My view on the Dangers of Cryptocurrency to Indian Economy and Indian Citizens

Introduction

In the last few years, there seems to be a group of people with high degree of investment in speculative cryptocurrencies who have been pressuring various government regulators around the globe to either legalize cryptocurrencies such as Bitcoin, Ethereum etc. Not just legalization of their usage in purchase of goods and services, these groups are also asking for minimum or no regulation with reasoning that it would create unbridled innovation ecosystem. They have been demanding that various tokenization of assets (digital as well as other types of assets). Further, they are asking for creating investment assets that are based on cryptocurrencies and their fractionalization for trade as investment instruments. Even those who are showing some deference and saying that cryptocurrency and crypto assets should be allowed with required regulations – do not always appreciate the tremendous difficulty of regulating crypto or knowingly misleading the people and the governments.

Some of the African and South American countries with limited technology knowledge, investment and research in cryptocurrencies and blockchain technology have already fallen for it. A number of podcasts, YouTube channels and other social media channels based in some African and South American countries have been pushing material into the mind space of common people that cryptocurrencies are solution to their economic woes, financial disempowerment etc. There is every reason to suspect that there is a vested interest in this – which are sponsoring such push in every country. There ?is a set of evangelists who are filling social media such as twitter, LinkedIn etc., without spelling out the risk associated with the cryptocurrency.

Bank of England has recently warned that a 2008 like meltdown may be precipitated by uncontrolled push of cryptocurrency as investment assets, or in allowing bundled assets backed by Cryptocurrency. Recently the US CFTC (Commodities Futures Trading Commission) has approved Bitcoin Futures which will be regulated by CFTC. For taxation purposes, state and federal tax regulations for futures market gains will have to be complied with. Since these are not anonymous, even though it is risky instrument for investment, it is not as problematic as cryptocurrency trading itself.?Investors can put a long or short contract in this market and given the sudden volatilities suffered by these currencies they may suffer large losses but if they are deep pocket investors –they might be able to withstand such losses and occasionally may even gain.

In India, we hear from some people whose aim is to build public pressure through their numerous posts on social media, through opinion columns in news papers and probably by lobbying the relevant government departments. They argue that by not allowing cryptocurrency to flourish in the Indian technology sphere, or strongly regulating crypto-assets – India will kill innovations in FinTech space.?This argument is as good as saying that disallowing genetic cloning of human embryo, we will kill innovations in the genetic technology or biotechnology space.

My argument against theirs is very simple. First of all, the cryptocurrency market is extremely volatile. They move drastically based on single tweet by a celebrity with millions of followers, or based on unilateral policy actions by foreign governments (e.g., China banning cryptocurrency, or El Salvador buying bitcoin in large enough quantity), or even by creating hypes in derivative tokens (NFT) space which may push prices by 2400% in a single day (recall: SQUID token).

The De-Fi (Decentralized Finance) proponents want to influence these assets through coordinated propaganda on social media which are not backed by any risk model or any economic value. ?Through such manipulation of the minds of common people, they make??huge profits by selling their holdings in the spot market when the price of a token or currency has been pumped up. Once such unscrupulous people are allowed to create investment assets out of these, and then use social media to influence their pricing, even by selling and buying the same NFT in the span of a single day to pump up the price, or by using movie stars to tweet and push up price and then dump their own coins or tokens – the retail investors will suffer huge losses. A case of suicide in the Indian state of Andhra Pradesh – a teacher killing himself after being in huge debt from loan sharks – due to a large fall in price of cryptocurrency for several days.

According to David Gyori, CEO of Banking Reports, the following are the major reasons why Cryptocurrency system is bound to crash:

1.????Due to emergence of decentralized exchanges, exchanges outside of a sovereign country and due to lack of technological enforcement banning the use of those (without creating a surveillance regime) would mean non-compliance with laws/regulations within a country.

2.????No price stability – goods priced in a cryptocurrency will have nominal prices fluctuating based on tweets of celebrities, pump and dump schemes by malicious cryptocurrency ecosystem owners (The SQUID Crypto went up 2400% one day, and crashed 2400% a few days later)

3.????Lack of Sovereign control of Money Supply – if government overspends (war situation or pandemic situation), supply of money has to be increased (quantitative easing) but with alternative currency in the hands of people, that control will be lost.?Keeping the strength of sovereign FIAT currency will require no alternative method of payment exists.

