The debate over Bitcoin across the world is becoming more and more intense as its price is touching new highs. Every day something is being said either for or against it. The regulators across the world, however, appear to be hesitant in taking a clear stand on the issue as Bitcoin and its impact is still not fully understood. The setting up of a committee by the Indian government to take a look into the issue from a taxation point of view followed by some field action by the Income Tax department and the stern warning from the US Securities and Exchange Commission to Bitcoin investors are welcome moves to put some check on the euphoria that has gripped the financial markets, more particularly the younger generation. Younger investors are relatively less aware of the fact that the history of financial markets is punctuated by ‘bubbles’ starting from the ‘Mississippi Bubble’ in the 18th century in France to the dotcom bubble in the late 1990s in the US. The bursting of all these bubbles, though not without undesirable consequences on the economy and society, has, time and again, reminded the world of the inviolable law of finance that ‘trees do not grow to the sky’. Unfortunately, our memory is very short.
Coming to the case of Bitcoin, another bubble appears to be in the making. Its price has surged by a multiple of 18 in a year to touch $17,600. Many are feeling ‘left out’ and are jumping on the bandwagon even at this price as some market pundits are predicting Bitcoins to touch $100,000 before crashing down. It is difficult to understand the rationale of permitting trading in Bitcoin futures on two renowned global exchanges —CBOE and CME — as the credibility of the underlying is still being heatedly debated. In this regard, Interactive Brokers’ founder Thomas Peterffy’s statement regarding bitcoin on the eve of its trading on CBOE deserves attention. He said his concern was that “cryptocurrencies (Bitcoin) could continue to rise to $100,000 or more before crashing to zero, and could pull down small brokerages in the process”. It is feared that trading in global exchanges may, though unintentionally, give appearance of credibility and legitimacy to a product as controversial as Bitcoin, and bring the cryptocurrency into the mainstream attracting more and more gullible investors to it.
In the debate on Bitcoin some very fundamental issues are being ignored. Bitcoin is being promoted as decentralised international virtual currency. Everyone knows, currency is nothing by itself. It is simply a medium of exchange. It is the ‘trust’ which makes people accept any particular currency —trust in a person paying it; trust in the person issuing it and trust in the bank which is honouring it. Money is not metal or paper but ‘trust’ inscribed. In the modern world it is the government or the central bank, whom the people trust while accepting any money or currency. In the case of cryptocurrency, where is this trust? In whom the people should trust. Nobody knows who is creating this currency and who is guaranteeing the same.
The second issue is relating to ‘price discovery’. The financial markets have evolved very fast over the last few decades learning from various ‘scams’ and cycles of ‘booms and busts’. Today, removal of ‘information asymmetry’ is considered imperative by regulators for protecting the interest of investors. In the case of Bitcoin, there is a huge information asymmetry existing between the insiders and lay investors leading to serious distortions in the price discovery. The whole trading appears to be happening in a ‘black box’ — where nobody knows who is managing the show; who is holding what; how concentrated are the holdings. This is why the price of Bitcoin is highly speculative and thriving only on the mass frenzy created by interested parties. In this scenario, the beneficiaries of this ‘irrational exuberance’ are going to be a few insiders who are managing the show at various levels and have substantial holdings created or bought at throw away prices in the initial stages.
The price of Bitcoin is thriving on the frenzy created by interested parties
The third and the most important is that in modern times when central banks are regulating money supply to control various vital economic parameters such as interest rate, inflation rate, exchange rate and economic growth, there cannot be a case for any kind of international cryptocurrency being allowed which may start to undermine the domestic currency. This may lead to various undesirable consequences, the most worrisome being the loosening of the control of the central bank and consequently the ‘Sovereign’ over the macroeconomic parameters of its own economy and the likely erosion of people’s hard earned wealth kept in the national currency or its equivalent. Further, the central bank will also find it difficult to deal with ‘systemic risks’ because of many externalities involved in the trade of cryptocurrencies.
Acceptance of any kind of international currency like Bitcoin may shift the control over the economy from the national government to international anonymous players who may be powerful financial wizards or proxies of foreign governments or even belong to the underworld. Whether any country will welcome this kind of scenario — certainly not. Time has come when the above basic issues need to be addressed before international Bitcoin lobby becomes too strong to be resisted. Bitcoin’s market capitalisation is already $300 billion (Rs 20,00,000 crore approximately) and is surging.
There are also serious concerns about cryptocurrencies being used for money laundering and funding of terrorism. Hence, international organisations like Financial Action Take Force need to take appropriate action.
The writer is a former whole-time member of the Securities and Exchange Board of India