“Change is the only constant,” wrote the ancient Greek philosopher Heraclitus of Ephesus. And in today's world, one of the greatest changes is the changing nature of money. As the world embraces the ease in accessibility to high-speed internet services across all spectrums, the medium of exchange is transforming from fiat currency to virtual and cryptocurrencies. The exchange of cryptocurrency heavily revolves around speculation by professionals, and institutional investors dealing with large sums of money. The global adoption of cryptocurrency has increased over the last few years and has seen an 880% increase in year-to-year transactions in the last year, reflecting the increased acceptance in cryptocurrency usage in emerging markets. India ranks second in the overall crypto-adoption index ranking, backing the increased interest of Indian investors in the cryptocurrency markets. The major focus of this paper is regarding the next phase of transition into digital and cryptocurrency and its implications on monetary policies with a specific focus on the Indian monetary system.
TopIntroduction
In her book Blockchain: Blueprint for a New Economy, Melanie Swan goes into great detail on digital currency and its possible applications. Swan claims that developing 21st-century digital currencies contain three distinct components: the digital money itself (for example, Bitcoin), the transaction software, and the underlying ledger on which all transactions are recorded. The currency itself is a string of code at the “top level” of the digital currency stack. The code identifies the money object and contains cryptographic protections to safeguard individual users and the system as a whole from hackers. It's also conceivable that the currency's code contains extra information. When it comes to something with the word “digital” in its name, a strong technological foundation is required. As a result, even with digital currency, Blockchain introduced a new paradigm. A blockchain is a consensus system for creating an append-only log (a transaction ledger in the case of Bitcoin) that can subsequently be used to establish an auditable database (in Bitcoin, a record of who owns which coins). This database is built by a group of people who may or may not trust each other, and it is secured using encryption so that every entry can be audited and validated. The outcome is a real-time, consensus-based record of transactions with a wide range of possible uses, including non-currency value and data transfers. (The blockchain catalyst for change | VOX, CEPR Policy Portal, 2018). Apart from private cryptocurrencies, The Bank for International Settlements is working with a group of seven central banks (the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank) to investigate central bank digital currencies (CBDCs) for the general public (“general purpose” or “retail” CBDC). With this increased interest in the cryptocurrency markets, it's now up to the policymakers and regulatory authorities to look into the type of regulations that can be bought in place to protect consumer interests as well as provide an equal platform to cryptocurrency exchanges rather than prohibiting the use of virtual and cryptocurrencies by the financial institutions and entities regulated by the central bank of India. Another important challenge, in the long run, is whether cryptocurrency can be used as a means of transfer for everyday transactions. Many factors have influenced the increase in the use of cryptocurrencies over the past few months and this paper discusses these factors. Along with this, the paper also focuses on whether cryptocurrencies can penetrate deeper into the Indian markets and the kind of changes that need to be brought in place to aid this transition if it is going to take place shortly. The emergence of one of the first major cryptocurrencies, Bitcoin in 2009 led to a revolutionary change in the financial system. Bitcoin, defined as a peer-to-peer version of electronic cash that would allow online payments to be sent directly from one party to another without going through a financial institution (Nakamoto, 2008), was first introduced by Satoshi Nakomoto in the paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”. This decentralized system has inspired the creation of many similar cryptocurrencies based on blockchain technology. Litecoin, ethereum, and Tether are some of the popularly mined cryptocurrencies in today's market.
Understanding the Technology Behind Cryptocurrencies
The underlying technology of such decentralized currencies is the DLT or the distributed ledger technology. DLT refers to the processes and related technologies that enable nodes in a network (or arrangement) to securely propose, validate, and record state changes (or updates) to a synchronized ledger that is distributed across the network’s nodes. (Townsend, 2020). Thus the payment system does not require any central authority to oversee the transactions made through these secure networks. The DLT focuses on specific protocols and procedures that are set in place to ensure the security of these networks through cryptographic codes. Under the DLT system, the blockchain system is particularly used as the underlying technology for cryptocurrencies like Bitcoin. Blockchain uses cryptographic code and algorithms that need to be solved by miners to obtain access to the cryptocurrency. This process is also used to verify the ever-growing, append-only data structure that takes the form of a chain of so-called ‘transaction blocks’ – the blockchain – which serves the function of a ledger. (Krause et al., 2017).