4.????Lack of Interest Rate Content and lack of intrinsic value – FIAT currency has no intrinsic value but it has interest as asset and liability. Cryptocurrencies without being accepted on bank account books will have no interest content.

5.????Environmental consideration – most reliable form of consensus on crypto-blockchains is proof of work – which is extremely bad for environment and energy supply. Other forms of consensus are highly problematic for public anonymous blockchains which hosts cryptocurrency eco-system.

6.????Cost of transactions – after the rewards for providing the consensus runs out in bitcoin or Ethereum, transaction fees will be the only incentive for nodes to participate in building the consensus. That will be too high for most such blockchains.

7.????Inequality – our research in 2019 showed that 98.86% of the cryptocurrency (specifically Ethereum) was owned by 100 (0.1%) or so wallets, top 100 (0.1%) smart contracts executed 95% of the transactions. This shows only a few individuals own most of the crypto and do most of the activities in crypto-blockchain. These are the vested interest groups. Such inequality is terrible when the crypto-blockchains move to “proof-of-stake” – where only about 100 or so people will mostly be able to participate in the consensus process.

8.????Deflationary Cycles – if price of cryptocurrency rises monotonically in FIAT, then people will not invest but store their assets in crypto creating a deflationary cycle.

?However, most concerning among these are that frauds are easy to do in crypto given the jurisdictional issue for compliance through regulation, and given that there is enough money laundering opportunity (our research has shown presence of money laundering cycles in the transaction graph are pretty common). With innovations of decentralized exchanges, mixer services – it is an immense challenge for law enforcement to find the criminals.

?Hayek, Denationalization of Money and Cryptocurrency

?The economist who represented the Austrian School of Economics, Fredrich Hayek, in 1976 propounded a monetary ecosystem that cryptocurrency is currently trying to implement. ?In his book “The denationalization of money”, Hayek argued for a private money-based ecosystem. Even Milton Friedman who created the free-market capitalism in the United States, and other economists (even from the Austrian school) found that as unacceptable for many reasons – primarily because this would could create private monopolies. One may argue that since bitcoin is decentralized, there is no private monopoly but our analysis shows that about 100 or so people own majority of assets – thus irrespective of decentralization – this could be like a monopoly.

?It is our considered opinion that instead of allowing cryptocurrency as an alternative currency in a country like India, RBI should quickly issue CBDCs as an alternative to fiat currency of the country pegged at the INR. However, given that India has a pretty effective ecosystem of digital payments through UPI, it may not be necessary to have a CBDC – except that it may be useful if implemented on blockchain platform – to ensure privacy of users of CBDC, integrity and protection against one sided actions. The CBDC blockchain may be made interoperable with other FinTech platforms.

?Innovation Ecosystem Argument

There is another misleading and mischievous ?argument that disallowing cryptocurrencies as alternate form of currency, the country will discourage and suffocate innovations in blockchain space, and opportunities of innovation in the FinTech space.

?First of all, innovation does not always mean it will be good for the society. ?Innovation such as human cloning is banned in most countries for a reason. Similarly, innovation of social media and various applications on social media, having not been regulated, has now posed a dangerous threat to most countries in the world – especially in the space of politics, and on-line fraud and extortions. So social media as an innovation was novel and got a lot of support in various legislatures around the world for its freedom and nonliability with the logic of encouraging innovation – but eventually now democratic countries are threatened by their very unregulated and unrestricted growth.

?Second, it is not true that blockchain innovation will be a missed opportunity for the lack of crypto ecosystem. ?There are a lot of innovations currently taking place in using blockchain technology for property registration, supply chain tracking, procurement processes, banking ledgers, privacy preserving medical information integration and sharing, CBDC etc. So, it is not at all true that India will not be able to lead in the blockchain innovation space if cryptocurrencies are not legalized.

