoin to be taken seriously, it is now one of the top 10 cryptocurrencies. Doge is the millennial coin.
More than 60 per cent of young students in the US see crypto as a long-term investment, and some 24 per cent have an appetite for “moderately aggressive” risk, according to a survey of more than 500 college students and grads published by College Finance, a site that specializes in advising student loan borrowers.
Bitcoin’s price is up nearly 16 per cent so far in 2021 after being up 122 per cent at one point. The adoption by institutional players to crypto assets from the last quarter of 2020 accelerated the upmove in their prices. By comparison, gold, bitcoin’s closest traditional rival asset, is down 1 per cent in 2021. The recent rise of Bitcoin toward all-time highs is creating millionaires, on paper, at a fairly rapid clip, according to data from BitInfoCharts. There are 78,870 accounts holding bitcoins worth at least $1 million and there are 6,797 that own bitcoins valued at more than $10 million, according to BitInfoCharts.
Crypto-exchange Coinbase said its more than 56 million users accounted for $335 billion in trading volume in the first quarter: $120 billion retail and $215 billion institutional. That compares to $30 billion in total a year earlier, of which $12 billion was retail.
While the cryptocurrencies have caught fancy across the globe, they are recently facing existential crisis. China’s latest salvo against cryptocurrencies and Elon Musk’s tweets has driven a brutal selloff in bitcoin and other crypto markets. China’s announcement of a tougher ban on banks and payment companies offering crypto-related services furthered a selloff that briefly wiped $1 trillion off crypto market capitalisation.
Central Banks are generally wary of giving up their hold over their respective currencies and hence are reluctant to approve/regularise the currency within their jurisdiction. The warnings by ECB and US Fed officials about crypto assets mention that these are no real investment and being highly volatile and that as these pose risks to financial stability, greater regulations may be warranted. The US Treasury Department, meanwhile, flagged its concerns that wealthy individuals could use the largely unregulated sector to avoid tax and said it wanted big crypto asset transfers reported to authorities.
The Boston Fed is currently working with the Massachusetts Institute of Technology to research the technology that could be used for a central bank digital currency and will be releasing those findings in the third quarter. While the Fed and some other developed economies are still conducting research on what a central bank digital currency would look like, China is moving ahead at a fast clip and is currently piloting a digital version of the yuan, with plans to ramp up usage before the 2022 Winter Olympics in Beijing.
However retail traders, miners and even crypto finance firms feel that Beijing’s bark is louder than its bite. While the objective of the announcement was an attempt by regulators to protect retail investors from volatile markets, but it would be a challenge for banks to identify crypto-related dealings. It’s not the first time China has banned crypto-related financial and payment services. Beijing issued similar bans in 2013, and in 2017, though the latest one has expanded the range of prohibited services. The repeated bans displays the challenge of closing the loopholes.
The quality of information in the cryptomarkets is poor. Even such basic data as accurate trading volume are hard to come by. Theories about the driv¬ers of cryptoasset valuations are untested and often poorly designed, and they are rarely—if ever—published in peer-reviewed journals. Due diligence efforts from leading consultants are in their infancy, and few people have care¬fully thought through the role (if any) that cryptoassets should have in a professionally managed portfolio. Investors who forget their Bitcoin password end up losing their wealth that has grown well over the past few years. Wallet Recovery Service analysis says that there are 1.85 crore bitcoins in the world. Of this, 20 per cent have been lost by their owners.
Apart from regulatory risks, the use of Crypto currency for ransomware and to skirt sanctions is gaining attention. Recently, the Ransomware Task Force released an 81-page report titled Combating Ransomware. The report noted that, in 2020, nearly 2,400 U.S.-based governments, healthcare facilities, and schools were victims of ransomware, costing an estimated total of $350 million, up 311 per cent from the previous year. Recently Colonial Pipeline paid Hackers a $4.4 Million Ransom to restore the East coast supply soon.
