Ill-timed euphoria over cryptocurrencies

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Monetary puritans have always considered cryptocurrencies as bubbles waiting to burst. But crypto fans go to the extent of describing its emergence as the most important development in the monetary system in 5,000 years of its history, stating it is set to completely reshape the financial landscape of our world. Bitcoin, the undisputed leader of all cryptocurrencies, which carried a value of double digits in the dollar at one point of time, is today valued at $2500 a coin. That gives an idea about its enormous earning potential.

Cryptocurrency firms have now begun proliferating in India. The likes of Zebpay, Unocoin, Coinsecure, Laxmi Coin, SearchTrade and BTCX India have all achieved significant traction since their early start-up days. So much so that a committee of the representatives of finance and IT ministries, NITI Aayog, and Reserve Bank officials are examining the possibility of legalising virtual currencies in India. Its report which will introduce new systems of regulating transactions in virtual currencies is expected soon. That the electronic wallet transactions are done on a peer to peer basis had initially prompted the monetary regulators to see only limited scope for the informal currency.

But with Indians showing a typical ingenuity to use anything for purposes other than those originally intended, there was a great danger of cryptocurrencies being used for money laundering and tax evasion, which the government seems to have finally woken up to. The stand of the Reserve Bank earlier was that the creation, trading or usage of virtual currencies, including Bitcoins, as a medium for payment are not authorised by any Central bank or monetary authority, even cautioning the public about the risks of getting into their realm. But all that seems to have changed now.

An impending new development in the evolution of cryptocurrency technology and its administration is, however, raising a doubt whether the new euphoria about the virtual currency may be a bit untimely.

The past two years have seen the raging of what is described as a 'civil war' between two major operative factions of the Bitcoin system and its final outcome is set to be known by the end of this month. Whichever way the 'war' ends, it will have serious implications for the virtual currency and its volatility, which is already on display to a significant degree. Since there is no external authority to adjudicate between the two factions, the outcome remains as uncertain as anyone's guess.

In the simplest terms, the war is between the hardware and the software, but in practice, it involves hugely complex concepts and infrastructural issues which could lead to perhaps the biggest turbulence in the history of Bitcoin. The conflict has been attributed essentially to an ideological split about the identity of Bitcoin. It relates to whether the virtual currency should remain the preserve of technology whizz kids or whether it should embrace the larger world of monetary systems, regulations, and mainstream investment players.

The problem, in a way, has its genesis in the increasing popularity of Bitcoin and the unprecedented growth of transactions to a level that has become almost unmanageable, although the currency's appeal still remains limited compared to the conventional monetary system. Since security is of utmost importance, the Bitcoin system takes extra care to protect itself from hacking attacks. This has placed a limitation on the amount of information that can be stored on the system as the burgeoning transaction volumes also tend to compromise the capacity of its network, known as the Blockchain, to hold information.

Blockchain itself is a very interesting model and has been likened to a village community marriage, in which a single function or ceremony announces to the whole village that two persons are getting into wedlock. There is no need to inform each member of the community separately about the matrimony because it becomes as good as common community knowledge. But imagine there are half a dozen marriages daily in the community: it won't be possible for the community members to take part and witness most of those marriages, and by implication know about the new arrangement between the respective couples.

This is exactly what is happening to Bitcoin's Blockchain and it has been agitating the two factions of miners, representing the costly hardware, and the rival Core group, which takes great pride in its bug-resistant software. The higher transaction volumes have been dogging the system, creating traffic congestions, causing higher transaction times and an increase in processing charges; a solution was thus inevitable. The miners, dominated by the Chinese, have been proposing an increase in the block sizes to overcome the problem while the software group has proposed storing of much of the data outside the main network because it is the software that has to handle the entire load. The software group has scheduled an upgrade to its software, called SegWit, which is expected to be rolled out later this month. The miners feel that the change would diminish their influence and could, therefore, force a climax to the bickering.

The miners are reconciled to the change, but it is feared that the possibility of a split in the identity of Bitcoin is very much on the cards, with both sides pursuing their own agendas and visions. This could mean the coin's value is cut into two halves, which will have disastrous consequences for investors. Already Bitcoin prices have dropped almost by a quarter since June and the prospects of further falls cannot be ruled out. In any case, it is perhaps the most inappropriate time for new players to get in, irrespective of whatever the newspaper inserts may claim. IPA

(The views expressed

are strictly personal.)