?“Worldwide blockchain in the fintech market is foreseen to grow from USD 231.63 million in 2017 to USD 6700.63 million by 2023, at a yearly growth rate (CAGR) of 75.2% during the prediction period”,?specified by?Market Research Future.

?Examples of FinTech innovations where Blockchain based Solutions are already common or will be common.

?1.????KYC processes are the backbones of a financial institution's anti-money laundering efforts. Currently, the centralized KYC process faces various challenges such as misidentifying fraudulent data, the inability to track customers, customers entering fake data, and delayed processing time. As a technological advancement, the KYC process is gradually being shifted to Blockchains, and Self-Sovereign Identity is being promoted. As these technology support immutability, non-reputability, and pseudonymity, they provide benefits such as distributed data collection, better operational efficiency, validation of information, and access to records is ensured. These aspects could help several financial operations, such as those listed below:

?2.????Stock Holding: Currently, NSDL and CSDL accounts are needed to open a DEMAT account to trade stocks. Blockchains and SSI can help streamline the stock-holding process and reduce any illicit activity, forged claims concerning stock holding.

?3.????Income Tax Return Filing: Current process requires several proofs of income and forms (such as Form 16 and Form 26 AS). However, many times many entities evade income tax. Blockchains along with SSI can help streamline ITR if the ledger for income is maintained. With CBDC blockchain interoperation, tax submission and tax credits and reimbursements can be instantaneous. Smart contracts can help automated tax audit much faster.

?4.????GST infrastructure – it has been pointed out that Blockchain platform for GST accounting, payment, forward credit etc., can be more efficiently done over blockchain platform. With CBDC blockchain directly interoperating with this, can lead to much faster settlements and much faster credit to the states.

?5.????Insurance and investments: Buying of insurance (health, home, vehicle, life), payment of premium, claims, and return of investments can be streamlined using Blockchains.

?6.????Bank locker access records: Blockchains can help maintain the history of locker access by the client. Any illicit activity (access by a person other than the owner) would be recorded and cannot be repudiated.

?7.????Loan Operations: Loan clearances can be done easily using blockchains.?Blockchains can be used for record-keeping for mortgage/collateral records against loans issued. One can also use credit tokens which can be used to prove loan worthiness and tracking if the loan is being used for purposes they are allowed.

?8.????Line of credit – this process can be auditable and also faster.

?9.????For demand draft, inter-bank transactions, and transfers: blockchain transactions can be used as a record for maintaining information about demand drafts, inter-bank transfers, including international transfers and traveler's checks.

?10.?IPOs on blockchain will make much faster operation of IPOs (not ICOs which are done typically on cryptocurrency blockchain and lots of frauds have happened in the pretense of ICOs)

?11.?Trusted Payment Solutions - UPI and other digital payment solutions when implemented on blockchain can provide faster, auditable direct transfer operations.

?12.?Smart Contracts based recurring payment solutions – the current problem introduced since Oct 1 can actually be solved by using smart contracts to obtain OTP with the user consent

?13.?Smart Contracts based Escrow - opportunities to escrow a transactional process with full transparency

?14.?Supply chain Financing and management -- single source of truth and real-time settlement and auditability

?15.?Digital Insurance -- Smart Contract based Automated Claim Processing with Transparency

?16.?Credit Scoring – each bank can provide credit-worthiness token through smart contract as and when loan installment are paid with regularity – smart contract enabled

?17.?Issuance of Commercial Paper – Axis Bank did one for Vendanta

?18.?Regulatory compliance in real time – regulators may have full visibility of entire process in real-time and checked using smart contracts

?19.?Cross border payments through blockchain interoperation

?Concluding Remarks

In this very short writeup, we have outlined the problems with enabling a cryptocurrency as a currency or even as ?an asset class for investment in a country like India. Chit fund scam examples are good pointer to how vested interests fool common people into scam assets and investments. We also point to some of our research in detecting malicious activities (gambling, money laundering, phishing etc.) on crypto-currency platforms. Finally, we disarm the argument that without bringing in cryptocurrency into the Indian financial system, innovation would be suffocated. We show several examples of innovations with the blockchain technology relevant to the FinTech industry.

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