GE Economics:

Money and Banking

Assignment:
Cryptocurrency – Risks, Growth, Potential

Submitted By:
Syed Dareen Hannash
Roll No. 114
Semester III
BA (Hons) Political Science
Introduction

Decentralised finance (DeFi) solutions have existed for years, but cryptocurrencies have
emerged in the past decade as a subject of extensive study and application (Yuan and F.
Wang, 2018). At the crux of the economic sense of cryptocurrencies lies the problem of
“surmounting the double-spending hassle” with its unique set of accounting challenges
wherein cryptocurrencies and their technical infrastructure still remains a murky area of
contention in the academic literature as well as common discourse (Chohan, 2017; Tomic,
2020). Wisetsri et. al (2022) posit that blockchain has emerged as an object of maximum
trend in the discussions surrounding cryptocurrency due to its centrality as the building
blocks of DeFi solutions. The blockchain in essence serves as a public ledger and transactions
encrypted with this technical infrastructure are nigh impossible to tamper with.

Meaning of Cryptocurrency: Functions and Principles

The phrase "cryptocurrency" denotes a type of digital currency that is issued privately and
utilises cryptographic technologies, such as blockchain, to facilitate secure transactions.
Currently, there exists a vast and growing array of cryptocurrencies, each exhibiting various
distinctions. Nonetheless, most of them share several fundamental characteristics with the
notable exception of the anonymity surrounding their creators – similar to Bitcoin – which is
the first and most prominent cryptocurrency by market capitalisation. Chey (2022) remarks
that the introduction of Bitcoin as the first ever cryptocurrency in 2009 was tinted by a
reactionary tendency to see it as an eccentric project for fringe libertarians and anarcho-
capitalists. However, it has since then exploded into one of the best performing financial
assets in the world, having attained legal tender status in El Salvador in 2021. This raises the
interesting possibility of a transition to a world of free competition between private
currencies through the metamorphosis of the “geography of money” via the installation of
new global currencies vis-à-vis “cryptoisations” or the replacement of domestic currencies
with cryptocurrencies (Hayek, 1976; Cohen, 1998; Chey, 2022).

Bitcoin was created in 2009 following the global financial crisis by an anonymous individual
or group operating under the pseudonym Satoshi Nakamoto. It is classified as a "peer-to-peer
electronic cash system," enabling direct online payments between parties without the need for
a central intermediary utilising blockchain technology (Nakamoto, 2008). A key feature that
sets Bitcoin apart from conventional currency is its decentralised nature which eliminates the
need for a middleman. In contrast, traditional centralised financial systems depend on a
central authority such as a central bank or a consortium of financial institutions, which holds
significant power and poses a risk of acting against the interests of individual users. Central
banks have the regulatory authority to devalue its fiat currency, thereby diminishing the
wealth of its citizens (Ammous, 2018). Bitcoin operates within a decentralised financial
framework that is not subject to the control of any single entity. Additionally, the total supply
of Bitcoin is capped at 21 million coins, leading proponents to assert that it represents "sound
money" that is insulated from inflationary pressures. Furthermore, the robust cryptographic
encryption associated with Bitcoin ownership is designed to ensure the anonymity of its
users. Given these exceptional attributes, advocates of Bitcoin anticipate that it will transform
the financial landscape by providing a viable alternative to centralised financial systems.

A peer-to-peer (P2P) network operates on the principle of decentralisation, enabling

participants to engage in transactions without the necessity of a central server. In this
network, peers or nodes interact directly with one another without the involvement of an
intermediary. In contrast to the conventional client-server architecture – where a client
submits a request and a server fulfils it – the P2P model empowers nodes to serve dual roles
as both clients and servers. This configuration grants them equal authority and allows them to
perform identical functions within the network. An example of a P2P network is blockchain,
which serves as a decentralised ledger for digital assets. Central to the credibility – or
discredibility – of cryptocurrency is the distributed ledger technology that governs exchange
protocols. The era of distributed ledgers is founded on consensus algorithms that govern the
introduction of new blocks. For a block to be recorded in the blockchain, all members of the
peer-to-peer community must accept it. There are various types of consensus mechanisms,
among which proof-of-work (PoW), proof-of-stake (PoS), delegated-proof-of-stake (DPoS)
and proof-of-authority (PoA) are some of the most widely recognised (Anurina, 2021).

Weaknesses and Opportunities

While there exists a degree of semi-anonymity – where the identities of bitcoin wallet owners
are not immediately discernible – this aspect can be somewhat unsettling for potential users.
The public nature of the blockchain renders it vulnerable to attacks due to its open
accessibility (King, 2013). To date, the Bitcoin network has experienced numerous "stress
tests," which were essentially distributed denial-of-service (DDoS) attacks (Hileman, 2016).
These tests were initiated by exchanges and miners to demonstrate a critical point regarding
Bitcoin's architecture: that the network struggles to accommodate high transaction loads. The
unfortunate reality is that the very participants involved in Bitcoin's ecosystem can
incapacitate the network to make a statement, highlighting a significant flaw in the system's
design. These two characteristics of Bitcoin's framework are fundamental to its operation and
cannot be altered. Consequently, any adoption by hesitant users must occur despite these
inherent features. This phenomenon is not particularly new, as seen in the discourse regarding
the regulation of e-money.

