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Problems with Private Crypto-Currencies

Cryptocurrencies, built on blockchain technology, as in the case of Bitcoin, is a different form/method of issuing or creating “currency or money”. Block-chain technology is a decentralized technology, which allows, every holder of a piece of crypto-currency to be part of a decentralized ledger. Transactions in cryptocurrencies are “mined” or located by the “miners” or the computer programmers, who get paid for in the same cryptocurrency.

Paper currency is issued by the Central Bank of a country and in this sense, it is a centralized currency with any individual owning or being part of the currency only to the extent of currency notes or broader money actually owned by her. Currency technology has evolved over time since time immemorial. Gold and Silver, the valuable metals ruled as currency bases for a long. Paper currency, which replaced the metal currency, has been around for quite some time. Increasingly, the currency is becoming digital now with more and more payments and transfers being made digital.

Cryptocurrencies, based on decentralized blockchain technology, can be understood as another potential evolution in the issuance of currency and the creation of money. In such a case, no paper currency, as we know it today, need to be issued or only a required number of small denomination notes can be issued in paper form for small transactions, with the bulk of money/currency being issued and managed using blockchain technology. Such a currency, the crypto-currency, would have a decentralized ledger, with all participants owning a part of the cryptocurrency stock, keeping the entire decentralized ledger, and then transacting- making and receiving payments- using this decentralized ledger.

The currency and monetary systems are very large. Maintaining the value of currency and money is complex. Block-chain technology is designed to keep a decentralized record, but it has no algorithms or programme which can manage, maintain or move the value of the currency with the real economy and stable conversion with the real/official currencies.

Inherent technological deficiencies can possibly improve in the future, though it is not known at this stage. What, however, has gone crazy is that the currency issuance function has been taken over by the private entrepreneurs and that too mostly in a secretive, manipulative and cryptic manner. 

Problems with Private Crypto-Currencies

There are three basic problems with the private crypto-currencies:

1. Is it a currency or a commodity? A currency primarily serves the purpose of making payments for goods and services. A commodity is a good which has value for the consumer. Some commodities like gold and silver have also served the purpose of currency. That required stable value of such a commodity. The value of gold and silver also fluctuated sometimes and the size of the economy grew much faster than the growth of gold and silver leading to the abandonment of these valuable metals also as currency. A crypto-currency is not a commodity with any intrinsic or commonly acceptable value. For some, it might have value like crazy work of art. Moreover, as crypto-currencies can be created in almost unlimited quantities, these, by economic logic, have no value as the supply far outstrips demand. Given the nature of private crypto-currencies, there are no attributes of a currency. Even as commodities, these seem to be regressing towards being of no value.

2. How do you maintain the value of a freely supply crypto-currency? The most basic feature of a currency is that it serves as a standard unit of value to enable payments to be made for goods and services in the economy. This standard unit of value cannot be set or discovered in isolation of the production and exchange of goods and services in the economy. The Central Banks, using their monetary policy tools and instruments, maintain the value of currency or money.

The crypto-currency private entrepreneurs do not have any ability to maintain the value of the currency. In fact, they mostly destroy the value by expanding supply, which can be limitless. That is the reason these crypto-currencies, barring a few, have not survived as a payment medium, including for making international remittances and payments, the purpose for which these were arguably designed. This is what is reflected in the demise of many crypto-currencies or almost total loss thereof.

The social media giant, Facebook, is attempting to come up with a decentralized block-chain based currency, in permission mode, called Libra to enable easier payments. Libra is not intended to create a quick fortune for Facebook as other crypto-currency entrepreneurs have tried to do.  Libra’s design is based on its standard value being set in relation to a basket of currencies. It is more like an attempt to use the concept of Special Drawing Rights or SDRs created by IMF.

Facebook can succeed in socializing the concept of SDRs for making payments, but in such a case, no new cryptocurrency will be created. It will be a digital currency based on the value of an underlying basket of official currencies.

The integrated world of today needed a common language. English is increasingly serving that purpose. The integrated financial world of today also needs a common currency. US dollar is serving that purpose. The English language is not owned or controlled by the British, the US dollar is by the United States of America. The world needs a global currency that no particular nation controls. Libra is possibly trying to meet this need.

Facebook, however, would find it difficult to implement the thought behind Libra.

First, Facebook would have to create enough of Libra by buying and retaining all the underlying currencies in the ratio of value as Libra fixes to determine the nominal/standard value of Libra. It will cost a lot. Any attempt to keep only a fraction of the underlying aggregate value would be fraught with lot of risk for Facebook.

Second, as none of the payment receivers and makers actually will have Libra as its own currency, the users would do conversion of Libra in their own currencies. Even those whose currency is used as a part of the pool, would find its value differently moving as the movement relative to their own currencies can be quite different. Building confidence in the value of Libra would be quite a tough task for the Facebook.

Finally, Libra would not make any money for Facebook which will be managing this system, as either, it will not charge anything for making the payments (as it does for messages) or, if it charges, it might not be large enough to cover the costs as the incentive of people to use Libra would disappear relative to making payment in their own currencies using normal banking channels if charges are quite high.

3. Can a currency be issued by a private entity? Value denominated on a currency note is many times more than the intrinsic value of the underlying paper. If any private person or entity is to issue such a paper currency, can it work at currency?

Let us see it in the context of paper currency first. If any person can issue a paper currency, why would everyone not print currency? If such a thing happens, it would only lead to chaos. There would be no demand for such worthless paper currency. Therefore, such a paper currency, even if permitted, would not come into being.

