-Article contributed by Pallak Goyal and Upasa Borah, MA students, Faculty of Economics, South Asian University
The acceptance of cryptocurrencies saw a spike in the aftermath of the Global Financial Crisis of 2008 and Bitcoin emerged as the pioneer at that time. Today, different cryptocurrencies like Primecoin, Dash, and Verge have come into play. For the purposes of this discussion, cryptocurrencies are distinguished as possessing three different properties. Firstly, they are a digital immutable ledger based on blockchain technology. This means that they are based on a book of accounts in which each entry is verified through the solution of a complex mathematical puzzle. These entries once made cannot be deleted (Haksar and Bouveret, 2018). Second, they are decentralized in control and operation. That is, there is no central authority with the power to issue the currency or control its circulation, under reasonable conditions, such as the absence of a 51% attack (Nahar, 2021). Third, their value is determined purely on the basis of demand and supply. This means that they do not have any intrinsic value. An implication is that stable coins, based on asset backing, are ruled out from this definition of cryptocurrency1. This is because the issuers of asset-based stable coins hold assets-like claims on the US treasury, publicly traded commercial bonds, etc., these can be the basis of demand for these stable coins.
In theory, cryptocurrencies could address the issue of excess inflation created by governments in a bid to undertake deficit financing (Marthinsen and Gordon, 2022). This follows from an extension of Friedrich Hayek’s theory in favour of having multiple commercial currencies (see Hayek’s Denationalisation of Money) (Aggrawal, 2022). However, the cryptocurrencies in the form discussed above cannot serve the other basic functions of money. Firstly, they cannot be a medium of exchange as they are not widely accepted. Unlike fiat currencies, they do not have any credible authority backing them and unlike gold, they do not have any intrinsic value (Haksar and Bouveret, 2018). Secondly, their fluctuating values rule out their use as a unit of account. Thirdly, they aren’t a store of value as they are not backed by any assets. Therefore, there seems to be no reason to believe that these currencies can become widely accepted in the future.
Any conversation by proponents of cryptocurrencies inevitably talks about the potential for inclusion that the decentralized nature of cryptocurrency can bring about (Stonberg, 2021). Several studies conducted in the US show that crypto owners belong to different races (Hale, 2021). A case can be made that crypto enables the inclusion of socially disadvantaged people, like sex workers or LGBTQ people, that are often excluded from the traditional banking and financial systems (Samantha Cole, 2022). A deeper look, however, raises several questions. The crypto industry is largely male-dominated, with female participation at only 4 to 6% (Hao, 2018). Forbes’ database of the richest cryptocurrency holders in 2022 includes only men and no women (Hyatt, 2022). Moreover, the owners of crypto are usually high-income individuals. Due to the high-risk, volatile nature of cryptocurrencies, only those empowered to take risks can invest in cryptocurrencies. Unsurprisingly, it often happens to be young upper-class men belonging to socially privileged communities. This, coupled with pre-existing inequalities in digital access and financial literacy, keeps large sections of disadvantaged social groups outside the cryptocurrency market altogether. There are also sharp inequalities in crypto-holding: a study conducted by MIT Sloan School of Management and London School of Economics in 2021 found that of the 19 million Bitcoins that were circulating that year, 0.01% of the buyers controlled 27% of the total supply (DeGeurin, 2021).
In developing countries, a similar disproportionate adoption of cryptocurrency could be seen. First, when it comes to technical know-how, there exists a huge gender gap. For instance, the number of female students in STEM courses is as low as 3% in IT ad 8% in engineering, world-over (Wood, 2020). Similarly, when it comes to finance, women do not have the same access to financial services as their male counterparts, and this inequality worsens in developing countries (Klapper & Demirguc-Kunt, 2013). This gender gap in knowledge and access to finance, compounded by other social barriers, could keep women from the potential gains of cryptocurrencies, further deepening the persistent gender inequalities. Second, internet and technological penetration in most developing countries is less than 50% (Okoth, 2022). The learning curve and hurdles are thus much higher for people without access to technological options. Third, with meager financial literacy rates in developing countries, people become more vulnerable to the scams and frauds that plague the crypto world and are seen to be increasing over the years2. Fourth, cryptocurrencies are not the solution that unbanked people are looking for. Several socio-economic factors like lack of trust, low income, unsuitable products, poor service, and discrimination lead to the exclusion of certain people from the banking sector in their country. What is required for them is safe, cheap, simple, and trustworthy ways of saving money. Crypto, with its volatility and costs involving knowledge and technology acquisition, and unregulated platform fees, is not the ideal alternative.
Cryptocurrencies can help reduce the costs and hassles of cross-border transactions and provide transparency and diversification. But when it comes to inclusion, high risks and lack of consumer protection could potentially exacerbate inequalities prevalent in our already unequal societies. Moreover, the use of cryptocurrencies for illegal transactions not only imposes an increased risk of crime but also gives rise to a shadow economy. This can have wide-ranging negative consequences if it spirals out of control: reduce government revenue collections, make all economic forecasts precariously unreliable and create unstable political conditions.
Cryptocurrencies are no panacea for developing economies. Theoretically, they are a cure for excessive inflation generated by seignorage, but they are unable to perform the basic functions of money. The claim that cryptocurrencies can lead to more inclusive growth does not stand scrutiny. They pose additional risks of the creation of a shadow economy and an increase in crime levels. However, the potential for reducing the cost of a cross-border transaction should be exploited. This could be done by the creation of Central Bank Digital Currencies, as is under progress in several countries. The existing cryptocurrencies should also be regulated, though we are against an outright ban because it is seldom effective in practice (Live Mint, 2021). The public at large should also be informed about the nature of these currencies to prevent the exploitation of unsuspecting citizens. The Reserve Bank of India (RBI) could direct public and media attention toward this issue by including it in important addresses of the Governor and Deputy Governors. It could also be made a part of consumer education initiatives such as ‘RBI Kehta Hai’. Central banks across the world should cooperate to come out with a coherent regulatory framework for crypto currencies.
Notes
1. Stable coins are cryptocurrencies that are either backed by an asset or have an algorithm that ensures the stability of their value. Meta’s Diem for example was backed by assets from around the world as well as dollar reserves. However, the reservation of the US Congress led to the project being disintegrated and sold to Silvergate Bank.
2. The recent fraud allegations against Sam Bankman Fried, founder of FTX.com are proof of rising cases across the world. Bankman Fried is accused of using client funds for speculative investment without their permission.
Development Study Group, South Asian University 