Understanding cryptocurrencies: What’s to like, and what’s to fear

  1. An inter-ministerial committee (IMC) that was set up to assess the viability of virtual currencies has recommended that India should ban private cryptocurrencies such as Bitcoin.
  2. A cryptocurrency is a subset of virtual currencies. It is decentralised, and protected by cryptography. Example: Bitcoin, Etherum, etc.
  3. A virtual currency is a digital representation of value that can be digitally traded. It functions as (a) a medium of exchange, and/ or (b) a unit of account, and/or (c) a store of value. However, unlike fiat currency like the rupee, it is not legal tender and does not have the backing of a government.
  4. All virtual currencies use Distributed Ledger Technology (DLT). It refers to technologies that involve the use of independent computers (also referred to as nodes) to record, share, and synchronise transactions in their respective electronic ledgers. Unlike traditional ledger, data in DLT is not centralised.
  5. Cryptocurrency like Bitcoin uses Blockchain technology- a special kind of DLT. A Blockchain is a digital, immutable, distributed ledger that chronologically records transactions in near real time.
  6. Internationally, the application of DLT is being explored in the areas of trade finance, mortgage loan applications, digital identity management or KYC requirements, cross-border fund transfers and clearing and settlement systems.
  7. The inter-ministerial committee (IMC) has recognised the potential of DLT and Blockchain. It has recommended the Department of Economic Affairs to take necessary measures to facilitate the use of DLT in the entire financial field after identifying its uses.
  8. Further, it has also recommended that that regulators — RBI, SEBI, IRDA, PFRDA, and IBBI should explore evolving appropriate regulations for development of DLT in their respective areas.
  9. However, it has called for a ban on private cryptocurrencies. It also noted that the RBI Act has the enabling provisions to permit the central government to approve a “Central Bank Digital Currency” (CBDC) as legal tender in India.
  10. The IMC has highlighted a number of concerns regarding private cryptocurrencies. These are: a) non-official virtual currencies can be used to defraud consumers, b) scaling up such a currency system over a large population would exploits huge levels of energy resources, c) the RBI would lose control over the monetary policy and financial stability as it would not be able to keep a tab on the money supply in the economy, d) anonymity of private digital currencies make them vulnerable to money laundering and use in terrorist financing activities, e) there is no grievance redressal mechanism in such a system, f) transactions are irreversible in such a system.