Cryptocurrency, also known as crypto, is a digital or virtual form of currency that utilizes cryptography to ensure secure transactions. Unlike typical fiat currencies, cryptocurrencies don’t have a central issuing or regulatory authority. Instead, they use a decentralized system to record transactions and issue new units. The backing for this decentralized system comes from a peer-to-peer network known as the blockchain.
Benefits of Using Cryptocurrency
Using cryptocurrencies provides several benefits. For one, they offer fast and cheap transactions, especially for international transfers, because they eliminate the need for multiple intermediaries.
Besides being a transaction medium, cryptocurrency also serves as an investment destination. Much like gold, there’s a finite supply of cryptocurrency. As a result, the increasing demand for these digital assets has led to their prices skyrocketing over recent years.
Additionally, due to the high demand and the limited supply of cryptocurrency, its price tends to be on a steady incline. Because of this, people are more likely to hold onto their cryptocurrency rather than spend it, creating a deflationary effect on the currency.
Countries Adopting Cryptocurrency as Legal Tender
Recently, the Central African Republic (CAR) became the second country after El Salvador to adopt Bitcoin as legal tender. This move was taken to facilitate “strong and inclusive growth” and put CAR on the map of “the most courageous and visionary countries in the world.”
There’s a potential direct relationship between inflation and countries allowing the use of cryptocurrencies. These digital currencies can transform an inflation-related decline from legal tenders into positive growth. This potential correlation is particularly relevant for countries like CAR that are expected to face increasing inflation.
Cryptocurrencies and Geopolitics
Countries that have formalized Bitcoin as legal tender like El Salvador and CAR don’t have their own currency. For instance, El Salvador uses the US dollar, while CAR’s franc is a shared currency across 14 African nations forming the ‘Franc Zone’.
Hence, adopting cryptocurrencies can help these countries circumvent sanctions, embargos, and dependencies on foreign currencies. However, it should be noted that such decisions also have geopolitical implications.
Potential Drawbacks of Using Cryptocurrencies
Despite the perceived benefits, using cryptocurrencies comes with its own set of challenges. Because of their unregulated nature, cryptocurrencies are highly volatile assets. This volatility risks the macroeconomic stability of countries, particularly those with weak socio-economic fundamentals.
The International Monetary Fund (IMF) has urged countries like El Salvador to limit the scope of unregulated assets due to the significant risk they pose to financial stability, financial integrity, and consumer protection.
Additionally, when taxes are collected in cryptocurrencies while expenditures remain in local currency, countries face a potential risk. For example, if a government collects $100 worth of taxes in crypto, but the value drops, they may only have $40 left to spend.
Moreover, unlike traditional assets, cryptocurrencies aren’t subject to a definitive mechanism and are speculative by nature. This means that central banks won’t have any reference point to adjust their interest rates based on domestic requirements.
Lastly, while blockchain technology can trace transactions, it cannot identify the parties involved, making it potentially usable for money laundering, terrorist financing or other illegal activities.
UPSC Civil Services Examination – Previous Year’s Questions
In the 2016 UPSC examination, a question was posed about Bitcoins: “With reference to ‘Bitcoins’, sometimes seen in the news which of the following statements is/are correct?” The options included: Bitcoins are tracked by Central Banks, anyone with a Bitcoin address can send and receive Bitcoins from anyone else, and online payments can be sent without either side knowing the identity of the other. The correct answer was options two and three.
These examinations highlight the growing importance and relevance of understanding cryptocurrency, both for its potential benefits and the challenges it poses.
