Nikunj Gandhi decodes the perils and ower of investing in cryptocurrencies, and why you should tread cautiously before putting your money in them
With cryptocurrencies creating such brouhaha in the virtual currency markets, it has certainly piqued the curiosities of the retail investors in India. The rollercoaster ride that the cryptocurrencies have been subjected to is mindboggling and has all the ingredients for the making of an asset bubble.The phenomenal return over the past year makes us wonder if we have missed an opportunity here for a windfall. Also, a lingering thought remains to speculate if there’s any steam left to this upcycle. I would like here to discuss the risks involved in encouraging that line of thought if we would persist to speculate on the further possibility of higher gains in this asset mania. A brief layman’s introduction involving its background: Cryptocurrencies, especially Bitcoins (since it forms a major chunk of the virtual currency pie), is a cryptography-based digital currency that uses a peer-to-peer open source protocol as an alternative to the cash system of payments, but without the intervention of any central authority. Bitcoins can be transferred through a computer or smartphone without an intermediate financial institution. The processing of Bitcoin transactions is secured by servers called Bitcoin ‘miners’. These servers communicate over an internet-based network and confirm transactions by adding them to a ledger which is updated and archived periodically using peer-to-peer filesharing technology, also known as the ‘blockchain’. The demand-supply economics of price discovery determines the equilibrium price for a Bitcoin.
There exists a lot of ambiguity as to the real nature of classification for Bitcoins. It cannot be classified as regular financial instruments such as ‘currency’, ‘security’, ‘derivative’ or ‘negotiable instruments’ as these instruments are currently defined under their respective Indian laws. This creates a difficulty of regulation in the absence of any clear guidelines. Since 2013, the Reserve Bank of India (RBI) has periodically reiterated its concerns over cryptocurrencies but has done little else. Unlike its counterparts elsewhere who have banned or otherwise severely restricted the use of cryptocurrencies, the RBI’s studied silence is arguably progressive in nature, letting the technology play out in the market while the stakes are relatively low.
Some of the concerns raised by the RBI include
VCs being in digital form are stored in digital/electronic media that are called electronic wallets. Therefore, they are prone to losses arising out of hacking, loss of password, compromise of access credentials, malware attack etc. Since they are not created by or traded through any authorised central registry or agency, the loss of the e-wallet could result in the permanent loss of the VCs held in them.l Payments by VCs, such as Bitcoins, take place on a peer-to-peer basis without an authorised central agency which regulates such payments. As such, there is no established framework for recourse to customer problems/ disputes/charge backs etc.l There is no underlying or backing of any asset for VCs. As such, their value seems to be a matter of speculation. Huge volatility in the value of VCs has been noticed in the recent past. Thus, the users are exposed to potential losses on account of such volatility in value.l It is reported that VCs, such as Bitcoins, are being traded on exchange platforms set up in various jurisdictions whose legal status is also unclear. Hence, the traders of VCs on such platforms are exposed to legal as well as financial risks.l There have been several media reports of the usage of VCs, including Bitcoins, for illicit and illegal activities in several jurisdictions. The absence of information of counterparties in such peer-to-peer anonymous/pseudonymous systems could subject the users to unintentional breaches of anti-money laundering and combating the financing of terrorism (AML/CFT) laws.In the final analysis, RBI ought to recognise Bitcoin as an opportunity and harness this opportunity for the social and economic betterment of the nation. As the internet represented an opportunity, Bitcoin too represents an opportunity which can help in decentralisation of economic power, greater financial access and ultimately, break down of socio-economic barriers. While the Union Government does have legislative powers to provide for transactions relating to Bitcoins, however, it should not legislate merely for the sake of legislating. Needless laws only complicate business transactions and leads to restrictions rather than regulation of business.
Only time will tell
Virtual Currency as an asset class for an investor cannot be speculative in nature in the long run. It only exposes its vulnerability if it continues with such gyrations without displaying any stability. Also, currency is more of a medium of transaction rather being an avenue for investment as an asset class for long term capital gains. Hoarders hold on to a currency when there exists a possibility of instability in the geopolitics. Bitcoin has a number of weaknesses and may have long-term viability issues. But it shows that virtual currencies can and probably will succeed in time, as innovators build on the lessons from the Bitcoin experience.The open source technology has brought about a disruption in the fiat currency regime. It is inevitable to note that digital currency will be the new currency of the future. The currency regime has passed through its trials and tribulations for maintaining the geopolitics of the new world order with fiat currency being the tried and tested formula for a stable economy in the era of capitalism. As long as this new entrant to the party is not formally recognized and regulated, we shall only be enamored by its outstanding future potential and continue to fall victim to The Greater Fool Theory by putting the Tulipmania to shame!
Nikunj Gandhi is an Equity Investor and can be reached at firstname.lastname@example.orgThese are his opinions and not necessarily of the newspaper’s.Reference: RBI press releases