Crypto emerges from the shadows

US decision to allow spot bitcoin ETFs marks the latest win for this asset class

It’s been about 15 years since Satoshi Nakamoto released the seminal paper that outlined the concept of Bitcoin, and launched a new class of financial assets, cryptocurrencies. Just by surviving through a tumultuous period, they have acquired acceptance.

The latest “win” for the asset class is the US Securities and Exchange Commission’s (SEC’s) permission to list spot bitcoin exchange-traded funds (ETFs) on US exchanges. Several such ETFs will list. This opens the door for institutional investors to put money into cryptocurrencies.

The 2008 paper introduced the concept of a currency not controlled by any entity (i.e. a central bank). Each “coin” is a unique electronic code that can be divided into 100 million unique sub-units. The money supply is driven by algorithms that create new coins by “mining”, which involves solving complex math puzzles.

Ownership is registered in an immutable electronic ledger, a blockchain, which is verifiable by anybody.  That ownership is anonymous.  The blockchain registers the history of each coin from the instant it is “mined” through every transaction. Each coin is placed in an electronic wallet, and only the owner has the password. Think of the wallet as a transparent bank locker; the contents are visible but only the key holder can operate it.

Transactions occur when the owner of a wallet proposes to move a coin from that wallet to another wallet.  Every transaction is verified collectively. Once a majority of people viewing the blockchain agree that coin “x” was in wallet “1” and it may be transferred to wallet “2”, the transaction is verified, and the blockchain is updated. Timestamps prevent dual transactions, and anonymous transactions can be carried out.

There are problems, of course. A forgotten password can’t be retrieved and there is no easy way to prove a hack if one occurs.

Fractional-reserve banking is impossible due to the fixed money supply, and blockchain design. Loans are cumbersome as a result. The anonymity lends itself to illegal transactions. The currency is not linked to anything, so it swings wildly — more than stocks, or fiat currencies, which are linked to variables like trade and gross domestic product data.

Apart from anonymity, one big advantage for cryptocurrencies lies in their ability to cross borders. This can be done by just sharing the password to a wallet.

Transferring from euro to bitcoin to US dollar thus can cost less than a direct euro to US dollar transfer, provided traders can stand the price volatility. Moreover, this circumvents bans, as the European Central Bank found when euro-to-other fiat transfers out of Cyprus were blocked.

 Easy processing of remittances is the reason why El Salvador adopted Bitcoin as an alternative legal tender. It’s one reason why Brazil, Argentina and Mexico generate high volumes. Given India’s $100 billion in inward remittances, it needs to look at this.

Enthusiasts claim the fixed money supply is an edge in an inflationary environment, or when a fiat currency is under the hammer. Thus, Bitcoin is touted as a store of value like “virtual gold”. It had a great year in 2023, for instance, as traders bid it up.

There are thousands of copycat cryptocurrencies built on similar models. They range from outright scams to improved design in cases like Ethereum, which has a better blockchain, allowing for the incorporation of “trustless contracts”.

Blockchains have been adopted for multiple tasks. Banks use them internally as anti-fraud tools. The United Nations High Commissioner for Refugees uses them for dispensing aid to refugees. Municipal corporations in Finland and Estonia have experimented with them for gauging citizen feedback on urban projects. Chinese students have used them to bypass censorship — a blockchain can be annotated and the note cannot be erased.

 Many applications such as non-fungible tokens (NFTs) are also linked to cryptocurrencies. Blockchain developers are often offered payments in cryptocurrencies. India’s refusal to clarify its stance on this asset class has retarded participation in these markets. Nobody is clear how cryptocurrencies are classified. Are they considered currency or art objects?

The decision to impose the highest tax rates on cryptocurrencies has also driven trading volumes underground, or abroad. However, buying ETFs should be legally possible without attracting punitive taxes.

This is the latest step in the global regulatory recognition of cryptocurrencies. India will, sooner or later, have to bite the bullet.