Cryptocurrency and its challenges

What’s in today’s article?

• Cryptocurrencies – about, opportunities, challenges
• About FTX Scandal
• News Summary

Why in News?

• RBI governor Shaktikanta Das has said that the next financial crisis will come from cryptocurrencies and that the developments at crypto exchange FTX have vindicated the central bank’s stance.
• He made these remarks at a BFSI summit organised by the Business Standard in Mumbai.

What is a Cryptocurrency?

• These are digital or virtual currencies in which encryption techniques are used to regulate the generation of their units and verify the transfer of funds.
• These currencies operate independently of a central bank.

Growth of crypto ecosystem presents new opportunities

• Technological innovation is ushering in a new era that makes payments and other financial services cheaper, faster, more accessible.
  • It allows these services to flow across borders swiftly.
• Bank deposits can be transformed to stable coins that allow instant access to a vast array of financial products and allow instant currency conversion.
• Decentralised finance could become a platform for more innovative, inclusive, and transparent financial services.

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What are the challenges posed by crypto assets?

• The rapid growth and increasing adoption of crypto assets also pose financial stability challenges as these are extremely volatile.
  • These are much more volatile than equities or commodities or even exchange rates. This volatility is introducing instability in the ecosystem.
• Challenges posed by the crypto ecosystem include:
  • operational and financial integrity risks from crypto asset providers,
  • investor protection risks for crypto-assets,
  • inadequate reserves and disclosure for some stable coins.

Use of cryptocurrencies in India: Statistics

• The number of blockchain start-ups surpassed 300 in 2021, with the daily crypto trading volume peaking between $300 -$500 million.
• As per Global Consumer Survey in 2020, India ranks higher than China, United States, Germany and Japan in crypto adoption.

About FTX scandal

• Recently, the cryptocurrency exchange FTX filed for bankruptcy and its chief executive, Sam Bankman-Fried, resigned.
• As a result, the savings of hundreds of thousands of customers who deposited their holdings on the FTX platform are in jeopardy.

What is FTX?

• FTX is a cryptocurrency exchange based in the Bahamas.
  • The company built its business on risky trading options that are not legal in the United States.
• It was founded by Sam Bankman-Fried in 2019 and lets users buy, sell, hold, and trade cryptocurrency.
  • It enabled customers to trade digital currencies for other digital currencies or traditional money; it also had a native cryptocurrency known as FTT.

Why did FTX run into trouble?

• FTX has a native cryptocurrency token called FTT, which traders use for operations like paying transaction fees.
• In November 2022, a report, based on leaked documents, appeared to show that Alameda Research held an unusually large amount of FTT tokens.
  • Alameda Research is a hedge fund run by Bankman-Fried.
  • FTX and Alameda are meant to be separate businesses, but the report claimed that they had close financial ties.
• With this revelation, FTT’s price plummeted and traders rushed to pull out of FTX, fearful that it would be yet another fallen crypto company.
• This resulted into liquidity crunch.

Impact on cryptocurrency market

• The cryptocurrency industry has long struggled to convince regulators, investors and ordinary customers that it is trustworthy.
• The fall of FTX, which seemed more stable than other companies, and the pull-out by Binance have jolted the market.
  • Binance is also a cryptocurrency exchanges.

News Summary

• Reserve Bank of India Governor Shaktikanta Das warned that private cryptocurrencies, if allowed to grow, would lead to the next financial crisis.

Key highlights

• On inherent risk associated with cryptos
  • The cryptocurrencies have certain huge inherent risks which could pose threat to the country’s macroeconomic and financial stability.
  • The RBI’s concerns arise from the fact that crypto does not have any underlying asset.
• On regulating cryptos
  • On the issue of allowing crypto after subjecting it to regulation, RBI governor said that how something could be regulated when its origin was based on bypassing the system.
  • Private cryptocurrencies owe their origin to bypassing and to breaking the system.
  • These currencies do not believe in the central bank currency and also in the regulated financial world.
• Total value of cryptocurrencies has currently shrunk
  • According to some estimates, the total value of cryptocurrencies has currently shrunk to $140 billion from $188 billion.

Q1) What are the benefits of cryptocurrency?

Transactional freedom, security, cost effective, decentralisation, ease of currency exchange, and ease of transaction are among the most important advantages of cryptocurrency.

Q2) Is cryptocurrency legal in India?

Cryptocurrencies are unregulated in India but in Budget 2022, the government announced a flat 30 per cent tax on gains from cryptocurrency transactions as well as a tax deducted source (TDS) of 1 per cent.  

Source: Cryptocurrency and its challenges