The Buzz Around Crypto Assets, Decrypted

The Buzz Around Crypto Assets, Decrypted
Cash is king... but is it, really?

Anyone who’s been paying attention to financial innovation in India the last few years will almost certainly tell you that cryptocurrencies and digital tokens seem to be the hottest new trend in finance today. Indeed, look around you, and it’s pretty hard to miss, amid the several YouTube ads for the plethora of crypto exchanges that have cropped up of late (each of them claiming to be India’s most trusted exchange, of course), and the multitudes of currencies and tokens that you can now trade in.

Where did all this begin, though? How did it catch on so quickly in India? And what else might you need to know about the cryptic new space of crypto assets? We try to unpack it all, in simple and relatively brief terms (as best we can), for you.

The origin story

The first time crypto hit the scene was in 2008. A certain individual or group of individuals published a paper that outlined the idea of what was to become Bitcoin, under the pseudonym “Satoshi Nakamoto.” He created the first blockchain database, and was an active, if not leading, force in the coding and development of Bitcoin.

What is Bitcoin in the first place? Simplifying a bunch, Bitcoin is a digital currency that people can use for transactions, without having to go through a central authority or an intermediary like a bank. At its core lies the idea of decentralization, where ledgers for transactions, the core network, and mining process (to create new Bitcoin and group transactions into blocks) are all without a central server or authority that dictates rules or norms. Anyone can send transactions to the network without the need for an intermediary signing off on it- the network merely confirms that the transaction made was a legitimate one.

This decentralization extends to the manner in which investors can register their funds to a completely private, pseudonymous key that isn’t publicly accessible off of a central database. While there are public keys that the Bitcoin network uses to verify signatures in a transaction made using Bitcoin, the signature itself cannot be made without the private key that’s known only to you as the address-holder. These private keys are highly secure instruments, which are made so difficult to hack or crack that trying to do so would be a waste of time. On the flip side, if you lose your private key, since the network doesn’t recognize any other evidence of ownership, you lose access to all your Bitcoin wealth: as one user who lost around $7.5 million-equivalent at the time in 2013 would testify.

The timeline at home

Commercial transactions started taking place in Bitcoin in 2010 (though adoption as a full-fledged currency remains limited to this day). In 2013, a cryptocurrency exchange called Unocoin was launched, which enabled Indian investors to buy and sell cryptocurrencies in exchange for other types of assets like conventional money- think of it as the Bitcoin equivalent of redeeming your tickets at an arcade for the plush toy on the shelves. This prompted the RBI to ring an alarm bell early on, warning investors not to use these currencies because their prices were a “matter of speculation” in the absence of backing by another asset or reserves. As you can see, some debates haven’t changed in a while!

Fast forward to the era of demonetization in 2016, and demand starts to pick up in India, as investors found in crypto an opportunity that afforded them significant privacy, decentralized ways to make payments, and a way to potentially make enormous profits from their price movements. Demonetization showed the entire country that the risk of the government reaching into your wallets and potentially invalidating chunks of your money wealth was no longer a negligible one, or something that would never happen, the merits or demerits of the move notwithstanding. Cryptocurrency gave investors a way to keep their money out of a central authority’s hands, and in the era of demonetization, this was certainly an attractive prospect.

This rise in demand paid off in 2017 when Bitcoin prices really started to spike and interest rose dramatically, mirroring trends around the world. This only intensified the debate surrounding how to view these assets, and how to regulate them in the best interest of the investors flocking to them without necessarily knowing how they worked. Again, some debates haven’t changed in a while!

The pandemic years have seen a strong surge in demand and interest in cryptocurrencies, and the regulatory push and pull continues onward. Prices swing wildly to and fro, often on very arbitrary cues online, and new taxes on profits from crypto trading, at around 30% rates, have left a bitter taste in several investors’ mouths, since they see these rates as being exorbitant. And the impasse over how to regulate these assets, and what they may be capable of, is far from settled at this time, too.

