Understanding Cryptocurrencies

This post first appeared on MyStory

Unless you’ve been hiding under a rock lately, there has been a whole lot of talk around Libra – the new cryptocurrency announced by Facebook.

Libra is a permissioned blockchain digital currency proposed by Facebook. The project, currency and transactions are to be managed and entrusted to the Libra Association, a membership organization founded by Facebook’s subsidiary Calibra and 27 others.

Wikipedia

If you could not make much of the above paragraph, you are not alone. If you’re new to the world of digital (or crypto) currencies, this post will help you understand the basics.

What the heck does “cryptocurrency” mean?

Cryptocurrency is best thought of as digital currency (it only exists on computers, not physically) that uses cryptography (encryption) for security. Bitcoin is one of the most well-known examples of a cryptocurrency, though there are many others in circulation.

Cryptocurrencies represent an alternative form of payment (to cash, credit cards, etc.), and all transactions are recorded on a digital ledger (called a “blockchain”). Since both the Transaction data and the Ledger are encrypted using cryptography, it is called “crypto” currency.

A distinguishing feature of it is that its underlying technology allows you to send payments directly to others without going through a third-party (like a bank).

Is cryptocurrency the future?

There are many different views about cryptocurrency, ranging from ‘it will replace everything we do’ to ‘it’s nothing but a fad’.

Here are some problems associated with it…

  • The (semi-anonymous) nature of cryptocurrency transactions makes them well-suited for a host of illegal activities, like money laundering and tax evasion. This is one reason why several countries have made it illegal to own or trade in cryptocurrencies.
  • Since cryptocurrencies are virtual and do not have a central repository, a digital cryptocurrency balance can be wiped out by a computer crash, say if a backup copy of the holdings does not exist, or if somebody simply loses their private key information (used to access their account).
  • While blockchains themselves are highly secure, the entire cryptocurrency ecosystem is not as secure. Over a ten-year period, millions of dollars worth of ‘bitcoins’ have been stolen due to hacking and theft.
  • Since prices of cryptocurrencies are almost entirely based on supply and demand (and not rooted in any material goods), the rate at which a cryptocurrency can be exchanged for another currency can fluctuate quite wildly. Cryptocurrencies are therefore considered by many to be speculative at best.
  • Cryptocurrencies also involve significant energy use. Mining – which is its validation process – is an integral part of cryptocurrencies, but very energy intensive. According to some estimates, Bitcoin mining consumes as much energy as Switzerland, which is an environmental disaster.

Here are some unique benefits of cryptocurrency…

  • Its underlying ‘blockchain’ technology provides us with the means to remove the middleman in financial transactions, as well as strengthen security. Many major financial institutions see tremendous potential in its ability to lower transaction costs by making payment processing more efficient, thereby making such transactions significantly faster and cheaper for consumers.
  • In a world where the value of “fiat” money (government-issued currency) is directly dependent on actions of national governments, some economists argue that cryptocurrencies can serve as a “stable store of value”, offering an antidote to excessive inflation. This is because no single country or government has (undue) control over its price or supply.

Is India ready to embrace cryptocurrencies?

Not quite…

Finance minister Arun Jaitley, in his budget speech on 1 February 2018, stated that the government will do everything to discontinue the use of bitcoin and other virtual currencies in India for criminal uses. He reiterated that India does not recognise them as legal tender and will instead encourage blockchain technology in payment systems.

Wikipedia

Also, according to a recent story in Business Today:

The draft of Banning of Cryptocurrency and Regulation of Official Digital Currency Bill 2019 has reportedly proposed a 10-year-long prison term for people who “mine, generate, hold, sell, transfer, dispose, issue or deal in cryptocurrencies”.

Business Today

Finally, Mint reported in July 2019:

A high-level government panel on virtual cryptocurrencies has recommended a ban on all virtual cryptocurrencies in India. The ban on virtual currencies comes along with a fine of ₹25 crore and imprisonment up to 10 years for any activity related to virtual currencies.

LiveMint

For all practical purposes, it looks like India is not likely to embrace any form of cryptocurrency in the near future. That said, blockchain-based tools are only just beginning to establish themselves, and many more exciting use-cases are yet to emerge.

Here’s to living in interesting times!

Also Read: Libra, Explained, The Verge, June 2019

One thought on “Understanding Cryptocurrencies”

  1. Good stuff. The harsh punitive stance that GoI has adapted towards cryptocurrency only strengthens those in favour of Cryptocurrency.
    On the other hand, criminal minds will always find a way to get rich quick – with or without Cryptocurrency.
    Lastly, history and time will tell if Cryptocurrency stands the trials of time. Reminds me of the Tulip crash in the Netherlands in the last century.

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