The task force recommended that the cryptocurrency sector that enables ransomware crime should be more closely regulated. Governments should require cryptocurrency exchanges, crypto kiosks, and over-the-counter trading desks to comply with existing laws, including Know Your Customer, Anti-Money Laundering, and Combatting Financing of Terrorism laws.
Around 4.5 per cent of all bitcoin mining takes place in Iran, allowing the country to earn hundreds of millions of dollars in cryptocurrencies that can be used to buy imports and lessen the impact of sanctions, a new study has found.
Regular traders in Crypto indulge in even riskier trades by way of leverage and yield farming. Globally, crypto criminals ran away with $432 million as of end-April, according to the CipherTrace report. About 56 per cent of that, or $240 million were DeFi-related (Decentralized Finance). The privacy that cryptos offer also results in such frauds being undetected or making it difficult for the criminals to be brought to book..
That the crypto asset is tumbling at a time when inflation fears are rising weakens the case for investing in the asset class to hedge against inflation. Instead, more traditional inflation hedges have been gaining ground, with gold up about 6 per cent this month.
Although Bitcoin has been seen with caution and distrust by authorities, its underlying technology, Blockchain, has a lot of advantages in today’s digital banking context as well.
Indians investing in cryptocurrencies may be taking a highly risky bet in the absence of regulations by the Reserve Bank of India (RBI) and the government with respect to these instruments. Unless we have regulations and an official view on this, Crypto is no different from gambling.
According to data from crypto exchanges, there are approximately 1.5 crore Indians who have invested in cryptocurrencies holding Rs 15,000 crore. There are 350 startups that operate in blockchain and crypto. Crypto exchanges, WazirX, CoinSwitch Kuber and other exchanges, have seen a big rush in demand from users and crypto exchanges are advertising heavily on investments.
Already, the RBI has raised concerns on crypto currencies. On March 25, speaking at the 7th edition of India Economic Conclave, the RBI Governor, Shaktikanta Das had said the central bank has flagged some major concerns to the Government about crypto currencies.
The RBI, in 2018, banned all banks from dealing in cryptocurrencies but a Supreme Court order overturned this ban on a plea by Internet and Mobile Association of India (IMAI). The court said that while the RBI has the power to regulate virtual currencies, in the absence of any legislation, the business of dealing in these currencies ought to be treated as a legitimate trade that is protected by the fundamental right to carry on any occupation, trade or business under Article 19(1)(g) of the Constitution.
While the RBI is clearly not comfortable with the idea of cryptocurrency as a medium of exchange, the government’s stance on this issue is not clear. The government has proposed to present a Bill to regulate cryptocurrencies called The Cryptocurrency and Regulation of Official digital currency Bill, 2021. The Bill has provisions to make any dealings in cryptocurrency illegal. But there is no clarity yet on when this Bill will be introduced in Parliament. Banks are staying away from crypto transactions since the RBI hasn’t clarified its position officially
In the past, unregulated investments and financial institutions have resulted in major crises. One example is the unregulated Chit funds market which used to thrive in India. In the absence of regulations, there have been many cases of fly-by-night operators, resulting in massive losses to customers. There have been other examples such as microfinance and gold loans where lack of regulation has led to crisis situations.
Since income from whatever source derived is included in the Income Tax Act, 1961, and supply of any service, if not specifically exempted, is taxable under Goods and Services Tax (GST), the gains from cryptocurrency (crypto) trading and services by crypto exchanges are liable to be taxable.
Crypto assets offer one more asset class especially for young traders/investors who want to get rich quick and are aware of the risks involved. In a sense it is similar to trading in penny stocks. Once the regulations evolve and the volatility reduces, even risk averse investors can consider investing a proportion of their wealth in these assets.
Deepak Jasani is head of retail research at HDFC Securities. Views are personal.
Disclaimer: Views expressed are personal. They do not reflect the view/s of Business Standard.