Private Cryptos And Financial Crisis

Context

RBI Governor Shaktikanta Das has stated that cryptocurrencies will cause the next financial crisis, and that developments at crypto exchange FTX have vindicated the central bank’s stance. He made these remarks at a Business Standard-organized BFSI summit in Mumbai.

Relevance

GS Paper -3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Mains Question

How have cryptocurrency markets changed? What are cryptocurrency regulations? Discuss. (150 Words)

Cryptocurrency

• These are digital or virtual currencies in which encryption techniques are used to regulate unit generation and verify fund transfers.
• These currencies operate independently of a central bank.

The expansion of the crypto ecosystem creates new opportunities.

• Technological advancements are ushering in a new era in which payments and other financial services are becoming less expensive, faster, and more accessible.
  • It enables these services to cross borders quickly.
• Bank deposits can be converted into stable coins that provide instant access to a wide range of financial products as well as instant currency conversion.
• Decentralised finance has the potential to become a platform for more innovative, inclusive, and transparent financial services.

Crypto assets’ difficulties

• Because crypto assets are extremely volatile, their rapid growth and increasing adoption pose financial stability challenges.
  • They are far more volatile than stocks, commodities, or even exchange rates. The ecosystem is becoming unstable as a result of this volatility. The crypto ecosystem presents several challenges, including: o operational and financial integrity risks from crypto asset providers, o investor protection risks for crypto-assets, and o insufficient reserves and disclosure for some stable coins.

Statistics on the use of cryptocurrencies in India

• In 2021, the number of blockchain startups surpassed 300, with daily crypto trading volume peaking between $300 and $500 million.
• According to the Global Consumer Survey 2020, India ranks higher in crypto adoption than China, the United States, Germany, and Japan.

FTX scandal

• Recently, the cryptocurrency exchange FTX filed for bankruptcy, and its CEO, Sam Bankman-Fried, resigned.
• As a result, hundreds of thousands of customers who deposited their holdings on the FTX platform have had their savings jeopardised.

About FTX

• FTX is a cryptocurrency exchange headquartered in the Bahamas.
  • The company’s business model is based on risky trading options that are illegal in the United States.
  • It was founded in 2019 by Sam Bankman-Fried and allows users to buy, sell, hold, and trade cryptocurrency.
    • It allowed customers to exchange digital currencies for other digital currencies or traditional money, and it also had its own cryptocurrency, FTT.

What went wrong with FTX?

• FTX has its own cryptocurrency token called FTT, which traders can use to pay transaction fees.
  • In November 2022, a report based on leaked documents claimed that Alameda Research possessed an unusually large number of FTT tokens.
    • Bankman-Fried runs the hedge fund Alameda Research.
    • Although FTX and Alameda are supposed to be separate companies, the report claimed that they had close financial ties.
  • Following this revelation, the price of FTT plummeted, and traders rushed to withdraw from FTX, fearful that it would be yet another failed crypto company, resulting in a liquidity crunch.

The effect on the cryptocurrency market

• For a long time, the cryptocurrency industry has struggled to persuade regulators, investors, and ordinary customers that it is trustworthy.
  • The fall of FTX, which appeared to be more stable than other companies, and Binance’s withdrawal have jolted the market.
    • Binance is another cryptocurrency exchange.
  • Reserve Bank of India Governor Shaktikanta Das warned that allowing private cryptocurrencies to grow would lead to the next financial crisis.
  • On the inherent risks associated with cryptocurrencies o Cryptocurrencies have certain significant inherent risks that could jeopardise the country’s macroeconomic and financial stability.
    • The RBI’s concerns stem from the fact that crypto has no underlying asset.
  • Cryptocurrency regulation
    • On the issue of allowing crypto after regulating it, RBI governor stated that it was difficult to regulate something whose origin was based on circumventing the system.
    • Private cryptocurrencies arose as a result of system bypassing and breaking.
    • These currencies have no faith in the central bank currency or the regulated financial world.
  • The total value of cryptocurrencies is currently decreasing.
    • According to some estimates, the total value of cryptocurrencies has now dropped from $188 billion to $140 billion.