Cryptocurrency

Cryptocurrency

Introduction

It is a digital currency that is an alternative payment method created using encryption methods. It uses blockchain technology to achieve decentralization, transparency, and immutability (the ability of a blockchain ledger to remain unchanged, unaltered and indelible). It has a decentralized structure and so it can exist independently of governments and central authorities.

 

What  is Cryptocurrency?

  • It means online money created using digits or digital encryptions.
  • It is an internet-based medium of exchange that is distributed across many computers.
  • It conducts financial transactions using cryptographic functions.
  • The most important characteristic of a cryptocurrency is that it is not controlled by any central authority. i.e., the decentralized nature of cryptocurrencies is theoretically immune to traditional methods of government control and interference.
  • Blockchain and related technology, according to experts, will disrupt many industries, including finance and law.
  • The benefits of cryptocurrencies include cheaper and faster money transfers, as well as decentralized systems that do not fail at a single point.
  • Its disadvantages include price volatility, high energy consumption for mining activities, and use in criminal activities.
  • They are not widely accepted as money due to their lack of legal tender status.
  • El Salvador became the first country in the world to accept cryptocurrency as legal tender in June 2021.

 

Evolution of Cryptocurrency

  • Bitcoin, the first decentralized cryptocurrency, was created in 2009 by a presumably anonymous developer named Satoshi Nakamoto.
  • Subprime mortgage crisis and recession in 2008-2009 resulted in Quantitative Easing (the introduction of new money into the money supply by a central bank) of the dollar in the United States, which increased dollar supply and eroded dollar purchasing power.
  • Banks charge fees for online transfers, credit card transactions, and ATM withdrawals.
  • From the creation of Bitcoin in 2009 to the present day, cryptocurrencies have grown in popularity all over the world.
  • The gains made by this sector since the onset of the Covid-19 pandemic in January 2020 have been astounding; the "crypto market" has grown by more than 500%.

 

Types of Cryptocurrency

There are thousands of types of cryptocurrencies. Some of the well-known types of cryptocurrencies are:

  • Bitcoin: It is one of the most traded and covered cryptocurrencies to date. Bitcoin was established in 2009. The currency was created by Satoshi Nakamoto, who is generally believed to be a pseudonym for an individual or group of individuals whose exact identity is still unknown.
  • Ethereum: It is  a blockchain platform created in 2015, has its own digital currency called Ether (ETH), also known as Ethereum. After Bitcoin, it is the most widely used cryptocurrency.
  • Litecoin: This currency is most related to bitcoin, although it has moved more quickly to build new features, such as speedier payments and processes to allow for more transactions.
  • Ripple: A distributed ledger system called Ripple was created in 2012. Ripple is a tool that can be used to track more than just cryptocurrency transactions. The organization that created it has collaborated with numerous banks and financial organizations.
  • The term "altcoins" is used to distinguish non-Bitcoin cryptocurrencies from the original.

 

How Does Cryptocurrency Work?

  • The ownership records of individual coins are stored in a digital ledger, which is a computerized database secured by strong cryptography.
  • This ledger controls the creation of new coins, verifies the transfer of ownership, and maintains transaction records.
  • Despite being called currencies, cryptocurrencies are not considered traditional forms of currency. They are often classified as commodities, securities, or a distinct asset class.
  • Some cryptocurrency systems use validators to maintain the currency.
  • In a proof-of-stake model, owners stake their tokens as collateral and gain authority over the tokens proportional to the amount staked.
  • Token stakes may receive additional ownership in the token over time through network fees, newly minted tokens, or other reward mechanisms.
  • Cryptocurrencies exist purely in a digital form and are typically not issued by a central authority. They employ decentralized control, unlike central bank digital currencies.
  • Cryptocurrencies operate using distributed ledger technology, commonly a blockchain, which acts as a public database for financial transactions.

 

Advantages of Cryptocurrency

Cryptocurrencies offer several advantages compared to traditional financial systems.

  •  Cryptocurrencies operate without the need for centralized intermediaries like banks. This eliminates the risk of a single point of failure, reducing the potential for financial crises.
  • Cryptocurrencies enable direct peer-to-peer transfers without relying on trusted third parties. This can make transactions faster and more efficient.
  •  Since cryptocurrencies bypass intermediaries, transfers between parties can be faster compared to traditional money transfers.
  •  Cryptocurrency investments have the potential for significant profits. The value of cryptocurrency markets has surged over the past decade, offering opportunities for substantial returns.
  • Cryptocurrencies, like Bitcoin, are used as intermediate currencies for remittances, streamlining cross-border money transfers and reducing costs.

