Changing Risk Appetite Towards Crypto Currencies

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With more and more countries accepting cryptocurrencies (CCs), a social vision is emerging in favor of regulating them rather than moving away from them. Although some forms of digital coins were used even earlier, the marked beginnings of CCs can be traced to the entry of bitcoin software developed and put into use in 2009 based on blockchain technology. It enabled the safe and secure recording of transactions, resulting in a massive increase in the number and volume of CCs. Since their data is stored on the network, every network user must authorize transactions, which gives credibility to their security.

The risk and vulnerability of the financial system arises from the fact that there is no central governing body, supervisor or issuing authority with sufficient capital buffers and risk management systems. such as a bank, an authorized non-bank or any regulated intermediary in the administration of CCs. Therefore, enforcing self-regulation to make each user responsible for the storage and security of their funds in the wallet is the essence of an operational minimum of CC.

1. How do CCs work:

They operate on four separate operating platforms. (i) Proof of Work (POW) basis where a CC unit must prove that it has completed the predefined task to exist, based on blockchain technology which is an incorruptible distributed ledger system. The most popular POW-based CCs are Bitcoin and Ethereum. (ii) Proof of Stake (POS) where the concept of providing proof of legitimation of a CC unit is required. It is fundamentally different from POW to overcome the challenge of scalability. Dash, Eos, and Tron are some of the examples of CCs that work with the POS method. (iii) Tokens are a basis upon which CCs are designed with specific and limited use, such as digital game assets such as weapons and extra lives, and are not intended for wider use. They are generally built around the blockchain. Popular tokens are Tether and BAT. (iv) Stable coins are a class of CCs that function as assets storing value that does not fluctuate as is the case with popular CCs such as Bitcoin. Examples of stable coins are Tether, Gemini, Paxos, and TrueUSD. The basis of CCs is the trust gained from the secure operating platform and it is about its monetary value and not who is issuing or selling.

Since there is no need for a centralized authority to float CCs, there has been a massive increase in their numbers. The latest information indicates that there are currently over 7,800 CCs in circulation today, of which nearly 2,000 are missing and many more are on the verge of stagnation or exit. They vary in aspects such as type, use and value. Many of them are not popular on a large scale, and the most popular CCs account for over 80% of the industry.

2. Change global position on CCs:

Since its rapid rise in popularity with the increase in the number of tech-savvy users with a higher risk appetite, the world is widely divided over their treatment, as are regulators. It is estimated that 16.36 percent of countries have banned it, 16.36 percent are hostile to it, 25.45 percent are on fence or neutral, perception is improving in 22.73 percent of countries. 19.09% of countries recognized or aggressively promoted them. But in India, given the level of financial literacy and the limitations of risk management, RBI reiterated its concern.

The Supreme Court overturned the RBI directive to banks issued on 6/4/2018 prohibiting them from facilitating cryptocurrency-related transactions. The judgment marks a milestone both in India and globally and helps bring a positive outlook to crypto trading activity. But RBI continues to be concerned about multidimensional risks in CCs, more importantly consumer protection and financial stability. The fear of money laundering and security concerns with pervasive risks cannot be ruled out. It is in terms of risk dimensions; it is as if the cashback tokens / scratch coupons provided by digital wallets need to be regulated. At least they’re low in value and don’t fluctuate.

3. Regulatory concerns:

Although many countries have allowed CC trade and even some have legalized it, its risk sensitivity persists. In the absence of a lack of control over issuers and a volatile monetary value, it is difficult to follow the flow of funds and its end user. Authenticating KYC and enforcing anti-money laundering laws would be difficult.

The Bank for International Settlements (BIS), which works to guide central banks around the world in institutionalizing a stable financial system, finds no constructive role for CCs. In his recent Annual Economic Report – June 2021, while referencing several recent developments that have placed a number of potential innovations involving digital currencies, he observed that “at the present time it is clear that crypto -currencies are speculative assets rather than cash, and in many cases are used to facilitate money laundering, ransomware attacks and other financial crimes ”.

However, the regulatory example may come from large countries like the United States where CCs are not legal tender, but CC exchanges are legal and considered to be money transmitters. The United States continues to make progress in developing federal cryptocurrency legislation. China recently banned all private CCs and is not a good host. Given these risk factors, if the regulation can ensure the protection of clients and is able to adequately track the end use of CC funds changing hands, then security can be ensured. But in the current level of financial and digital literacy, while protecting consumers from cyber attacks is a challenge, policymakers need to consider whether the financial ecosystem is able to create a safe path for CCs that are relatively riskier and less understood as a financial product. While global consultations to articulate the regulatory and legal framework can be helpful, tailoring them to the needs of individual economies will always be a difficult challenge, especially for a large and diverse country like India. The point for policymakers to ponder – will the financial ecosystem be able to cope with the nuances of risk emanating from CCs – in recognizing the merits of the way the RBI approaches it.

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The opinions expressed above are those of the author.

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