13 Feb 2018 19:35 IST

Is this the endgame for cryptocurrencies?

cryptocurrency

It is the duty of the government to protect investors, which is why it shouldn’t legalise the virtual asset

Goldman Sachs’ Steve Strongin’s statement that he believes most cryptocurrencies will most likely trade to zero within a decade, was one of the strongest pronouncements against this asset class in recent times. It also signals that the recent manic rally in Bitcoin and other cryptocurrencies, which was as bad as the tulip mania in the 1600s and the dotcom bubble in 2000s, is probably complete.

Bitcoin, Ethereum, Litecoin and over a hundred other cryptocurrencies are virtual assets created through computer programs by miners across the globe. The creation of coins and all subsequent transactions are maintained in open ledgers, called blockchains, that give these assets transparency not enjoyed by traditional currencies. The fact that this asset did not have any government or authority controlling it caught the fancy of non-conformists, who thought that cryptocurrencies could be an alternative to traditional currencies.

But as business magnate Warren Buffett said, lack of intrinsic worth was the greatest drawback of these assets. Since they are created out of thin air, they had no value at all; or to put it another way, any fancy value could be attributed to them. With no authority acting as a check against price rise, runaway rallies and steep crashes have become common. This renders them unsuitable to be used as a currency or medium of exchange.

Stance taken by India

India, in the Union Budget, has taken a stand that cryptocurrencies are not legal tender, mentioning their use in illegal activities.

While the Securities and Exchange Board of India (SEBI) is yet to formulate its guidelines on trading in cryptocurrencies and recognise cryptocurrency exchanges in India, treating them as a tradeable asset, like other commodities, could create more trouble for the regulator.

Can it be an asset?

As of now, the age profile of those trading on Indian cryptocurrency exchanges is between 25 to 40 years. These investors had begun investing small sums of around ₹5,000 every month, as stories of those who had made mouth-watering profits trading these cryptocurrencies did the rounds in late 2017 and early 2018.

Now, it is clear that cryptocurrencies are a high-risk asset class since they operate in a regulatory vacuum. High volatility in prices is another major issue dogging these assets. Sample this: in January 2012, few had heard about Bitcoin, the largest cryptocurrency by trading value, with the value $7. The price raced past $100 in April 2013 and by December 2013, it peaked at $945. But with a series of regulatory bans due to misuse through illegal activities, the value of Bitcoin crashed to $230 by September 2015.

After lying low for a couple of years, it again made headlines in March 2017, when Japan allowed use of the cryptocurrency as a kind of prepaid payment instrument.

Prices surged from $1,000 in January 2017 to hit $10,000 in November 2017. After that it became manic, with a 90 per cent gain in the next one month; Bitcoin’s value hit $19,000! The script was similar thereafter. China, which accounted for the largest share in trading volume, banned trading in Bitcoins and initial coin offering (this is a kind of crowdfunding activity through new cryptocurrencies). This made the Bitcoin price crash to $6,000 in the first week of February 2018, wiping out almost 70 per cent of the value in under two months.

Can it be an alternative asset?

It is possible that prices could drop close to zero, as Strongin has predicted. It is also possible that prices could rise again towards $10,000 and even surpass $1,00,000. Given this volatility, it is critical to protect small investors from getting exposed to this risk.

Trading in Bitcoin and other cryptocurrencies, if legalised, could therefore be classified as alternative investment. But, in this case, SEBI should stipulate a minimum investment limit at ₹1 crore, similar to other alternative assets, so that only investors with deep pockets can take positions in it.

But given that it is SEBI’s duty to protect all investors, whether big or small, is it right to expose large investors to such risk? For there is no authority to curb runaway prices in these assets. Since it is a globally traded asset, price control from India is not possible.

Exchanges trading crypto-assets need to be asked to register with SEBI, before which they need to bolster their net worth, and create a security guarantee fund, surveillance mechanism, clearing corporations, and so on. All this appears a tough ask for the small exchanges that are facilitating trading in cryptocurrencies in India currently.

Given the issues in supervising cryptocurrency trading and the unnecessary risk that investors are taking by trading in these assets, the government should not legalise trading in crypto-assets yet. As India has a small market, with daily traded volume under ₹300 crore, it is not likely to cause a systemic risk.