Cryptos, a byproduct of Blockchain technology, are often called currencies as they can be a medium of exchange. But unlike paper money or bank accounts, they use encryption tools to verify the monetary unit and to control its creation. They are not validated by a government or bank, but by the repeated use of computing processes that are electricity-dependent. They live like equity shares, only within ‘their specified exchange’ and can be bought/sold by members of only that exchange. Unlike equity shares, however, they have no intrinsic worth or ‘earning power’, except ‘mining’ gains. They command prices based on their ability to convince the buyer of their ‘scarcity’ premium.
Crypto was invented in 2008, the year of the Global Financial Crisis. It was seen as an alternative asset class, like gold, because it was generated by a mathematically designed framework to ensure a precise finite supply. Each bitcoin is unique and cryptographically secured and cannot be replicated or hacked. So, crypto cannot be spent twice or counterfeited.
This created glamour and hype. Supporters of Blockchain technology and its associated crypto currencies foresee increased prominence in the future, given that in the current monetary set-up, governments are reckless about printing money, regardless of inflation, which wipes out laboriously earned income/wealth. Cryptos have been quick to command a global market capitalisation of over $1.5 trillion. In India, there are about 15 million subscribers, with an estimated investment of over $6 billion. Currently, it is classified as an unregulated asset.
Blockchain technology is basically a system of authenticating a shared database. It has potential to reform financial record-keeping, including asset transactions. It can underpin smart contracts, facilitate instantaneous low-cost settlement of cross-border payments, and curb money-laundering.
In Blockchain technology, each ‘block’ of a shared database is required to be validated by all the computers linked to the network, before it is added to the earlier chain. Users of a publicly distributed database need incentives. This is provided endogenously. The authentication process or mining, if done a specific number of times, ‘produces’ the crypto. This ‘rewards’ the miner doing the authentication. The mathematics is such that each crypto requires an increasingly larger number of ‘authentications’ for production than its predecessor. Computers internal to an institution will not seek incentives, so they will use less computing power than ‘public/open’ systems.
The need to incentivise makes the technology power-intensive. According to Cambridge University’s bitcoin electricity consumption index, bitcoin miners currently consume 130 Terawatt-hours of energy (TWh), roughly 0.6% of the global electricity consumption. This puts the crypto economy at its current size at par with the carbon dioxide emissions of Finland or Sri Lanka.
The hype regarding a technologically-limited finite supply may be contrasted with the fact that in May 2021, there were already 10,115 different crypto currencies. The number rises daily. Two cryptos, Bitcoin and Ethereum, account for 60% of the market valuation, not on account of any intrinsic quality difference or separately proven income stream but owing to branding/first mover advantages. This can change course, or even evaporate overnight.
Neither Bitcoin nor any other specific crypto is essential to carry out a commercial-scale Blockchain operation. Any of the large number of variants will do, or a brand-new variant can be set up with equal ease. Further, it is often ignored that the ‘Core Banking Technology’ (housing all the global accounts of a bank, irrespective of country, in a single central supercomputer set-up) now used by banks permits the same instantaneity claimed for Blockchains. Banking transactions are priced based on what the regulator allows. In India, inter-person UPI remittances from Mumbai to J&K or the North-East are free of charge, but a bank transfer to an account in Dubai would attract a high charge.
There exist apprehensions that cryptos confer anonymity to the holder and may thus be a popular settlement mechanism for a variety of illegal/dark web transactions. So, there is an interesting conundrum. On the one hand, there is a new technological discovery, the Blockchain, which has the potential to grow but has a power-intensive byproduct, the crypto. On the other hand is a planet scrambling to save itself from climate disaster due to global warming caused by excessive carbon use, by focusing on achieving carbon efficiencies/reducing power dependencies. In the recently concluded CoP-26 summit, the EU and the US committed to becoming net carbon zero by 2050, China by 2060 and India by 2070. So, how will this paradox be managed?
The recent government announcement of an intent to regulate cryptos is a welcome move in this highly volatile, nascent sector, given that currently policy lags technology. What should the regulators do? Attempts to ban outright, limit use or adopt a rigid stance may not be appropriate. Nor will picking and choosing between cryptos be desirable. Excessive exuberance in a power-hungry sector is what needs to be curbed.
It will be best to treat cryptos as a luxury good, as it is neither currency nor equity nor a common-use asset. It should be subjected to standard GST, income and capital gains taxation rules. Also, like all equity, commodity or currency remittances, crypto trading should be made fully compliant with RBI norms, permitting only domestic inter-relationships. All export/import transactions should be made ‘Exchange to Exchange’ with full KYC. All crypto exchanges should be subjected to usual SEBI enunciated regulations. Thereafter, authorities may allow scenarios to develop before attempting additional regulation.