Friday, August 19, 2022


OPINION : The emerging world of Cryptocurrencies

The frontier spirit of cryptocurrencies and its potential to disrupt the status-quo global financial system have far-reaching consequences on a macro and micro-economic scale, writes Jaykhosh Chidambaran

By Jaykhosh Chidambaran

Tuesday, July 26, 2022

In an era where technological innovations redefine socio-cultural and socio-economic paradigms at a blistering pace, cryptocurrencies are the latest entrants to join the illustrious bandwagon of digital products in the ongoing digital revolution. In layman’s parlance cryptocurrencies are digital money created for online transactions without the intermediation of a central bank controlled financial system. Cryptocurrencies provide the same functional value as a fiat currency in terms of utility as medium of exchange, unit of account and store of value in a decentralized, peer-to-peer enabled networks that is built on underlying blockchain technology. Currently, there are more than 6000 cryptocurrencies in circulation worldwide and on a good day, the global cryptocurrency market is worth over 2 trillion dollars.

The frontier spirit of cryptocurrencies and its potential to disrupt the status-quo global financial system have far-reaching consequences on a macro and micro-economic scale. A deep and developed financial system is the bedrock and driving force behind economic development and growth. In contemporary world of finance, legislations and regulatory frameworks dispensed through central banks mitigate the risk of mainstream banking that enables the common man to conduct an array of financial activities like savings, borrowings, trade and investments. Conventional banks are instrumental as channels through which monetary policy transmission is conducted and creates “multiplier effect” in the economy through credit creation which acts as the engine of growth. Percentage of private credit to GDP is a true measure of economic growth and investment in an economy and even if there is no perfect financial system in the world, the current global financial system with a pyramidal network of central banks, public/private sector banks and other non-banking financial institutions (NBFC) offer individuals and corporations relative stability and insurance against defaults, liquidity crunch and bank-runs.

Cryptocurrencies require at least the most basic level of regulation and risk-insurance as to what the issuers are doing with people’s money and whether they have the liquidity and reserve cash to pre-emptively thwart a ‘crypto-run’ similar to a ‘bank run’. If cryptocurrencies are to emerge as one of the global financial system standards, then regulatory frameworks have to be customized and applied to crypto issuers. Since cryptocurrencies are also investment vehicles, these should come under the remit of securities and exchange commissions and insolvency and liquidity regulations of global economies, following the policy of United States. The anonymity of cryptocurrencies account information is one of its key differentiators with fiat money that accounts for its popularity and adoption. Unlike traditional banking protocols like “Know Your Customer” (KYC) requirements, cryptocurrencies pose a threat to civil societies if crypto assets are held by terrorist groups, drug dealers, crime syndicates, tax evaders, financial fraudsters and other fringe elements with nefarious motives if they are allowed free reign, devoid of tamper-proof systems and processes to track the identity of such spurious accounts. In the absence of regulatory frameworks, cryptos could soon evolve into the lynchpin of the global underground economy. It will become the ideal option for anyone to evade stringent capital controls like in China and Argentina, launder illicit money from drug trade and circumvent US sanctions against rogue nations. The ongoing Russia-Ukraine War may accelerate adoption of digital currencies for international payment gateways, at least between revisionist countries hard-pressed to find an alternative to dependency on US Dollar.

Even the stability of stablecoins touted as a risk-free investment cryptocurrency asset as they are pegged to a major currency like US Dollar or the claim of fully collateralized against money and capital market financial instruments is an illusion. The leading stablecoin issuer, Tether Limited, upon criticism of its opacity, revealed that it held only 25% of its reserves in cash, bank accounts and government securities, while holding a substantial portion (more than 50%) in commercial paper and corporate bonds, both subjected to high market risk and volatility. Information asymmetry on the quality of the commercial paper and corporate bonds could trigger a panic if their price drops and eventually leading to a stablecoin run. Another disquieting development on the vile use of digital currencies emerged when there was a massive ransomware cyberattack on Colonial Pipeline, an American oil pipeline system in May 2021, which drove up gas price in the US East Coast until a negotiated ransom payment of $ 5 million in Bitcoin to the hackers. In the same month, there was another malicious ransomware attack on a prominent Brazilian meat producer, JBS targeting their US and Australian operations and the blighted company was forced to pay hackers $11 million dollars in settlement. Both ransomware attacks were facilitated by cryptocurrencies which brought them under public limelight and official scrutiny, the security features of digital currencies that conduct clandestine operations in the shadows with total anonymity and near-impossibility to track the felons.

