Dr. Jaijit Bhattacharya
Much has been debated over the cryptocurrencies that has posed a significant regulatory challenge to policymakers. In its worst, the argument of cryptocurrency backers is the threat of the nuisance value of crypto i.e. many people have already invested into cryptos and hence, any regulatory framework that leads to reduction in the value of the cryptos will hurt the considerable number of people who have invested into cryptos. This is not a tenable argument since the government must ensure that there is no further harm to the rest of the public.
In fact, to begin with, cryptocurrency itself is a misnomer as its legal existence in most countries is that of a commodity and not a currency. What it implies is that most countries globally do not accept cryptos as legal tender.
As free people of free nations, one is free to buy anything that they want with their tax-paid money, and hence people are free to buy cryptos. But the cryptos cannot be used as a currency. They can buy it only as a commodity and trade in it, pretty much like the way children trade in cricket cards (or baseball cards in US). So perhaps, we should refer to cryptos as cryptocommodities.
However, what is more critical is that cryptos do not have any inherent value per se. Is there any other currency that does not have any inherent value?
Yes, there are many such currencies, the first among them being the US dollar which in 1971, delinked itself from gold and rescinded from its commitment to pay one ounce of gold for every $35.
This made the US Dollar the first crypto from the perspective that it had absolutely no underlying value any more. And hence, the US government could merrily print as much of US dollars as it wanted, to fund its own growth. And that is exactly what the US government did, within certain parameters.
But why did the rest of the world give credence to such a currency, to the extent that US dollar become the benchmark currency and the de facto currency for most international trade? It is because the US dollar was backed by the strength of the US economy.
The powerful US economy was one of the largest exporters as well as importers of goods and services and hence, it commanded the currency for trade, which obviously was the US dollar. And thus, a currency with no underlying value became the strongest currency in the world.
With this argument, why cannot a crypto, with absolutely no underlying value, become a strong currency?
Actually, it can, as cryptos such as Bitcoin are actually backed by a large economy, which is largely black in nature. Bitcoin gained popularity as trade on the “Silkroute” went up. Now “Silkroute” is not the trade route of the past but is a place in the darknet where drugs, guns and other illegal commodities are traded on the internet.
Therefore, need for anonymity while dealing with such illegal commodities becomes paramount. Can someone pay for drugs online using their bank account or credit card?
No. The buyers can be traced and caught, if they make payments from their bank accounts or from their credit cards. This is where bitcoin comes in. It enables the payment for such illegal commodities being traded in the darknet.
Fiat currencies just cannot be used as it would leave trace of the buyer and lead the person to be identified and caught. Hence, Bitcoin was the perfect currency for this darknet trade and therefore, Bitcoin is backed by this dark economy, just as US dollar was backed by the US economy.
This is primarily where the Bitcoin derived its early value from. Bitcoin is not controlled by any one person or government. It provides perfect anonymity.
Till June 2021, it was widely believed that cryptos provide the anonymity described above. However, in May, there was a ransomware attack in the US on the pipeline system by the name Colonial Pipeline, which is the largest oil pipeline system in the US. A very large sum of ransom was paid to the attackers and this money was paid in Bitcoins.
The attackers conveniently thought that no one would be able to catch them, once they have the Bitcoins, as Bitcoins is anonymous and not traceable. But, within weeks, the US government was able to trace the Bitcoins and recover them.
Now this is possible since the Bitcoins actually have a public ledger where one can see which email address owns them. With the resources at the disposal of the US government, it was possible for the US government to trace out the IP addresses and the ownership of the Bitcoins and recover the same. The same cannot be easily done by other governments. For other jurisdictions, such as India, cryptos remain de facto anonymous.
So, why would anyone prefer to use cryptos for payments over say a centralised construct such as UPI (Unified Payments Interface)? Why would people move to an energy-guzzling, high-carbon footprint crypto such as Bitcoin over an easy-to-use, low-carbon footprint solution like UPI? The answer is the same as for the use of Bitcoin for Silkroute anonymity.
For long, it was theoretical that cryptos could be used for money laundering and for terror financing. Last week, it turned out that the Enforcement Directorate of India had identified that using cryptos, Rs 4,000 crores has been laundered out of India in the last one year.
As if on cue, the global body on terror financing, FATF (Financial Action Task Force) updated its Guidance for a Risk-Based Approach to Virtual Assets (cryptos) and Virtual Asset Service Providers (VASPs).
The FATF standards now require countries to assess and mitigate their risks associated with crypto transactions and subject them to supervision or monitoring by competent national authorities. This guidance is supposed to help countries and VASPs understand their anti-money laundering and counter-terrorist financing obligations, and effectively implement the FATF's requirements as they apply to this sector.
One needs to understand that the implication of not aligning with FATF is severe. As an example, FATF has put Pakistan on the grey list and has threatened to put them on the black list, which will severely limit the ability of Pakistan to raise funds and to do transactions.
With so many challenges, regulating cryptos becomes a tough job. On the other hand, it is also difficult to ban the march of technology. But how does one regulate something, which transcends the jurisdiction of one's own country?
One can perhaps put KYC (Know Your Customer that banks use to ensure they know whose account they are opening up in order to remove anonymity) on crypto exchanges operating in India.
But what about crypto exchanges that are operating outside India and accessible from India just like any other internet-based service? Such exchanges will not follow the laws of the Indian government. What if money laundering is done through the fungibility of the exchanges per se? How can one enforce any regulation brought in by the government?
It appears to be a situation where one is damned if one regulates cryptos, and is damned if one doesn't. It will be a challenging situation for governments across the world to regulate cryptos within the FATF framework and to manage the diminishing control of central banks on their monetary policies due to cryptos replacing their fiat currencies in a creeping manner.
(This article has been authored by Dr Jaijit Bhattacharya, President, Centre for Digital Economy Policy Research. Views expressed are personal.)
