Should You Consider Cryptocurrencies as an ‘Investment Avenue’?
February 15, 2022 Mutual Fund
Cryptocurrencies in recent years have witnessed an ebullient phase. It seems the ultra-loose monetary policies and rapid debasement of fiat currencies, especially during the pandemic, has attracted investors to cryptocurrencies. Nearly 1.5-2 crore Indians invested/participated in cryptocurrencies, according to Reuter’s estimates, with an aggregate exposure currently worth over Rs 40,000 crore to the so-called digital assets. The kind of extraordinary returns that cryptocurrencies have generated continues to be the key pull factor.
Bitcoin, is the most popular cryptocurrency by far, globally and in USD terms, it has shot up more than 10 times over the last 3 years.
Graph: The Bitcoin rollercoaster…
Data as of February 13, 2022
(Source: CoinMarketCap)
Likewise, other cryptocurrencies, such as Binance, Cardona, Ethereum, Dogecoin, and the recently launched Avalanche clocked stellar returns. The year 2021 was clearly a ‘year of cryptos’.
Thus, I see a lot of investors curious to know more about cryptocurrencies and whether to invest in them. I have observed that greed and generating astronomical returns to meet aspirations in a short span of time are the self-propelling forces behind the cryptocurrency mania.
But, how long will this last going forward, is the real question.
You see, ever since the U.S. Federal Reserve has begun tapering its bond-buying programme and signalled that it may raise interest rates from March 2022 (owing to record-high inflation), numerous cryptocurrencies have displayed extreme volatility. It appears that the meltdown in cryptocurrencies has begun.
Recently, in the Union Budget 2022-23 the government of India proposed a 30% tax on the transfer of virtual digital assets (cryptocurrencies). Further, only the cost of acquisition will be allowed as a deduction on the transfer of cryptocurrencies and the loss on account of such transfer cannot be adjusted against any other income. The transfer of crypto assets is subject to a 1% Tax Deduction at Source (TDS).
The aforesaid proposals were made without tabling any Bill in the winter session of the parliament to regulate cryptocurrencies. And now proponents of cryptocurrencies have been treating these developments as the early signals of cryptocurrencies getting legal status in India very soon.
But hold on…
The Reserve Bank of India (RBI) continues to have its reservations against cryptocurrencies. Recently, the RBI governor, Mr. Shaktikanta Das, in a press meet after the RBI bi-monthly monetary policy held in February 2022 compared cryptocurrencies with the infamous Dutch Tulipmania of the mid-1600s.
“These cryptocurrencies have no underlying (value) – not even a tulip” , he said and termed them worse than the arguably first asset price bubble in the known history, the ‘Tulipmania’. He has cautioned investors to be vigilant while investing in cryptocurrencies. “Investors must remember that they are doing so at their own risk,” he stated. According to Mr Das, cryptocurrencies are a big threat to India’s macroeconomic and financial stability. Besides, the alleged role of cryptocurrencies in money laundering and terror funding has been a topic of discussion for quite a while now.
His deputy, Mr T Rabi Sankar too has expressed to the media that banning cryptocurrencies is perhaps the most advisable choice open to India. “They have no underlying cash flows, they have no intrinsic value, are akin to Ponzi Schemes,” said Mr Sankar. In his view, cryptocurrencies should be kept away from the formal financial system.
Currently, the countries where cryptocurrencies are legalised/regulated are the United Kingdom (U.K.), Ukraine, Singapore, Indonesia, and Canada, among a few others. The United States with a dual system of regulation (of central and states — just like India) has different laws for cryptocurrency for different states. The list of countries that have banned cryptocurrency, on the other hand, is fairly long — it includes China, Alegria, Iraq, Oman, Egypt, Tunisia, Egypt, and forty-two others according to the report of the Law Library of Congress published in November 2021.
India as well has not given any legal recognition to cryptocurrencies; there is no regulatory framework for crypto assets currently. In his virtual address at the World Economic Forum 2022 (held in January 2022), Prime Minister Narendra Modi has expressed that a collective effort is necessary to deal with the problems posed by cryptocurrencies. Earlier in December 2021, in a virtual address at the Summit for Democracy hosted by the U.S. President, Joseph R. Biden Jr., he (Prime Minister, Modi) said, “We must jointly shape global norms for emerging technologies like social media and cryptocurrencies so that they are used to empower democracy, not undermine it.”
