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How cryptocurrencies get their value, are we in a bubble, and can crypto be regulated? Raghuram Rajan answers

‘Regulators are struggling’: Top moments from the former RBI Governor’s interview on the underlying issues of crypto in India.

In a wide-ranging interview with CNBC-TV18, former Reserve Bank of India (RBI) Governor Raghuram Rajan shared his views on the valuation of cryptocurrencies, the problem with regulating them, and what can governments do to address this rapidly growing financial sector.

His views come as the Indian government is looking to introduce the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, during the winter session of the parliament, which is set to begin on November 29. While there is a lot of confusion as to whether the government will outright ban cryptocurrencies or take a more lenient approach, one thing is for certain: the discussions on cryptocurrencies are only getting started.

Where do cryptocurrencies get their value from and are we in a bubble?

  • Cryptocurrencies have two sources of value: Rajan explained that cryptocurrencies currently have two sources of value:
    1. It is a store of value that people buy as an asset thinking it will appreciate. But the underlying source of this appreciation is that;
    2. It can be used as a form of payment
  • We do not need 6000 cryptocurrencies for payments:

“Do we really need six to 6000 cryptocurrencies to do payments?  One or two, maybe a handful are what are going to survive to be used as payments, even if the technology is so useful that it substitutes for cash and fiat currency issued by the central banks. So that would suggest that most cryptos are unlikely to survive with high values going forward because there’s no use case for them” – Rajan

  • We are in a bubble: If cryptocurrencies have value only because people think they’ll have more value down the line, then that’s what we call a bubble, Rajan said.

Why is it difficult to regulate cryptocurrencies?

  • We do not understand the asset well: “I think the issue across the world is what can regulators do? What is it that they understand about this asset? In the case of a chit fund, you know that it’s taking money and what you can do is ensure that it’s invested appropriately. In the case of stablecoins, you know that they promise to preserve a certain value for their currency in terms of fiat currency. So there are clear reasons for regulating there and clear ways you can regulate. Much harder for the standard cryptocurrency, which is essentially a token issued to the public and the public is buying it. It’s not clear for what reason,” Rajan said.
  • What does regulation even mean? “In part regulators don’t fully understand this industry and how to regulate it. If a lot of the industry can escape the clutches of the regulator, then you create even more confusion. Which ones are regulated? Which ones are not? And what does regulation really mean? […] In the case of ordinary cryptocurrencies, you’re not checking their balances behind it. Maybe at best you’re checking that the transaction happens as advertised. And there is a sound system for recording transactions. But beyond that, what can you do? You cannot attest to the value of these because there is no underlying business for most of them. They are not really used as a payment mechanism. And so in that sense, how do you ascribe any kind of certainty to investors in those?” Rajan said.
  • Can’t regulate people’s sentiments: Rajan said regulators are struggling because they can’t regulate people’s sentiments. “They can’t credibly say to people don’t ever buy this because we say, if I bought it, I would have been rich by now. So you can’t deal with human greed. What you can do is ensure that at least this thing doesn’t evaporate overnight, that the transactions are being recorded and so on,” Rajan explained.
  • Do regulators have the capacity? Rajan opined that regulators currently do not have the capability to regulate cryptocurrencies. For example, crypto exchanges pose cyberattack risks and theft happens all the time. “So the difficulty for regulators is what exactly am I going to regulate and how capable, how competent am I? Do I have the personnel to do even the basic minimum of regulation?” Rajan said.
  • Temporary ban might push more people towards cryptocurrencies: When asked if a temporary ban on cryptocurrencies is an option, Rajan responded: “I’m not sure how you enforce it. This is one of those things where a lot is being done because it’s in the dark, because it’s beyond the eyes of the authorities. How do you enforce a ban when most of it is beyond your control? It may actually encourage people to go into that when they see it surviving despite the ban.”

What can regulators do?

  • Central banks should ensure their currency is strong and stable to make cryptocurrencies less attractive: Central banks should ensure their currencies are strong and stable and they control inflation. “Those are the things central banks can do to ensure that these alternative currencies don’t become too attractive in the hands of people,” Rajan said.”You can’t completely eliminate [cryptocurrencies]. There will be some people who want some portion of it in their investment portfolios, investment managers sometimes advocating for that. But what you can do is prevent it from being a big part of the payment system by ensuring your own payments systems are attractive, fast, and your fiat currency holds its value.”
  • Provide the same privacy as cryptocurrencies: “One special attractiveness of cryptocurrencies is the data they generate about payments, about the identity of the payer is hidden from the authorities,” Rajan said. So we have to examine ways to make official digital payments more privacy focused, Rajan added. “This is not to help them evade taxes or evade, you know, legal issues, but it is to keep the prying eye of the government away from ordinary individuals protecting their privacy,” Rajan remarked.
  • Regulators should not stamp their imprimaturs on cryptocurrencies and say they are well regulated: “For the most part, what one can insist on is getting information from these entities and also when entities get too big, certainly examining them more closely to make sure there isn’t outright fraud. It is a situation where at best you can send warnings to the broader public. […] You certainly don’t want to stamp your imprimatur on them and say they are well regulated.
  • We must ensure we allow the underlying technology to flourish in the Indian ecosystem: Opposed to a complete ban, Rajan suggested that we must allow the underlying technology to flourish.

“Blockchain ways of transacting, which are much cheaper. The use of micropayments for services provided on the internet. The use of smart contracts to eliminate the intermediary. And to ensure that contracts can be done at low cost especially across borders. These are all useful uses of the technology and it would be inappropriate for us to make to ensure that these aren’t available to the Indian economy.” – Rajan

What are some worries caused by cryptocurrencies?

  • Do cryptocurrencies pose a serious problem of financial instability? Rajan said the current RBI governor Shaktikanta Das is right to be worried about the impact cryptocurrencies might have on financial stability because like any technology it can be used for good and bad and “it’s worth investigating this further and understanding what the technology is and how it can be channeled towards good.”
  • Dollarisation is only a worry if central banks are not doing a good job: When the interviewer suggested the bitcoins and other cryptocurrencies might result in the problem of dollarisation because these currencies are only denominated in dollars, Rajan replied saying dollarisation is an issue for countries have volatile currency such as Venezuela. But in India, companies and people will still prefer using the rupee because it doesn’t fluctuate so much. “Credible central banks can certainly maintain the value of the fiat currency and ensure that it’s not substituted by some kind of crypto, which fluctuates all the time,” Rajan said.
  • Will there be a foreign exchange issue? Not immediately but it depends, Rajan said. For example, if there is a rush into bitcoin then it becomes a question of how much bitcoins are mined in India versus how much you’ll be buying from outside. If there are relatively few bitcoins mined in India, it is going to be a foreign exchange issue, Rajan explained.

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