The collapse of a major cryptocurrency exchange like the Bahamas-based FTX has brought home the need for a recognised entity like the central bank to deal with digital currency
BY MADHAVAN NARAYANAN
It began with Bitcoin. Can you say it has ended with FTX? You never know what capitalism’s manipulative wizards will do next, but this much is clear: with the ugly bankruptcy in November of the shady FTX, a cryptocurrency exchange company, what was thought to be a crypto bubble has become a veritable scam and might usher a much-needed reality check.
And yet only a few might finally emerge officially guilty, because America’s financial markets are so loosely regulated that risk is largely a personal thing in a regular occurrence of boom-and-bust cycles. A good bit of the bill is footed by the average Joe or Jill, putting in hard-earned savings or borrowed money with a painful mix of stupidity and greed. Honestly, I have not found out much about the details of the FTX collapse because it is like looking for pearls in the Pacific Ocean. I know deep oceans contain sharks that look more real than elusive pearls. That should be enough.
But there can certainly be two beneficial side effects of the FTX bust and the plunge of the Bitcoin, which is still lingering around as a cryptocurrency after a steep fall to $16,000 levels from the heights of $64,000 early last year.
First, Bitcoin with its core promise of non-reversible digital footprints has encouraged technologies like blockchain (called the Internet of Trust) that generate reliable audit trails for digital transactions that should make things like real estate registration as easy as share purchase in the future. Secondly, Sam Bankman-Fried, the alleged whiz kid who built FTX with a handful of colleagues, has proved to us that you cannot trust some by investing big amounts of money just because they are youthful and spout smart technology in geekspeak with casual looks to match. Young witch doctors are as real as old charlatans.
That brings us to the Reserve Bank of India (RBI) and other such regulatory institutions of eminence. What they are doing with digital currency can be called sane and socially acceptable versions of the anarchic bunch of cryptocurrencies that offer roller coaster rides for get-rich-quick schemes that often prove to be bubbles or, worse, rackets. We shall reserve judgment here on the future of cryptocurrency as such but look at the fundamentals of what this is all about.
Theoretically, a 100-rupee note is only a piece of paper; but, apart from its reasonably foolproof printing, it has the guarantee of the RBI governor, whose signature appears on the currency note with a “promise” to pay the bearer the “equivalent” of 100 rupees. This is in effect a state assurance, and therefore shows the collective will of a society to honour it.
Cryptocurrencies, on the other hand, are like an anarchic, separatist bunch that huddle on a remote island, declare independence and print their own currency notes—and lure many outsiders into recognising them in various states of confusion and greed. Just as any piece of land with a flag may not be recognised as a country, cryptocurrencies are like virtual property created by guerrilla outfits trying hard to be seen as governments-in-waiting.
You can call the crypto kids, like many youthful guerrilla groups, a weird mix of rebellion and idealism. Much like an Islamic State bunch carving out portions of Syria or Iraq for a risky, adventurous, unrecognised Utopia.
Another way to understand this is to use the analogy of Antarctica, which is an unpeopled continent without any countries. Argentina, Australia, the UK, France, Chile, New Zealand and Norway have made territorial claims on Antarctica but this is not recognised by the US and most other countries. Even India has planted its flag in the icy southern continent though without any territorial claim as yet. All countries hope to use the mineral wealth of the huge landmass some day.
Cryptocurrencies are like various flags planted in a mass of cyberspace resembling Antarctica—with the promise that future wealth will be traded, recorded or grown on that territory. Many creators and sellers of these currencies are like realtors and their agents trying to sell pieces of the promised land. FTX was in effect like a stock exchange for these “tokens”—deeds with underlying property that has no real value in current terms.
Now, suppose a country develops technology that actually extracts and safely ships out from Antarctica real minerals that can be used by industries and its government opens a company that actually does this. The Central Bank Digital Currency (CBDC) is a bit like that. The RBI recently launched a pilot project to that effect. Some other countries, including China, are also stepping cautiously into CBDCs.
We need to ask how different is the US from India in dealing with crypto investments?
The key point about FTX is that its backers include some of the biggest names in institutional investment, a veritable who’s who of private equity and hedge funds such as SoftBank, Tiger Global, Sequoia, BlackRock and the Singapore government-backed Temasek. Note that Sequoia invested early and reaped big in companies such as Apple, Google, Oracle, Yahoo, PayPal, LinkedIn, Instagram and WhatsApp. Naturally, small investors must have been impressed by FTX—much as we learn routinely from advertisements that share and mutual fund investments are subject to market risk.
Investigators and regulators in the US are now looking into whether FTX used funds from its customers to back Alameda, a research company backed by Bankman-Fried. This, on the face of it, seems to have potential conflict of interest and/or insider trading. But these pale in comparison when you look at the fundamental unreality of cryptocurrencies without state recognition. It is almost as if you paid for visas to visit Xanadu, Wessex and Malgudi—all of which are fictional territories created by writers. According to its bankruptcy filing, FTX, which was once valued at $32 billion and has $8 billion of liabilities it cannot pay, may have as many as one million creditors. The key point is that cryptocurrencies have no underlying real value except in the minds of those who believe in a fuzzy future where it becomes a parallel currency—much like an informal IOU between friends or like smuggled gold coins that are widely recognised. But there is a vast difference between theory and practice—which is why governments and regulators exist in the first place.
The sad part is that US regulators only cover issues like fraud, not general investment risks in flimsy products. But the cryptocurrency craze has created a strange challenge for governments worldwide. Indian Finance Minister Nirmala Sitharaman in her last Budget included cryptos within the virtual digital asset (VDA) category and announced that there will be a tax of 30% on income from their sale. That is a bit like sale of paintings: the value is in the eyes of the beholder but you have got to pay the tax if you profit from it.
A more realistic way to a crypto future is to introduce a CBDC, which would be the digital age equivalent of the printed paper that we call a currency note—something that has strong state endorsement. India’s Budget also gingerly kicked off the digital rupee. Media reports said recently that the RBI has roped in the State Bank of India, ICICI Bank, IDFC First Bank and Yes Bank to join a pilot project to deal in the digital rupee. More banks are expected to join the efforts to create a planned framework for digital rupee transactions or introduce the CBDC into the current digital payments system. We already have mobile wallets and online bank transfers that in some way function like digital equivalents of the rupee for transaction purposes. The official digital rupee would hopefully take it to the next level but this requires a lot of learning and reorientation for various financial entities.
A lot has to do with Know Your Customer (KYC) requirements and audit trails. In a recent concept note, the RBI suggested it was considering anonymity for CBDC retail payments valued under ₹50,000, much like cash transactions. Such measures will have the advantages of digital ease—without the risk of counterfeit-like private currencies which, like hawala transactions in Dubai, can even support criminal activity. On current reckoning, the CBDC will have retail and wholesale versions. It is all, as they say, work in progress.
The Narendra Modi government is also trying to use its G20 presidency to arrive at a global consensus-based decision of elite economies on regulating cryptos. That looks far away, but more real than bubble values of dubious currencies.
The FTX crash shows the need for governments to check manipulation—and the best way to look at it is to say that anything legal is socially accepted manipulation with public sanction. After all, there is a line dividing safe freedom from reckless anarchy. Or there has to be one.
(The writer is a senior journalist and commentator who has worked for Reuters, Economic Times, Business Standard, and Hindustan Times. He can be reached on Twitter @madversity)