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The Crypto Conundrum

  • IASbaba
  • November 2, 2021
  • 0
UPSC Articles
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SCIENCE & TECH/ ECONOMY

  • GS-3: Science and Technology- developments and their applications and effects in everyday life. 
  • GS-3: Economy & its challenges

The Crypto Conundrum

Context: Since 2020, when the Supreme Court overturned an order by the Reserve Bank of India dated April 6, 2018, restricting the use of cryptocurrencies, traffic in domestic cryptocurrency exchanges in India has grown many-fold. 

Bitcoin and other private cryptocurrencies have been on a bull run recently. Unlike previous rallies, the current rally in bitcoin has witnessed the increasing participation of retail investors in India.

Are Crypto Currencies on speculative run?

  • The most important feature of cryptocurrencies is their limited supply.
  • In a world where central banks create a lot of money out of thin air, it is natural for investors who are looking to protect their wealth to seek alternative assets (like cryptocurrencies) whose supply cannot be increased up as easily.
  • Scarcity alone is not sufficient to facilitate the adoption of cryptocurrencies as money. 
  • Any asset must have either use value or exchange value in order for it to possess any fundamental value. This fundamental value, in turn, is reflected in the price of these assets in the long run. 
    • Stocks and bonds, for instance, possess exchange value that is based on the expected future cash flow from these assets. 
    • Commodities such as oil and steel possess use value because these assets are used to run vehicles and build real estate
  • Bitcoin and other cryptocurrencies may be scarce but it is questionable whether they possess any use value or exchange value.
  • We can say that cryptocurrencies possess no significant fundamental value to sustain their current high prices. Yet, many believe that the rising prices of cryptocurrencies reflect their likely future value as a currency. 
  • It is possible that investors are bidding up the price of bitcoin because they foresee a future in which private currency is widely accepted as money. 
  • One may also grant that the extreme volatility seen in the price of cryptocurrencies. may be due to the nascent, illiquid nature of the cryptocurrency market. 

What is the possibility of governments cracking down on Crypto Currencies?

  • The more cryptocurrencies are accepted in exchange for goods and services, the greater the chances of governments cracking down on them.
  • The monopoly that governments (and central banks) possess over the issuance of money is at the root of their power and influence. 
  • It allows central banks to control the money supply under the mandate of managing aggregate demand in the economy. 
  • In essence, monopoly control over money allows governments to indirectly tax citizens by increasing the supply of currencies, thus devaluing them. 
  • If cryptocurrencies like bitcoin are going to challenge fiat currencies like the U.S. dollar or INR as a medium of exchange, they would essentially be challenging the authority of the government to print and spend. This will not be tolerated by governments for long. 
  • Governments will allow cryptocurrencies to exist only as long as these currencies remain a speculative asset and not a medium of exchange.
  • This doesn’t mean that governments are justified in their crackdown against cryptocurrencies. There are obvious benefits of free market competition. Private alternatives to fiat currencies offer people greater choice in what currencies they choose to use as a medium of exchange. 

Connecting the dots:

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