Are cryptocurrencies really worse than the ‘Tulipmania’?
The concept of cryptocurrencies is quite innovative. In layman’s language, cryptocurrencies are decentralized digital currencies that use Blockchain technology as their engine and are free from any government intervention.
It appeals to the animal spirit in us and feeds it rather intelligently, claiming to solve problems the existing payment systems may have.
For instance, Bitcoin is said to be an innovative payments network and a new medium of exchange. It arguably endeavours to replace the electronic payments system based on trust with that based on cryptographic proof. Through a peer-to-peer payment system, Bitcoin eliminates financial institutions with its decentralised system. In other words, buyers and sellers can settle transactions on a privately operated network. It claims that the transactions performed using Bitcoin are computationally impractical to reverse, which not only saves costs, but also shields the transacting parties from frauds. Nevertheless, such decentralised transactions could potentially dismantle the banking system for which a central bank is responsible.
Now the question is can an asset class that aspires to be a medium of exchange and perhaps the store of value afford to fall so much so soon? Imagine, the Indian Rupee falling 40% or the greenback, i.e. the US Dollar, falling 30%-40%.
Furthermore, the claims of cryptocurrencies shielding currency bearers against the arbitrary centralized monetary and fiscal policies don’t hold much ground either, at least not at present.
Traditionally a currency is supposed to be backed by the sovereign guarantee and revenues of the country. Typically, your financial transactions are recorded in the financial system of the country. For instance, when you transfer money using an internet banking facility, your bank maintains a record of these transactions. Your income statement has to support your transactions. This system of dual checks ensures that an individual uses monetary resources only for legitimate transactions.
In the case of cryptocurrencies, there is no such backing or underlying system. Its value is solely derived by the demand-supply traits on the respective network. Plus, there is anonymity between the transacting parties in the absence of any regulatory framework. Besides, until the government imposed a tax on profits on the transfer of cryptocurrencies in the Union Budget 2022-23, there wasn’t any accountability on the part of cryptocurrency holders. Traceability is still an issue.
Therefore, it is in this context that India’s position on cryptocurrencies will be important, which according to me is quite ambiguous as of now. Cryptocurrency transactions are still unregulated in India.
What about the RBI Digital Rupee?
In the Union Budget 2022-23, Finance Minister hinted that RBI will rollout Digital Rupee in FY23. The government believes that the Digital Rupee will give a big push to the digital economy and managing currency will become cheaper as well.
RBI’s Deputy Governor, Mr. T Rabi Sankar has already clarified that the Digital Rupee is going to be exactly like the physically issued Rupee. The only difference will be that it will be stored digitally. In other words, the Digital Rupee will be a Central Bank Digital Currency (CBDC) or digital cash that could be used as a means to transact. And since it will be issued by the RBI, it will still form part of India’s officially circulated currency, unlike Bitcoin and other cryptocurrencies.
Cryptocurrencies remains a speculative asset class; undoubtedly, it is a gamble. You could make good money today and lose a sizeable chunk tomorrow. Therefore, it cannot be considered to be an ‘investment avenue’
Before you look at speculative virtual crypto assets to generate wealth, make sure that you have allocated your investible surplus meaningfully into the conventional asset classes, such as equities, debt, and gold, plus invest in suitable and the best avenues therein, so that you can achieve your envisioned financial goals.
As regards the technology backing cryptocurrencies, Blockchain–that is quite innovative and promising. Blockchain technology is massively used in payment or money transfers, fintech, monitoring supply chains, cybersecurity, digital Ids, data sharing, immutable data back-up, healthcare recording keeping, education universities for record-keeping, digital voting, and much more apart from just cryptocurrencies. For these reasons, many mutual fund houses are rushing to launch Blockchain Funds.
To know if you should be investing in mutual fund schemes betting on Blockchain Technology, click here.
This article first appeared on PersonalFN here