 

Disadvantages of Cryptocurrency

  • Cryptocurrency transactions are not entirely anonymous and leave a digital trail. Governments and investigative agencies can potentially track financial activities, which may raise concerns about privacy.
  • Cryptocurrencies have been exploited by criminals for illegal activities like money laundering and illicit purchases. Hackers also use cryptocurrencies for ransomware attacks.
  •  Ownership of cryptocurrencies is often concentrated in the hands of a few. A small number of addresses hold a significant portion of circulating cryptocurrencies, leading to wealth disparities.
  •  Mining popular cryptocurrencies requires substantial energy resources, contributing to environmental concerns. Mining operations are often controlled by large firms, limiting participation by individuals.
  •  While blockchain technology itself is secure, off-chain storage repositories like exchanges and wallets can be vulnerable to hacking. Several incidents have resulted in significant losses of cryptocurrency funds.
  •  Cryptocurrencies traded in public markets are known for their price volatility. Rapid surges and crashes in value can make them appear speculative or unstable to some.

 

Impact of Cryptocurrency on Indian Society

  • Investment Opportunities: Many Indians have started investing in cryptocurrencies as an alternative asset class, with the hope of generating high returns.
  • Remittances: Cryptocurrencies have provided a more cost-effective and faster means of sending remittances from abroad to India, benefiting both the sender and the receiver.
  • Technological Development: The growing interest in cryptocurrencies has led to an increase in blockchain technology development in India, with several startups and established companies working on blockchain-based projects.
  • Regulation and Legal Status: The Indian government and regulatory bodies have had a mixed stance towards cryptocurrencies. While there have been efforts to regulate and even ban cryptocurrencies, the government has also shown interest in exploring the potential of blockchain technology for various applications.
  • Awareness and Adoption: Cryptocurrency awareness and adoption in India have been gradually increasing, with businesses and individuals becoming more familiar with digital currencies and their use cases.

 

Concerns over Cryptocurrencies

  •  Cryptocurrencies pose risks to consumers.  They do not have any sovereign guarantee and hence are not legal tender.
  • Their speculative nature also makes them highly volatile.  For instance, the value of Bitcoin fell from USD 20,000 in December 2017 to USD 3,800 in November 2018.
  •  A user loses access to their cryptocurrency if they lose their private key (unlike traditional digital banking accounts, this password cannot be reset).
  • In some cases, these private keys are stored by technical service providers (cryptocurrency exchanges or wallets), which are prone to malware or hacking.
  • Cryptocurrencies are more vulnerable to criminal activity and money laundering.  They provide greater anonymity than other payment methods since the public keys engaging in a transaction cannot be directly linked to an individual.
  • A central bank cannot regulate the supply of cryptocurrencies in the economy.  This could pose a risk to the financial stability of the country if their use becomes widespread.
  • Since validating transactions is energy-intensive, it may have adverse consequences for the country’s energy security (the total electricity use of bitcoin mining, in 2018, was equivalent to that of mid-sized economies such as Switzerland).

 

What are the Challenges?

  • Volatility: Cryptocurrency prices are highly volatile, which makes it difficult for businesses to accept it as a form of payment.
  • Regulation: There is a lack of clear regulation around cryptocurrency, which makes it difficult for businesses and individuals to know how to legally use it.
  • Security: Cryptocurrency exchanges and wallets are susceptible to hacking attacks, which can result in the loss of funds.
  • Adoption: Despite its growing popularity, cryptocurrency still has low adoption rates, which makes it difficult for individuals to use it as a form of payment in everyday life.
  • Scalability: The scalability of cryptocurrencies is limited, which makes it difficult for the technology to handle a large number of transactions.
  • Energy consumption: The process of verifying transactions in a cryptocurrency network, known as mining, is energy-intensive, and contributes to climate change.

 

Way Forward

  • Regulation is required to prevent serious problems, to ensure that cryptocurrencies are not misused, and to protect unsuspecting investors from excessive market volatility and potential scams.
  • The regulation must be clear, transparent, and coherent, and it must be animated by a vision of what it seeks to achieve.
  • A legal and regulatory framework must define crypto-currencies as securities or other financial instruments under applicable national laws and identify the regulatory authority in charge.
  • Rather than outright prohibiting cryptocurrencies, the government should regulate their trading by instituting stringent KYC norms, reporting, and taxation.
  • To address concerns about transparency, information availability, and consumer protection, steps such as record keeping, inspections, independent audits, investor grievance redressal, and dispute resolution may be considered.
  • Cryptocurrencies and Blockchain technology have the potential to rekindle the entrepreneurial spirit in India's startup ecosystem by creating job opportunities at all levels, from blockchain developers to designers, project managers, business analysts, promoters, and marketers.

 

 

 

With reference to 'Bitcoins', sometimes seen in the news, which of the following statements is/are correct?

1. Bitcoins are tracked by the Central Banks of the countries.

2. Anyone with a Bitcoin address can send and receive Bitcoins from anyone else with a Bitcoin address.

3. Online payments can be sent without either side knowing the identity of the other.

 

Select the correct answer using the code given below.

A. 1 and 2 only

B. 2 and 3 only

C. 3 only

D. 1, 2 and 3

 

Answer B

 

 

What is Cryptocurrency? How does it affect global society? Has it been affecting Indian society also?