Most of us have heard terms like Cryptocurrencies and Bitcoin by now. Even ‘Google Search Trends’ for some of the keywords are showing parabolic trends. Bitcoin is breaking all-time high records on almost daily basis. It is trading above $1,610 (i.e. above Rs 1,00,000) at the time of writing this article.
Bitcoin was created in the wake of the 2008 global financial crisis to operate outside of governments, central banks and financial institutions. Since then, Bitcoin’s framework has challenged many regulators, as most of them struggled to find ways to bring it under control. This led to some countries banning it or making it illegal, while some others remained observant and the rest worked out ways to tax and regulate its operations. Recently in February, RBI reiterated their 2013 stance on distancing itself from cryptocurrencies, highlighting various potential financial, operational, legal, customer protection and security related risks.
Before we dwell down on factors fuelling the growth of this industry, we need to understand what is Bitcoin or any crypto-currency in general. A cryptocurrency is a digital currency that is created and managed using advanced cryptographic techniques. Like fiat currencies, crypto currencies are also used as means to transfer value. However, they have several advantages over traditional currencies in terms of accessibility, immutability, faster settlement, lower/negligible transaction fees, fraud/identity theft prevention and anonymity.
Cryptocurrencies derive their value from active community, trust of the network, demand/supply forces and underlying use cases. Since there is no central authority involved, in order to keep track of all the transactions and transfers, technology like Blockchain is used. Blockchain is mainly a distributed ledger where participants keep records of all the transactions. Transactions happening within a particular time frame are grouped under a Block which is then mined (by solving mathematical problem) using computers or specialized machines. These Blocks are then referenced to previous Block creating a linked chain. If a particular Block is changed, all the subsequent Blocks become invalid unless all of them are mined again. Mining is very difficult and computationally heavy for popular cryptocurrencies like Bitcoin. Your normal desktop computer will not be able to mine a single Bitcoin within 500 years! That’s the reason most of the people either buy specialized but expensive Application Specific Integrated Circuits (ASIC) or team up and mine Bitcoins in a pool and distribute rewards.
Let’s have a look at some of the factors that are driving growth of Bitcoin and cryptocurrencies.
Higher visibility and adoption: Countries like Japan recently recognized Bitcoin as a legal method of payment. Although they treat it as an asset and not as a currency, Japan has seen huge surge in Bitcoin demand. In India, the Department of Economic Affairs, Ministry of Finance has constituted an inter-disciplinary committee to examine the existing framework around Cryptocurrencies and submit report by July. The committee will not only examine the present scenario of crypto currencies in India and around the globe, but will also suggest measures and means to deal with consumer protection, education and money laundering. In Estonia, government is implementing blockchain technology for healthcare, banking services and even governance by allowing its citizens to become ‘e-Residents’. Countries like US, UK, Denmark, Sweden, South Korea, Netherlands, Finland, Canada and Australia have been supportive of Bitcoin and Cryptocurrencies. Billionaire Mike Novogratz recently revealed that he holds more than 10% of his net worth in cryptocurrencies like Bitcoin and Ethereum.
Political Instability and Mistrust: In times of Political unrest, Economic instability and uncertainty around the world, currencies like Bitcoin became safe-haven for many people. Further news on NSA targeting SWIFT banking network increased fear of government espionage and resulting mistrust provided boost to currency like Ripple.
Fear of Missing out (FOMO): Like normal stock market when people see higher returns and new avenue for investment, they would like to ensure that they don’t miss the bus. Last few months there has been huge uptick in terms of new wallet opening and trading volumes indicating expanding userbase.
Increasing usecases and linked Products: Due to borderless characteristics, Bitcoin and other Cryptocurrencies are used for P2P landing, Margin Lending and Freelancing services without any fees. Further products like Smart Contracts, self-directed IRA account and proposed ETFs are also fuelling the demand.
Initial Coin Offering (ICOs): Unlike IPOs where people must go through cumbersome regulatory process, ICOs just requires a whitepaper and interested user base. It is new method of crowdsourcing where digital tokens are issued to the participants in exchange of Bitcoin or other crypto currencies. In last few months we have seen more than 100 ICOs raising $1 million to 5 million within couple of months. Interestingly there is also a rating agency for such ICOs! While in US SEC has issued guidelines on ICOs, India has not yet issued any advisory.
As a conclusion, while cryptocurrencies are promising, one should not ignore the risks associated with them. Many new cryptocurrencies are highly illiquid and some of the ICOs are outsight scams. Specifically, in India, till the time RBI or Government come up with clear guidelines, it is better to play safe.
