WHAT IS CRYPTOCURRENCY

• Virtual currency
• Secured by cryptography
• Designed to work as a medium of exchange
• Individual ownership records are stored in a computerised database.
• Not issued by the government agency of any country making them immune against any interference and manipulation from them

ADVANTAGES

• Funds transfer between two parties will be easy
• No need of third party like credit/debit cards or banks
• Cheaper alternative compared to other online transactions
• Payments are safe and secured
• Unprecedented level of anonymity
• Minimal processing fees
• Potential to spur financial innovation
• Increase efficiencies through faster and cheaper payments
• Augment financial inclusion

DISADVANTAGES

• Easy to be the focus of illegal activities such as money laundering, tax-evasion and possibly even terror-financing
• Payments are not irreversible
• Not accepted everywhere and have limited value elsewhere
• Outsized energy needs to mine cryptocurrency
• Serve largely as speculative assets

CHALLENGES OF USING CRYPTOCURRENCY AS FIAT CURRENCY

MONETARY POLICY

• Domestic monetary policy will become less potent in responding to business cycle needs and external shocks.
• Because aggregate supply is inelastic, demand shocks result in outsized price volatility. Hence, fixing Bitcoin’s aggregate supply is difficult
• Above factors lead to a cryptocurrency becoming a Speculative asset
• IMF points out, if cryptos are only used for “niche purposes” — narrow cross-country transfers and remittances — which are then quickly converted back into local fiat currencies, the implications for monetary policy will be contained
• If these currencies gain credibility and acceptance over time, there will be every incentive for network owners to break free from fiat currencies pegs to generate monetary discretion
• If legalized without proper laws , the fate of economies to respond to shocks, at least in part, would be in the hands of private firms. This would present an existential threat to monetary policy

FISCAL POLICY

• More the loss of seigniorage revenues to governments from the monopoly issuance of fiat currency
• Adversely impacted by the increased tax evasion opportunities
• Reduces the efficacy

IMPLICATIONS FOR THE RUPEE

• If mined inshore it leads to induce capital inflows
• Increase capital account volatility
• De facto increase capital account convertibility
• Accentuates the policy trilemma that emerging markets confront

CONCLUSION

As the 2021 Global Financial Stability Report underscores, there must exist a triangular arbitrage between, say, the local Rupee-Bitcoin market, the Dollar-Bitcoin markets and the Rupee-Dollar market. Consequently, changes in the Rupee-Bitcoin markets will inevitably spill over into the Rupee-Dollar markets for markets to clear.

There is justifiable angst about growing household attraction for cryptos as speculative assets, with its attendant regulatory implications. But the true macro challenge will emerge and compound if and when unbacked private digital currencies are seen as viable mediums of exchange. That’s what policy must anticipate and prepare for.