Nikunj GandhiJun 21, 2019 13:49:59 IST
With cryptocurrencies creating a brouhaha in the virtual currency markets with their mindboggling rollercoaster rides, Facebook has thrown its hat into the ring with its latest currency offering called Libra via its digital wallet service called Calibra.
The new currency envisions to overcome most of the hurdles faced by the existing cryptocurrencies, by becoming an actual transaction-based currency rather than a mere object of speculation and volatility like its counterparts. The ambitious Libra Reserve set-up aims at controlling this speculation by pegging the virtual currency to asset collaterals like a basket of world currencies, bank deposits, government securities and with the provisions of changing these compositions to ensure the stability of the currency. The system aims at being a complementary alternative to the existing fiat currency regime, rather than making it redundant.
In layman’s terms, this grand project has the objectives of introducing wallet services at a global level which has the potential to tap each of the Facebook users irrespective of their nationalities and borders, being omnipresent as a mode of transaction with lower fees, acting as an extension to the banks and with decentralised regulation.
The recent and regular gyrations in the cryptocurrencies have certainly piqued the curiosities of the retail investors world over and have all the ingredients for the making of an asset bubble. The phenomenal return over the past years makes one wonder if there are further opportunities here for a windfall. Hence the introduction of a new cryptocurrency will be viewed with a similar scepticism of being speculative in nature rather than facilitating transactional functionalities like a stablecoin.
Effects on currency trading
It would be interesting to observe the daily Libra’s fluctuation after the launch, as it shall be the first time that a currency of this high magnitude will be offered in the market that has the hybrid features of both cryptocurrencies and fiat currencies. The current forex market churns an average turnover of more than $5 trillion per day. If Libra happens to find a liking amongst the traders, it will be some time before it makes a dent in the existing currency trades. In case if the gyrations in Libra replicate its other cryptocurrency counterparts, it could find some takers amongst the speculators. However, the Libra will have to prove its mettle of a quintessential reserve currency before it could find any takers for hedging and investing.
In the long run, if the Libra manages to pass its acid test and finally finds acceptance as a global currency, it could have a potential of changing the dynamics of the forex market. It could also become a reserve currency that represents a basket of other currencies as the underlying collateral. This would further help in the strengthening of the Libra as it would be immune from the shocks or gyrations of any country-specific currency risk, as such risks would be absorbed by the other currencies from its composition basket. Hence, unless the entire global market faces a recession, then technically the Libra shall have the potential to stand stable in the face of an unforeseen devaluation or appreciation in some of the basket currencies. The adjustments made in the compositions of the basket will ensure to maintain the stability of the Libra and not be susceptible to the gyrations of any specific currency.
Facebook faces multiple challenges at a global level both from the perspective of maintaining its own identity compounded with the unstable nature of cryptocurrencies. The company has been riled in the recent past over data breaches, fake news, meddling in elections, testifying before Congress.
The Libra addresses issues of threatening privacy, raises regulatory concerns, the speculative nature of the cryptocurrencies. Introduction of a new currency regime is a subject matter of geopolitics and cannot be subjected to a similar regulatory compliance that can be expected to be followed by all participant nations. Moreover, considering the debacle of the existing cryptocurrencies, the major economies of the world like China and Russia have already banned them. A similar ban has been mooted in India too.
So, when the most populous demography of customers reside in the countries that have placed a ban or are in the process of placing a ban on cryptocurrencies, how does it bode for Libra’s future?
Risk concerns from India's perspective
There exists a lot of ambiguity as to the real nature of classification for cryptocurrencies. Cryptocurrencies cannot be classified as regular financial instruments such as ‘currency’, ‘security’, ‘derivative’ or ‘negotiable instruments’ as these instruments are currently defined under their respective Indian laws. This creates a difficulty of regulation in the absence of any clear guidelines. Since 2013, the Reserve Bank of India (RBI) has periodically reiterated its concerns over cryptocurrencies but has done little else. Unlike its counterparts elsewhere, who have banned or otherwise severely restricted the use of cryptocurrencies, the RBI’s studied silence is arguably progressive in nature, letting the technology play out in the market while the stakes are relatively low.
Some of the concerns raised by the RBI include:
- Cryptocurrencies, being in digital form are stored in digital/electronic media that are called electronic wallets. Therefore, they are prone to losses arising out of hacking, loss of password, compromise of access credentials, malware attack, etc. Since they are not created by or traded through any authorised central registry or agency, the loss of the e-wallet could result in the permanent loss of the cryptocurrencies held in them.
- Payments by cryptocurrencies, take place on a peer-to-peer basis without an authorised central agency which regulates such payments. As such, there is no established framework for recourse to customer problems/disputes/chargebacks, etc.
- There is no underlying or backing of any asset for cryptocurrencies. As such, their value seems to be a matter of speculation. Huge volatility in the value of cryptocurrencies has been noticed in the recent past. Thus, the users are exposed to potential losses on account of such volatility in value.
- It is reported that cryptocurrencies are being traded on exchange platforms set up in various jurisdictions whose legal status is also unclear. Hence, the traders of cryptocurrencies on such platforms are exposed to legal as well as financial risks.
- There have been several media reports of the usage of cryptocurrencies for illicit and illegal activities in several jurisdictions. The absence of information of counterparties in such peer-to-peer anonymous/pseudonymous systems could subject the users to unintentional breaches of anti-money laundering and combating the financing of terrorism (AML/CFT) laws.
Need a rethink of the stance on cryptocurrency from regulators
In the final analysis, a Banking regulator of any country ought to recognise that cryptocurrencies as an opportunity and harness this opportunity for the social and economic betterment of the nation. As the internet represented an opportunity, cryptocurrencies too, represent an opportunity which can help in the decentralisation of economic power, greater financial access and ultimately, break down socio-economic barriers. While the Union/Federal Government does have legislative powers to provide for transactions relating to cryptocurrencies, however, it should not legislate merely for the sake of legislating. Needless laws only complicate business transactions and lead to restrictions rather than regulation of business.
Cryptocurrencies, as an asset class for an investor cannot be speculative in nature in the long run. It only exposes its vulnerability if it continues with such gyrations without displaying any stability. Also, currency is more of a medium of transaction, rather being an avenue for investment as an asset class for long term capital gains. Hoarders hold on to a currency when there exists a possibility of instability in the geopolitics. Cryptocurrencies have a number of weaknesses and may have long-term viability issues. But it shows that virtual currencies can and probably will succeed in time, as innovators build on the lessons from the cryptocurrencies experience.
The open source technology has brought about a disruption in the fiat currency regime. It is inevitable to note that digital currency will be the new currency of the future. The currency regime has passed through its trials and tribulations for maintaining the geopolitics of the new world order with fiat currency being the tried and tested formula for a stable economy in the era of capitalism.
As long as this new entrant to the party is not formally recognised and regulated, we shall only be enamoured by its outstanding future potential and continue to fall victim to The Greater Fool Theory by putting the Tulipmania to shame!
The author is an equity investor.
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