[Editorial] Evolution of Crypto

How has cryptocurrency evolved?

  • In the financial ecosystem, banks function as intermediaries to address the trust deficit. For instance, if there are 2 persons- A and B, living in different parts of the country. They are strangers but A has something B wants to buy. In such a situation, questions arise about whether the money or the goods should be sent first. In such a situation, a guarantor is required to show that a particular person is good for money.
  • When the Lehman Brothers went bankrupt in 2008, financial institutions started collapsing in many part of the world, in a domino effect i.e. the actions of a single intermediary led to an interconnected financial system going bust.
  • When this happened, the Lehman Brothers were bailed out using the US taxpayers’ money– instead of the moral hazard problem being addressed.
  • In this premise, the 1st generation of cryptocurrency sprouted. A white paper on bitcoin was published in October, 2008. It is revolutionary in that the whole function of the intermediaries is decentralized and the system is able to self-incentivise people.
  • It started off as an alternative system of finance. Bitcoin based DeFi or Decentralized Finance removes the intermediaries that grants permission for undertaking financial activities.
  • Other developers came along and brought in more concepts like smart contracts– which are programs that are stored on a blockchain and these run only when a set of pre-determined conditions are fulfilled i.e. conditionality was added to the payments.
  • It has now evolved to take up the role of a commodity too. Crypto tokens represent assets and can be used for investment purposes. When a person buys a token, he/ she owns a piece of the network. Some network designs allow these tokens to be staked and interest can be earned on it.
  • It has evolved to a point where there isn’t a real blanket identity for crypto. It is simultaneously many things.

Why are banks hesitant to allow cryptocurrency transactions?

  • In many countries, crypto is legal and the banks don’t object to their use. However, banks don’t bank on crypto.
  • Banks provide financial services based on the type of asset possessed by the client. Given the volatility of crypto, banks get worried.
  • The operational risk in dealing with crypto assets is very high for the banks.
  • In a sense, crypto is competing with banks.

Most probable and repeated topics of upsc prelims

What is the global view on regulating cryptocurrency?

  • With regards to the KYC (know your customer) side, there is already a global consensus. The FATF issued guidelines for monitoring and regulation of virtual assets (crypto) and virtual asset service providers (exchanges) in 2019. This was revised in 2021. All the countries are expected to ratify it. Hence, a standards has already come in with regards to the issues of terrorism financing and money laundering.
  • With regards to other aspects, the lack of an agency with that kind of authority over every country’s economy makes things difficult. We don’t have an agency which can require a country to have capital controls or to have a particular kind of law for its securities market.

Conclusion:

  • Bitcoin (crypto in general) is as much a political movement as it is a technological movement. Many factors come into play- philosophy and belief as much as technology and new models.
  • Simply calling crypto a commodity doesn’t change the fact that it lacks a blanket identity. It is simultaneously an equity in the network and a currency.
  • Hence calling it one thing or another doesn’t solve the problem.
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