Be a pro with the pros…

Cryptocurrencies have some salient advantages that can make them attractive to investors.

  1. They are extremely secure as methods of payment, and are completely private, meaning that theft is a difficult proposition (though not impossible, in the event of data breaches).
  2. They maintain their value even in the face of high inflation, something that has been making them quite attractive of late, too. This is because there is a limited supply of Bitcoin that sees demand fluctuate, and its value may increase in the long run as a result, rather than decrease with inflation.
  3. They dramatically simplify cross-border payments, because of their decentralized nature and general lack of transaction fees and costs. This means that, unlike with regular payments systems where intermediaries like PayPal or Visa might charge you extra for transacting outside your country, cryptocurrencies are much simpler and cost-effective across borders.
  4. No single organization has a monopoly over their flow and value, a key result of their decentralized nature.
  5. There are several exchanges that are compatible with a range of traditional currencies that allow you to make conversions with a fair degree of ease.

… but don’t get conned and fall for these cons!

With all the advantages, however, it’s important to keep a close eye on the several risks involved with these currencies. Here are some that you should know about.

  1. They may be vulnerable to hacks and data breaches that could compromise your security and result in you losing all your invested wealth.
  2. The price volatility in cryptocurrencies such as Bitcoin and Ether is extraordinary: prices may often surge or tank spectacularly with something as simple as a tweet from influential investors or tech players.
  3. The legality of these instruments is dubious at the moment, and the regulatory risks surrounding them could put your investment in them at this stage in jeopardy.
  4. These currencies are also often used for several illegal transactions and this adds to the risk of government crackdowns on them.
  5. Payments, once made, can’t be refunded or canceled with these systems, and if you get cheated into a payment that you weren’t supposed to make, you have no way to nullify it.
  6. If you lose your private key, somehow, you have no way to unlock your wallet or make any transactions in these currencies.

Join the club, central bankers!

With all the regulatory uncertainty surrounding privately issued cryptocurrencies like bitcoin, a new digital currency has come to town, one issued by central banks themselves. These are called Central Bank Digital Currencies, or CBDCs, and they could be game-changers in this space.

CBDCs are digital forms of the traditional fiat currencies that central banks issue, in electronic forms like electronic coins or digital accounts that are completely backed by the faith and credit of the government. These currencies differ from privately-issued cryptocurrencies because they are completely recognized by governments and central banks as completely valid tender, making them very safe digital assets to hold.

Governments may want to issue digital currencies for several reasons. Some of these reasons are:

  1. They lower transaction costs, making them more cost-effective than traditional cash.
  2. They can promote financial inclusion by connecting people to the banking system with ease, just through their phones.
  3. They are highly transparent assets, meaning they can compete with the transparency standards of private issuers like Ethereum, while also generally being more effective at cracking down on illegal transactions than those private issuers.
  4. They can also help monetary policy get implemented quicker, which is crucial to governments from a policy perspective.

To investors, this means that investing in a CBDC is effectively like combining the regulatory safety and legacy of traditional currencies with the efficiency, and the ease of access, monitoring, and transaction that cryptocurrencies offer to their investors. That said, CBDCs lack the decentralization and privacy that cryptocurrencies bring to the table, and the jury definitely remains out on whether they will gain much traction with the public at large.

Still, as far as we here in India are concerned, the RBI has begun to push forward with the potentially transformative digital rupee whose introduction it announced in the Budget for this fiscal year, and this forward-looking move puts us ahead of even central banks like the Federal Reserve of the US, and the Bank of Japan. This could position us very well indeed, to really accelerate our move into the future of digital payments systems and settlements.

Where do I even begin?

You might say, “All this sounds promising, of course, but there’s so much volatility and risk in this stuff! How and where do I even begin?” We might have a bit of a solution for you if you’re keen on getting in on that cryptocurrency action but are understandably jittery about the risks involved. Our answer: stablecoins.

