The Risks of Cryptocurrencies

Reserve Bank of India (RBI) Governor Shakti kanta Das recently spoke at the Business Standard BFSI Insight Summit, where he emphasized the risks associated with cryptocurrencies. He even went so far as to say that private cryptocurrencies, which were originally intended to disrupt regulated fiat currencies, could potentially cause the next major financial crisis. These cryptocurrencies present a danger as they are not anchored to anything and are "100% speculative." The collapse of the FTX exchange is a cautionary tale and other major exchanges, including binance, are currently under regulatory scrutiny.

It is clear that cryptocurrencies are speculative instruments, with the original white paper on Bitcoin stating that they were designed to break the fiat system. The fact that many people, including central bankers and "big four" accountants, have difficulty understanding cryptocurrencies has made regulation difficult and exacerbated the problem. There has been a significant drop in crypto prices in the past year, and it is uncertain if this downturn will trigger a financial crisis. The extent of contagion in the traditional global financial system will be a determining factor.

Innovations Introduced by Cryptocurrencies

Despite the risks and uncertainties associated with cryptocurrencies, the design of these assets has incorporated several innovations that will likely continue to have an impact even if the value of the assets themselves evaporate. Bitcoin introduced the concept of blockchain technology, which is an electronic ledger used to verify the authenticity of transactions while maintaining privacy. Blockchain has since been adapted for various purposes, including verifying the provenance of luxury goods and creating "trustless contracts" in Estonia and Finland. It has also been used by investment banks as a strong safeguard against internal fraud and in China to bypass censorship.

Cryptocurrencies have also made it easier to conduct cross-border transactions, leading to the development of central bank digital currencies. The ease of use of cryptocurrencies in cross-border transactions has resulted in central banks smoothing the process for such transfers by launching their own digital currencies. The cost of cross-border transfers has been reduced as it has been observed that converting the euro into Bitcoin and selling it in US dollars can be cheaper than traditional bank transfers.

Regulatory Stance on Cryptocurrencies

Regulatory bodies around the world have taken different approaches to cryptocurrencies, ranging from outright bans to more permissive approaches. Some countries, such as China, have encouraged the development of blockchain-related uses while being against the use of cryptocurrencies. Other countries, such as the US, Canada, and Australia, have allowed the use of cryptocurrencies, but have implemented regulations to mitigate the risks associated with their use. It is worth noting that cryptocurrencies are still legally usable in many countries.

Implications summarized

Cryptocurrencies have had a significant impact on the global financial system, introducing innovations such as blockchain technology and making it easier to conduct cross-border transactions. However, they remain speculative instruments that carry a degree of risk. Tightening of global financial conditions could further affect the performance of these assets. The blockchain technology introduced by cryptocurrencies has also had a range of real-world applications, and it is likely that these will continue even if the value of the assets themselves evaporate. It is important for investors to be aware of the potential risks and uncertainties associated with cryptocurrencies.

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