Cryptocurrency is a digital currency that is an alternative payment method created using encryption methods. Cryptocurrency uses blockchain technology to achieve decentralisation, transparency, and immutability (the ability of a blockchain ledger to remain unchanged, unaltered and indelible). Cryptocurrency has a decentralised structure and so it can exist independently of governments and central authorities. “Cryptocurrency” is one of the important concepts in the UPSC/IAS 2023 Economy syllabus which is discussed in this article in detail.

What exactly is Cryptocurrency?

• Cryptocurrency or crypto-currency or crypto means online money created using digits or digital encryptions.
• A cryptocurrency is an internet-based medium of exchange that is distributed across many computers.
• A cryptocurrency conducts financial transactions using cryptographic functions.
• The most important characteristic of a cryptocurrency is that it is not controlled by any central authority. i.e., the decentralised nature of cryptocurrencies is theoretically immune to traditional methods of government control and interference.
• Blockchain and related technology, according to experts, will disrupt many industries, including finance and law.
• The benefits of cryptocurrencies include cheaper and faster money transfers, as well as decentralised systems that do not fail at a single point.
• Cryptocurrency disadvantages include price volatility, high energy consumption for mining activities, and use in criminal activities.
• Cryptocurrencies are not widely accepted as money due to their lack of legal tender status.
• El Salvador became the first country in the world to accept cryptocurrency as legal tender in June 2021.

Evolution of Cryptocurrency

• Bitcoin, the first decentralized cryptocurrency, was created in 2009 by a presumably anonymous developer named Satoshi Nakamoto.
• Subprime mortgage crisis and recession in 2008-2009 resulted in Quantitative Easing (the introduction of new money into the money supply by a central bank) of the dollar in the United States, which increased dollar supply and eroded dollar purchasing power.
• Banks charge fees for online transfers, credit card transactions, and ATM withdrawals.
• From the creation of Bitcoin in 2009 to the present day, cryptocurrencies have grown in popularity all over the world.
• The gains made by this sector since the onset of the Covid-19 pandemic in January 2020 have been astounding; the "crypto market" has grown by more than 500%.

Bitcoin

• Bitcoin is an electronic or digital currency that operates on a peer-to-peer basis. It is decentralized, with no centralized authority in charge.
• Bitcoins can be digitally sent to anyone with a bitcoin address anywhere in the world. One person may have multiple addresses for various purposes such as personal, business, and so on.
• Satoshi Nakamoto proposed bitcoin, a mathematically-proofed electronic payment system.
• A bitcoin is not printed currency, but rather a non-reputable (assurance that no one can deny the legitimacy of something) record of every transaction that it has been through. All of this is part of a massive ledger known as the blockchain.
• Since no authority controls or tracks the generation of the coins, the system is designed in such a way that the network keeps a foolproof record of every transaction as well as tracking the issuance of the currency sent without either side knowing the identity of the other Bitcoins is 'mined' using computing power in a distributed network.
• It is the first example of a new type of currency known as cryptocurrency.

Types of Cryptocurrency

• There are thousands of types of cryptocurrencies. Some of the well-known types of cryptocurrencies are
• Bitcoin: Bitcoin is one of the most traded and covered cryptocurrencies to date. Bitcoin was established in 2009. The currency was created by Satoshi Nakamoto, who is generally believed to be a pseudonym for an individual or group of individuals whose exact identity is still unknown.
• Ethereum: Ethereum, a blockchain platform created in 2015, has its own digital currency called Ether (ETH), also known as Ethereum. After Bitcoin, it is the most widely used cryptocurrency.
• Litecoin: This currency is most related to bitcoin, although it has moved more quickly to build new features, such as speedier payments and processes to allow for more transactions.
• Ripple: A distributed ledger system called Ripple was created in 2012. Ripple is a tool that can be used to track more than just cryptocurrency transactions. The organisation that created it has collaborated with numerous banks and financial organisations.
• The term "altcoins" is used to distinguish non-Bitcoin cryptocurrencies from the original.

How does Cryptocurrency work?

