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Cryptocurrency | Science & Technology for UPSC CSE PDF Download

Introduction

A cryptocurrency is a digital asset designed to work as a medium of exchange wherein individual coin ownership records are stored in a ledger existing in a form of a computerized database.
It uses strong cryptography to secure transaction records, to control the creation of additional coins, and to verify the transfer of coin ownership. It typically does not exist in physical form (like paper money) and is typically not issued by a central authority.
Cryptocurrencies typically use decentralized control as opposed to centralized digital currency and central banking systems.

Why is it in demand?

  • Funds transfer between two parties will be easy without the need of third party like credit/debit cards or banks.
  • It is a cheaper alternative compared to other online transactions.
  • Payments are safe and secured and offer an unprecedented level of anonymity.
  • Modern cryptocurrency systems come with a user “wallet” or account address which is accessible only by a public key and pirate key.
  • The private key is only known to the owner of the wallet.
  • Funds transfers are completed with minimal processing fees.

 Significance of Cryptocurrencies

  • Corruption Check: As blocks run on a peer-to-peer network, it helps keep corruption in check by tracking the flow of funds and transactions.
  • Time Effective: Cryptocurrencies can help save money and substantial time for the remitter and the receiver, as it is conducted entirely on the Internet, runs on a mechanism that involves very less transaction fees and is almost instantaneous.
  • Cost Effective: Intermediaries such as banks, credit card and payment gateways draw almost 3% from the total global economic output of over $100 trillion, as fees for their services.
  • Integrating blockchain into these sectors could result in hundreds of billions of dollars in savings.

 Concerns over Cryptocurrencies

  • Sovereign guarantee: Cryptocurrencies pose risks to consumers.  They do not have any sovereign guarantee and hence are not legal tender.
  • Market volatility: Their speculative nature also makes them highly volatile.  For instance, the value of Bitcoin fell from USD 20,000 in December 2017 to USD 3,800 in November 2018.
  • Risk in security: A user loses access to their cryptocurrency if they lose their private key (unlike traditional digital banking accounts, this password cannot be reset).
  • Malware threats: In some cases, these private keys are stored by technical service providers (cryptocurrency exchanges or wallets), which are prone to malware or hacking.
  • Money laundering: Cryptocurrencies are more vulnerable to criminal activity and money laundering.  They provide greater anonymity than other payment methods since the public keys engaging in a transaction cannot be directly linked to an individual.
  • Regulatory bypass: A central bank cannot regulate the supply of cryptocurrencies in the economy.  This could pose a risk to the financial stability of the country if their use becomes widespread.
  • Power consumption: Since validating transactions is energy-intensive, it may have adverse consequences for the country’s energy security (the total electricity use of bitcoin mining, in 2018, was equivalent to that of mid-sized economies such as Switzerland).

Cryptocurrencies in India

  • In 2018, The RBI issued a circular preventing all banks from dealing in cryptocurrencies. This circular was declared unconstitutional by the Supreme Court in May 2020. Recently, the government has announced to introduce a bill; Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, to create a sovereign digital currency and simultaneously ban all private cryptocurrencies.
  • In India, the funds that have gone into the Indian blockchain start-ups account for less than 0.2% of the amount raised by the sector globally. The current approach towards cryptocurrencies makes it near-impossible for blockchain entrepreneurs and investors to acquire much economic benefit.

Issues Associated with Banning Decentralised Cryptocurrencies

  1. Blanket Ban: The intended ban is the essence of the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021. It seeks to prohibit all private cryptocurrencies in India.
    • However, categorising the cryptocurrencies as public (government-backed) or private (owned by an individual) is inaccurate as the cryptocurrencies are decentralised but not private.
    • Decentralised cryptocurrencies such as bitcoin aren’t or rather, can’t be controlled by any entity, private or public.
    • Brain-Drain: Ban of cryptocurrencies is most likely to result in an exodus of both talent and business from India, similar to what happened after the RBI’s 2018 ban.
    • Back then, blockchain experts moved to countries where crypto was regulated, such as Switzerland, Singapore, Estonia and the US.With a blanket ban, blockchain innovation, which has uses in governance, data economy and energy, will come to a halt in India.
  2. Deprivation of Transformative Technology: A ban will deprive India, its entrepreneurs and citizens of a transformative technology that is being rapidly adopted across the world, including by some of the largest enterprises such as Tesla and MasterCard.
  3. An Unproductive Effort: Banning as opposed to regulating will only create a parallel economy, encouraging illegitimate use, defeating the very purpose of the ban.
    • A ban is infeasible as any person can purchase cryptocurrency over the internet.
  4. Contradictory Policies: Banning cryptocurrency is inconsistent with the Draft National Strategy on Blockchain, 2021 of the Ministry of Electronics and IT (MeitY), which hailed blockchain technology as transparent, secure and efficient technology that puts a layer of trust over the internet.