In this discourse, Helleiner (1998, 2003) argued that states possess the ability to regulate
electronic money, which is categorised as private currency, and are likely to exercise this
regulatory power. However, he acknowledged that the emergence of such currency would
present significant challenges to state authority. Helleiner asserted that the mere introduction
of e-money technology would not ensure its widespread acceptance; rather, he posited that
the technological advancements must be integrated into a successful political initiative aimed
at fostering its broad utilisation. This perspective aligns with his analysis (Helleiner, 2003) of
the establishment of national or territorial currencies in the nineteenth century, where he
identifies the emergence of nation-states as one of the two essential prerequisites for the
creation of these currencies, alongside advancements in industrial technologies for the
production of coins and notes. This analysis is consistent with his assertion that states have
been instrumental in the evolution of financial globalisation as well (Helleiner, 1994).

Allen (2022) wrote for the International Monetary Fund a scathing indictment of
cryptocurrency in terms of its shortcomings. A financial system based on cryptocurrency is
likely to exacerbate many issues inherent in traditional finance. For instance, the potential for
an unlimited supply of tokens and coins to be used as collateral for loans could significantly
increase the level of leverage within the financial system. The use of rigid, self-executing
smart contracts may strip the system of the necessary flexibility and discretion required in
unforeseen and potentially critical situations. More broadly, the complexity of the crypto
ecosystem poses a significant risk as such complexity can hinder effective risk assessment
even in the presence of abundant data. Complex systems are more vulnerable to "normal
accidents," where minor triggers can lead to substantial disruptions. Consequently, a crypto-
based financial system is likely to experience frequent and destabilising cycles of booms and
busts. In practical terms, nearly every cryptocurrency transaction necessitates conversion into
a traditional currency (Böhme et al., 2015), which consequently involves the participation of
'traders' acting as intermediaries (Yermack, 2015).

Price volatility renders cryptocurrencies unreliable as stores of value and units of account
(Baldwin, 2018). As these digital assets have increasingly become subjects of speculation,
their prices have become highly impractical. The volatility of Bitcoin does little to alleviate
concerns regarding an unpredictable future (Keynes, 1973). While stablecoins aim to mitigate
this issue, the function of a unit of account ultimately reverts to the fiat currency to which
these cryptocurrencies are linked - most commonly the US dollar - which still requires a
significant degree of trust. As a result, a crucial aspect of the Hayekian argument is
diminished (Fantacci, 2019; Zook & Blankenship, 2018). Furthermore, the stability achieved
by stablecoins has proven to be imperfect (Joo et al., 2019), relying on assumptions that are
difficult to verify regarding their capacity to maintain par values against speculative pressures
or that such maintenance can be effectively managed through electronic algorithms.

Growth and Potential for Cryptocurrency in India

The Indian cryptocurrency market capitalisation size is expected to show a growth rate
(CAGR) of 54.11% during the period 2024-2032 (IMARC, 2024). The market is driven by
factors such as the widespread adoption of cryptocurrency as an investment avenue, growth
of the digital economy, government focus on digital initiatives and the development of
cryptocurrency startups and exchanges. Sharma (2022) examines the expansion of
cryptocurrencies, highlighting a substantial level of global adoption, particularly in India,
which exhibits a significant adoption rate. The Indian government's implementation of a 30
percent tax on digital currency earnings reflects its support for cryptocurrency users.
Nonetheless, a primary challenge in the Indian market is the insufficient information or
understanding surrounding cryptocurrencies. The establishment of a well-regulated and
accessible policy could enhance India's position as a leading cryptocurrency hub. A SWOT
analysis uncovers notable strengths, weaknesses, opportunities, and threats within the
cryptocurrency market, emphasising its decentralized structure, low transaction fees and
worldwide accessibility as key strengths. Weaknesses include security risks, fraudulent
activities and considerable price fluctuations. Opportunities lie in the potential for a global
market and the mitigation of systemic risks, while threats encompass illicit trading, limited
adoption due to knowledge deficiencies and legal complications in various jurisdictions.
Overall, cryptocurrency remains a highly lucrative DeFi asset for investment. However,
challenges still surmount in terms of high stochastic volatility, price fluctuation and
susceptibility to cyber attacks. More research has to be done in order to reach a conclusive
statement.

References:

Akhtar et al (2019) "Potential of Blockchain Technology in Digital Currency: A

Review," 2019 16th International Computer Conference on Wavelet Active Media
Technology and Information Processing, 2019, pp. 85-91, doi:
10.1109/ICCWAMTIP47768.2019.9067546

Yuan and F. Wang (2018) "Blockchain and Cryptocurrencies: Model, Techniques,

and Applications," in IEEE Transactions on Systems, Man, and Cybernetics: Systems, vol.
48, no. 9, pp. 1421-1428, Sept. 2018, doi: 10.1109/TSMC.2018.2854904.