Perhaps the biggest deterrent of cryptocurrencies often elucidated by their detractors and traducers is that of environmental sustainability. Citing case of the benchmark cryptocurrency in market value and popularity, the Bitcoin and its mining process to validate a single transaction leaves a larger carbon footprint than 1.8 billion Visa transactions. Data suggests that more than 70% of Bitcoin’s global energy consumption is generated from non-renewable sources like coal. The quantum jumps in Bitcoin’s market capitalization from $70 billion USD November 2018 to over $1 trillion USD also witnessed an alarming fourfold increase of its global energy consumption to more than 200 terawatt-hours (TWh). This is equivalent of powering an average US household for 61 days and the electronic waste generated by the staggering computational demands of Bitcoin is tantamount to discarding a brand-new iPhone with each transaction.

Ethereum, the world’s second largest cryptocurrency consumes 95 Twh of electricity annually and with Bitcoin combined ranks 15th in terms of global energy consumption. To put things into perspective, the entire population of Mexico consumes less energy than Bitcoin and Ethereum annually. The herculean energy demands of Bitcoin and Ethereum is due to a transaction-validation consensus protocol called proof-of-work (PoW). Bitcoin and other cryptocurrencies function on a distributed ledger platform (DLT) called blockchain (database) that stores all transaction data. When a new block is added (mined), the current protocol warrants all preceding blocks to confirm the transaction, which is touted as the defining feature of its impregnable security. As the blockchain grows, more computing power is required which is directly proportional to energy input. To curtail energy costs, crypto issuers have created a proof-of-stake (PoS) consensus protocol unlike Bitcoin miners who compete with other miners solve the complex algorithmic puzzle to be rewarded with more Bitcoins. In PoS, miners/validators are chosen randomly on the basis on their stakes (number of possession of cryptocurrencies) in the network. Though it is highly energy efficient since transactions are validated off the blockchain, the initial capital investment to procure the minimum cryptocurrencies to be designated as a validator is exponentially high based on the current market value of the specific cryptocurrency. For instance, Ethereum (ETH) will require 32 ETH to be staked for calling an user a validator.

Current technological and environmental challenges don’t consign cryptocurrencies into a doomed nondescript innovation but has the firepower to disrupt the global financial system, for its potential benefits outweigh the latent limitations. Foremost among them is the lower transaction costs by cutting out financial intermediaries- banks, payment gateways-from individual and corporate transactions, both domestic and cross-border. It rules out information asymmetry in customer creditworthiness for originating loans and such creditworthiness could become the only collateral warranted across the blockchain network. Another possibility of cryptocurrencies is in facilitating micropayments. You could pay-as-you-go if you are reading a particular article for example rather than paying for monthly or annual subscriptions, which, is an outcome of reduced transaction costs. Smart Contract is quite a promising application of blockchain based cryptocurrencies where bilateral or multilateral parties could consensually agree on pre-determined clauses and conditions for instantaneous cross-border transfers and thus eliminating fee-charging banking and other financial intermediaries in the process. Blockchain based fin-tech solutions could revolutionize financial inclusion for the billions of unbanked individuals in developing, emerging market and least developed economies.

Disruptive innovations are the lifeline and bedrock of socioeconomic changes and therefore blockchain based cryptocurrencies even in its nascent form offers tremendous possibilities to shake up the existing hierarchical and bureaucratic global banking and financial services industry. Though Bitcoin, Ethereum, Stablecoin and the like could be facing “crypto-winter” and other market volatilities currently, these digital innovations are akin to Uber, Airbnb, Lyft, and Amazon of the world that not only disrupted their respective industries but also made it more efficient, productive and customer-centered, shedding off legacy baggage. The global banking and financial services are in the crossroads of sweeping change with the advent of open-source, peer-to-peer and disintermediated cryptocurrencies.

Disclaimer : The opinions expressed within this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of TAS and TAS does not assume any responsibility or liability for the same.