“Wonderful, yet another bit of jargon,” you might mutter under your breath. We understand how much this could make your head swim, but that’s what we’re here to help you with! Stablecoins are incredibly easy to understand. This is a category of cryptocurrencies whose value stays relatively stable compared to the wild swings in either direction where regular cryptocurrencies are concerned.

How is this stability achieved? It’s a result of the value being pegged to something like a commodity (like gold), or fiat money (i.e. regular currencies like dollars or rupees), or even other cryptocurrencies (where you’re insured against collapses in prices as a result of those cryptocurrencies’ blockchain serving as collateral). This means that you can enter your trade breathing a little easier in the knowledge that there’s something more stable underpinning the value of your investment- much like how money used to be pegged to the value of gold back in the days of the gold standard, which kept its value fairly stable.

So if you feel like you want to get in on that cryptocurrency action but you’re unsure about the risk profiles involved, or if you’re just starting out and haven’t completely understood how that market works, stablecoins may just be the starting point that you were looking for.

Are cryptocurrencies the only crypto assets around here?

Crypto assets have branched out dramatically in recent years, with the underlying blockchain technology being used in a wide variety of tokens. One particular token that’s gained a ton of traction is a non-fungible token, or an NFT. NFTs are also built around blockchain, but the crucial difference between an NFT and a cryptocurrency like Bitcoin is the idea of non-fungibility.

Non-fungibility is a fancy way of saying that the token is a totally unique asset that can’t be replaced by something else. With cryptocurrencies like Bitcoin, for example, the units of Bitcoin are fungible, meaning you can exchange them for another one of the same thing, i.e. you can trade Bitcoin for another unit of Bitcoin and the units you’ve traded for and gotten will be exactly the same as each other. This isn't the case with NFTs.

With NFTs, you get completely unique tokens that can’t be copied, making them particularly useful for a lot of artists, musicians, and designers, who have duly jumped on to this bandwagon (side note, NFTs don’t necessarily have to be restricted to art: Jack Dorsey, the founder of Twitter, sold an NFT of his good tweets for around $3 million).

“Flipping” NFTs has become a significant source of revenue for a lot of especially young retail investors, who find that their NFTs are valued at potentially sky-high prices, sometimes going into the millions. It also gives artists a unique way to make money off of their hard work and ensure that it is technically exclusive to them, though there may certainly be loopholes in the system that could still allow for copies to be sold as separate tokens. However, much like traditional forms of art collection that have grown to be immensely valuable in economic history, it is difficult to put price tags on and value tokens, while also ensuring that prices aren’t unjustifiably high.

This also makes NFTs risky bets- finding markets when you need to sell might not always be easy. Admittedly, you might find that it’s not easy to be taken seriously when you’re dealing in an asset category that has seen investors unironically place price tags of tens and hundreds of thousands of dollars on NFTs of pet rocks and call them good investments.

Still, this new type of asset could be a significant part of the world of art collection in the near future and beyond, and while it really doesn’t do much to address the idea of illegal piracy or copying in art, it still gives the owner of the unique original some form of a revenue stream that’s theirs alone. The idea of agency over your own work as an artist, after all, is a very important one.

So, what’s the take-away from all this?

India has seen a rapid rise in interest in several crypto spaces, owing to its large demographic of technologically savvy and globally connected young people, its economic and political circumstances, and its interest in the real advantages that crypto assets do have to offer.

What’s important to understand, though, is just how fledgling these asset classes still are. It will still take time for investors, regulators, and transactors to figure out whether a space like cryptocurrencies sees itself as something that could one day supplant traditional currencies like the dollar or rupee, or whether it sees itself as an alternative asset class like gold, or whether it turns out to be something else altogether, too.

Ultimately, the signs are clear: crypto assets, for better or worse, seem to be established presences now, and are here to stay. How will we respond to them? That’s far from established. Are we excited about the innovation in markets that spawned something so fascinating, and continues to revolutionize how and where we invest our money? You bet we are!