Tag: digital asset

After being out of favour for the past few years, cryptocurrency has seen a resurgence over the last year. Bitcoin, the poster child for the crypto movement, saw its value rise six times to ~ $ 63,000 by March 2021. Although it has sharply corrected post that it is still at four times the May 2020 levels. The primary reason for this has been the high participation, especially from retail players. This has been driven by the emergence of crypto exchanges like Coinbase, which went public April 2021 at a $100 billion valuation. Another key reason for its high value has been the scarcity; this is primarily because there is a limit set at 21 million bitcoins, and about 19 million of them has already been mined. Basis the success of Bitcoin, which has a current market cap of above $600 Billion, many more cryptocurrencies have emerged. Some of them, like Ethereum, Binance coin and tether, have a current market cap of more than $50 billion. So, what lead to the emergence of cryptocurrencies?

The cryptocurrency movement was driven by the distrust of the current financial system post the financial crisis of 2008. It was envisioned as a democratised currency created and owned by the people. The key to creating such a currency was a decentralised system where ownership is with everyone who participates. The trust this system created meant two parties not knowing each other could transact without needing an intermediary. It is this anonymous and decentralised nature that had the governments and central agencies concerned. Various governments had to impose restrictions on the use of cryptocurrency, owing to their increasing usage in illegal activities like money laundering, ransom payment, etc. This led to the fall in the value, post the initial enthusiasm. But globally, given the ease of launching a cryptocurrency and the interest, especially in the young, lead to multiple currencies being launched. There are more than 4000 cryptocurrencies globally, and they are still growing. While they might differ in their construct, the underlying volatility has been a feature of most of the cryptocurrencies launched, and therein lies the problem.

For any currency to act as a medium of exchange, the currency needs to be easy to carry, transact and should have a stable value over time. In the modern era, the primary role of central banks has been to provide this stability. Any drastic variation in the underlying value can lead to inflation or deflation, depending on the movement. While cryptocurrencies have been easy to transact and carry but the variability in their value and inability of a central agency to control it makes it a poor candidate to replace the current currency system. Widespread use of cryptocurrency can make the financial system vulnerable; this is especially true in developing countries where central banks ability to control inflation using monetary policy interventions can get severely impacted. Hence, we believe there is a very low probability that cryptocurrencies with their current construct can be seen as an alternate to the existing monetary system.

While cryptocurrencies have their drawbacks, having a digital currency is beneficial and hence many countries are looking to implement it. China has launched its digital currency. RBI has also been looking at creating a central bank digital currency (CBDC). The critical difference between these and existing cryptocurrencies is that they are expected to have a component of central control to help the central banks intervene and keep the value stable.

So what next for cryptocurrencies? While cryptocurrencies like bitcoin have not been able to serve their intended purpose of being a medium of exchange, they have emerged as an alternate asset class over the last few years. Given the limited availability and interest, especially among the millennials, their value is expected to increase. This has attracted significant capital flows towards this asset class. Given this, we believe the more prominent cryptocurrencies like Bitcoin, Ethereum, etc. are here to stay. At what value? That seems to be a trillion-dollar question.

The blog has been authored by Nilaya Varma, CEO, Primus Partners and Shravan Shetty, MD, Primus Partners.

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