• A distributed public database known as blockchain, which is updated and maintained by currency holders, is the foundation for cryptocurrencies.
• Through a process known as mining, which employs computer power to solve challenging mathematical problems, units of Bitcoin are created.
• Additionally, users have the option of purchasing the currencies from brokers, then storing and spending them in digital wallets.
• When a user holds cryptocurrencies, they don't actually own anything. What they possess is a key that enables them to transfer a record or a unit of measurement between people without the use of a reliable third party.
• Despite the fact that Bitcoin has been available since 2009, the financial applications of cryptocurrencies and blockchain technology are constantly developing, and more are anticipated in the future.
• The technology could someday be used to trade bonds, equities, and other financial assets.

Cryptocurrency - Significance

• Cryptocurrencies represent a new, decentralized money paradigm.
• Centralized intermediaries, such as banks and monetary institutions, are not required in this system to enforce trust and police transactions between two parties.
• Thus, a cryptocurrency-based system eliminates the possibility of a single point of failure, such as a large bank, triggering a global crisis, such as the one triggered in 2008 by the failure of institutions in the United States.
• Cryptocurrencies promise to make it easier to transfer funds between two parties without the need for a trusted third party such as a bank or credit card company.
• Cryptocurrency transfers between two transacting parties are faster than traditional money transfers because they do not use third-party intermediaries.
• Profits can be made from cryptocurrency investments. The value of cryptocurrency markets has skyrocketed.
• It is a less expensive option when compared to other online transactions.
• The transfer of funds is completed with minimal processing fees.

Cryptocurrency - Limitations

• Cryptocurrencies, while claiming to be an anonymous form of transaction, are actually pseudonymous. They leave a digital trail that agencies can decipher.
• Cryptocurrencies have grown in popularity among criminals as a tool for nefarious activities such as money laundering and illegal purchases.
• Cryptocurrencies have also become popular among hackers, who use them to carry out ransomware attacks.
• In theory, cryptocurrencies are supposed to be decentralized, with their wealth distributed among many parties via a blockchain. In practice, ownership is extremely concentrated.
• One of the conceits of cryptocurrencies is that anyone with a computer and an internet connection can mine them.
  • Mining popular cryptocurrencies, on the other hand, necessitates a significant amount of energy, sometimes equivalent to that consumed by entire countries.
• While cryptocurrency blockchains are extremely secure, other crypto repositories, such as exchanges and wallets, are vulnerable to hacking.
• Price volatility affects cryptocurrencies traded on public markets. Bitcoin's value has gone through rapid ups and downs.
• Some economists believe that cryptocurrencies are a passing fad or speculative bubble.

Cryptocurrency in India

• The RBI issued a circular in 2018 prohibiting all banks from dealing in cryptocurrencies. In May 2020, the Supreme Court ruled that this circular was unconstitutional.
• The government recently announced the introduction of a bill, Cryptocurrency, and Regulation of Official Digital Currency Bill, 2021, to create a sovereign digital currency while simultaneously prohibiting all private cryptocurrencies.
• The funds invested in Indian blockchain start-ups account for less than 0.2 percent of the total amount raised by the sector globally.
• The current cryptocurrency approach makes it nearly impossible for blockchain entrepreneurs and investors to gain significant economic benefits.

Way Forward

• Regulation is required to prevent serious problems, to ensure that cryptocurrencies are not misused, and to protect unsuspecting investors from excessive market volatility and potential scams.
• The regulation must be clear, transparent, and coherent, and it must be animated by a vision of what it seeks to achieve.
• A legal and regulatory framework must define crypto-currencies as securities or other financial instruments under applicable national laws and identify the regulatory authority in charge.
• Rather than outright prohibiting cryptocurrencies, the government should regulate their trading by instituting stringent KYC norms, reporting, and taxation.
• To address concerns about transparency, information availability, and consumer protection, steps such as record keeping, inspections, independent audits, investor grievance redressal, and dispute resolution may be considered.
• Cryptocurrencies and Blockchain technology have the potential to rekindle the entrepreneurial spirit in India's startup ecosystem by creating job opportunities at all levels, from blockchain developers to designers, project managers, business analysts, promoters, and marketers.

Conclusion

Cryptocurrencies provide unique opportunities for increasing people's economic independence all across the world. Even in nations with strict government restrictions over citizens' finances, unrestricted trade is facilitated by the intrinsic borderlessness of these digital currencies. Cryptocurrencies also can serve as an alternative to malfunctioning fiat currencies for savings and payments in regions where inflation is a major issue.