Is crypto mania more a symptom than a cause?

News: Instead of rooting for its ban, we must try to decipher the reasons behind popularity of Cryptocurrencies and why they appear so attractive an asset for investors.

What are the reasons behind fascination and attraction around Cryptocurrencies?

– They are a fascinating technological innovation. Part of their initial attraction was that they promised a new governance order.

– Faced with the inflation of the 1970s, thinkers like Friedrich Hayek theorized about reasserting the dominance of private currencies, protected from the state. This required a solution to the problem of ‘trust’ on which every currency depends. Crypto seemed to solve that problem, with its decentralised architecture and community and self-verification protocols.

– The global economy currently has an abundance of cheap money, while small savers are desperate for return. In this context, it is easy for the powerful to misallocate money, and the small saver to indulge in speculation via cryptocurrency.

Why a new governance order backed by Crypto can never be a reality?

This obvious due to the following reasons:

– No state is going to let go of its power to assert control over the monetary system. The sustenance of state-sponsored fiat money is one of the great achievements of modern state formation, and the foundation of its power and legitimacy.

– Crypto requires substantial material infrastructure, which a state could always control. States can shut down mining, as China has done.

– Neither Bitcoin, nor any other cryptocurrency currently possess stability, efficiency, privacy and safety that would allow it to dominate central bank money.

Crypto is now considered more like an asset.

Are there any tangible benefits to Cryptopcurrency?

Some financial products bring genuine gains for the economy or development, others pose a risk. Cryptocurrency doesn’t bring any concrete development benefits.

The underlying technology of Blockchain can be harnessed for potential benefits even without crypto. Hence, a ban on cryptocurrency should not be a major problem.

Why a ban instead of regulation is a good choice for India?

Because the insulation of the financial system from the volatility of crypto markets will be difficult to achieve for the following reasons:

The first reason is political economy. A large number of investors, and some influential ones, will become a vested interest in their own right, potentially demanding the socialisation or mitigation of losses. Now RBI is facing lobbying by investors as an interest group.

A major new class of assets, especially if volumes grow, will have systemic effects on the rest of the economy. For instance:

– In a crisis, if stable coin redemptions go up, RBI will have to step in.

– Opportunity costs of investments flowing into crypto on prices of other assets and monetary instruments.

What is the way forward?

– RBI should avoid a scenario where it bans but then carves out exceptions.

– Ensure that trade does not go offshore. Not fully banning and allowing it offshore will be the worst of both worlds.

– Lastly, RBI’s case would be strengthened if it spelled out the systemic risks that crypto might pose to the stability of the real economy.

Source: This post is based on the article “Is crypto mania more a symptom than a cause?” published in The Indian Express on 27th Nov 2021.