The same logic applies to private crypto-currency. It costs nothing to issue a crypto-currency, except burning units of power, akin to the cost of running a printing press. Therefore, in the situation of full information symmetry and everyone being able to issue crypto-currency, no such crypto-currency will have any buyer or user. As there is considerable information asymmetry and it is believed by many to be a big technological innovation known to only a few, for a short period of time, crypto-currencies may have some fans. When others catch up with technology, as many are already doing, the crypto-currencies would become a totally useless and valueless commodity. It will lose value very fast. Recall the hullaballoo over dot.com mania earlier and its eventual disappearance.

For the reasons stated above, I am convinced that private crypto-currencies would have a very short future. However, some people will make profits, and a lot of gullible people would lose. It is generally the small persons who suffer. If today’s valuation is anywhere close to $200 billion, the crypto-currency magic must have made some billionaires, obviously at the cost of a lot of people who have purchased these essentially worthless codes.

Money is fast becoming digital

With the economy, fast becoming digital, currency and money cannot remain physical. Paper currency will increasingly become insignificant.

It costs to print paper currency and manage the system of paper currencies. As it is easier to fake paper currency, the Central Banks have to constantly upgrade the security features embedded in currency notes. Thieves take some time to catch up, but they do. If any enemy country is interested in sabotaging, such attempts become much more serious. Building upgraded security features require new paper notes to be printed. It costs. Paper notes have limited life. Replacing the paper notes with plastic material or other material is costlier. The physical movement of paper currency notes also costs money. It costs also to store notes, stuff the same in ATMs, or deliver it on the counter of banks. Digital transactions relatively have almost no cost. Yes, digital systems can be hacked. The Central Banks have to build appropriate security systems. Relatively, still, digital money management is a lot cheaper than the cost of managing the paper currency system.

Despite the costs, the Central Banks/Governments make a lot of profit in the paper currency business. The cost of printing and managing paper currency systems is a fraction of the total value of currency notes issued. Some Governments/ Central Banks treat the difference between the nominal value of the currency and the cost thereof as profits. Most treat the difference between the returns on financial assets purchased from the currency issued less the cost of printing the currency notes as profits. In India, it is the latter. Tension and tussle between the Government and the RBI over the surplus is actually the sharing of this profit.

The Central Banks create ‘digital money. M3, which is generally the broadest measure of money supply, is several times the paper currency held by the public. The difference between broad money and currency is largely the deposits of various types held in banks. Deposits in the banks are increasingly used to make payments digitally.

Digital payments are expanding fast.

While being cautious in liberalizing payment systems, India has been quite a good innovator in several aspects of the payment systems. The Unified Payment Interface or UPI is one such innovation. By bringing all the bank account balances digitally together under one digital system, the National Payments Council of India (NPCI) allows every account holder to make or receive payments using their bank accounts. The system is quite simple and well designed. UPI payments have crossed 100 crores transactions a month. In November, 122 crore payments were made using UPI, transacting payment of Rs. 1.89 lakh crore in the process. It is growing quite fast.

Digital transactions, including UPI and other methods, are also growing quite fast having crossed 2100 crore transactions in the first 8 months of 2019-20.

The UPI-led digital payment system in India costs almost nothing compared with the system of paper currency-based transactions. The ease of payments and almost no cost of transactions has been enabled by integrating all the bank account balances in one digital system.

International transfers and payments cost much more. A World Bank study estimated this cost in 2017 to be of the order of about $30 billion or about Rs. 2.1 lakh crore. Indian diaspora ends up paying about 2.5% or more for small-ticket transactions. Immigrant workers of some countries lose 15-20% of their earnings in the transfer of funds to their homelands.

All this happens because there is no integration of bank accounts and its balances internationally. In fact, most developing countries and even many advanced countries, have not been able to do so even domestically.

One possible way is to take the concept and technology of UPI to all over the World. Beginning can be made from countries in the Middle East. Once this integration takes place, all that is required to do is to fix a reference exchange rate, which the Central Banks can do. This will almost eliminate the cost of international transfers and payments as well.

This will make currency and money digital domestically as well as internationally. You don’t need crypto-currencies to do that.

Final switch over to digital money

It is possible to conceptualize the final make-over from the paper currency system.

In the securities system, dematerialized record keeping of securities has replaced the physical system of securities. No longer are share or bond certificates are issued or held by the holders in physical form. A depository keeps all the shares and bonds in its ledger. Holders only have a statement noting their beneficial ownership of the number of shares and bonds of different companies and governments they hold. But, they buy, sale and transfer these securities with total ease and at much less cost compared to what used to be the system when these required physical transfers.

In India, stamps required to be affixed on the registration documents are also now being issued increasingly in dematerialized form. It allows much easier use and the Governments also collect their revenues more efficiently. Recently, the Government of India and the State Governments have agreed to collect stamp duty on securities in a seamless manner digitally using a centralized collection system.

It is possible to dematerialize currency notes also.  The Central Bank can issue currency in dematerialized form. The Central Banks issue currency when they buy bonds or foreign currencies or other instruments from the Banks. The Central Banks can do this by paying in dematerialized digital currency. Holders can hold dematerialized currency in a digital currency card or virtually. Only small notes which are required for very small denomination transactions can be issued physically for some time till everyone gets ready to move fully to digital.

The Central Banks would benefit more as they would continue to get the seigniorage as they are getting presently. In fact, this would be somewhat higher as the cost of printing physical notes would be saved.

People would be real beneficiaries as making payments would be much easier, faster, and less costly.

It is time to make a move towards full digital currency or money.