Way Forward

  • Regulation is the Solution: Regulation is needed to prevent serious problems, to ensure that cryptocurrencies are not misused, and to protect unsuspecting investors from excessive market volatility and possible scams. The regulation needs to be clear, transparent, coherent and animated by a vision of what it seeks to achieve.
  • Clarity on Crypto-currency definition: A legal and regulatory framework must first define crypto-currencies as securities or other financial instruments under the relevant national laws and identify the regulatory authority in charge.
  • Strong KYC Norms: Instead of a complete prohibition on cryptocurrencies, the government shall rather regulate the trading of cryptocurrencies by including stringent KYC norms, reporting and taxability.
  • Ensuring Transparency: Record keeping, inspections, independent audits, investor grievance redressal and dispute resolution may also be considered to address concerns around transparency, information availability and consumer protection.
  • Igniting the Entrepreneurial Wave: Cryptocurrencies and Blockchain technology can reignite the entrepreneurial wave in India’s start up ecosystem and create job opportunities across different levels, from blockchain developers to designers, project managers, business analysts, promoters and marketers.

Conclusion

India is currently on the cusp of the next phase of digital revolution and has the potential to channel its human capital, expertise and resources into this revolution, and emerge as one of the winners of this wave. All that is needed to do is to get the policymaking right.
Blockchain and crypto assets will be an integral part of the Fourth Industrial Revolution, Indians shouldn’t be made to simply bypass it.

The document Cryptocurrency | Science & Technology for UPSC CSE is a part of the UPSC Course Science & Technology for UPSC CSE.
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FAQs on Cryptocurrency - Science & Technology for UPSC CSE

1. What is cryptocurrency and how does it work?
Ans. Cryptocurrency is a digital or virtual form of currency that uses cryptography for secure financial transactions, control the creation of additional units, and verify the transfer of assets. It operates on a decentralized technology called blockchain, which is a distributed ledger that records all transactions across multiple computers. This ensures transparency, security, and eliminates the need for intermediaries like banks.
2. Is investing in cryptocurrency risky?
Ans. Investing in cryptocurrency carries a certain level of risk. The crypto market is highly volatile, with prices fluctuating rapidly. Factors like government regulations, security breaches, and investor sentiment can affect the value of cryptocurrencies. Additionally, the lack of regulations and potential for fraud or hacking pose risks. It is important to conduct thorough research, diversify investments, and only invest what one can afford to lose.
3. How can I buy cryptocurrency?
Ans. There are several ways to buy cryptocurrency. One common method is through cryptocurrency exchanges, which are platforms where users can buy, sell, and trade digital currencies. These exchanges usually require users to create an account, verify their identity, and link a bank account or credit card for purchasing. Some popular cryptocurrency exchanges include Coinbase, Binance, and Kraken. Alternatively, some people engage in peer-to-peer transactions or use Bitcoin ATMs to acquire cryptocurrencies.
4. Can I use cryptocurrency for everyday transactions?
Ans. While the acceptance of cryptocurrency for everyday transactions is growing, it is not yet widely adopted. Some businesses, online retailers, and platforms do accept cryptocurrencies as a form of payment. However, the majority of traditional brick-and-mortar stores still primarily accept traditional fiat currencies. Additionally, the speed and scalability limitations of certain cryptocurrencies can hinder their use for day-to-day transactions. However, developments like the Lightning Network aim to address these challenges and improve cryptocurrency's usability.
5. How secure is cryptocurrency?
Ans. Cryptocurrency is generally considered secure due to the use of cryptography and the decentralized nature of blockchain technology. Transactions are encrypted and recorded on multiple computers, making it difficult for hackers to alter the data. However, individual security measures are crucial. Users must protect their private keys, which are necessary for accessing and transferring cryptocurrencies. Utilizing hardware wallets, strong passwords, two-factor authentication, and keeping software up to date can enhance security. Nonetheless, vulnerabilities can still exist, such as phishing attacks, malware, or human error, so users must remain vigilant.
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