UPSC current affairs

Crypto Currencies and Blockchain

Recently bitcoin saw huge fluctuation in its value in the span of few days, Venezuela has launched its own oil-backed cryptocurrency called “petro”.

• A cryptocurrency is a digital currency which can be used in place of conventional money.
• In the cryptocurrencies, cryptography is used to secure and verify the transactions. It is also used to control the supply of cryptocurrencies.

Characteristics of Cryptocurrencies:
• Irreversible: A transaction done by cryptocurrency is irreversible and cannot be reversed.
• Intangible: the cryptocurrencies are not backed by any tangible good or any kind of guarantee.
• Instant and global: the transaction is instantaneous and since the network is global, the transaction can be done across the globe without restrictions.
• Secure: it uses cryptography technology which is almost impossible to break.
• No central authority: There is no gatekeeper like that of government and central banks and users are responsible for all the transactions.

• Limited Supply: The supply of cryptocurrency is limited. For example, The supply of Bitcoins will exhaust somewhere around 2140.
• No Debts: There is no concept of debts in cryptocurrencies. All the transactions are actual exchange of money.

Blockchain Technologies:
• The underlying technology in cryptocurrencies is blockchain technology.
• In simple terms, a blockchain is a continuously growing chain of blocks which are linked together and are secured with the use of cryptography. It is a kind of open and distributed ledger that can record transactions between two parties which can be verified in a permanent way.
• Each block contains 3 information:
– Cryptographic hash of the previous block,
– A timestamp and
– Transaction data.
• Cryptocurrency is one of the use of blockchain technology. It has potential to be used in Smart Contracts, Proof of Ownership, Authenticated Voting, Stock exchange, Real Estate, etc.

Historical Background:
• In 2009, an anonymous hacker or hacker group called Satoshi Nakamoto introduced Bitcoin.
• It was described as a ‘peer-to-peer electronic cash system.’
• It was completely decentralized system due to absence of any servers and central authority.
• Bitcoin was the first cryptocurrency which became widely popular. Later other cryptocurrencies also came up like Litecoin, Namecoin and PPcoin.

Advantages of Bitcoin Over Fiat Money:
• Fast and efficient: Fund transfer is easier and faster with cryptocurrencies as compared to conventional money
• Low transaction cost: the processing fee is virtually zero in case of cryptocurrencies.
• Durability: bitcoin being a digital code is infinitely more durable than any paper currency.
• Counterfeiting: it is created by cryptography and uses blockchain technology and hence is much harder to counterfeit than paper currency.

Disadvantages of Bitcoins Over Fiat Money:
• Less acceptability: Only a small number of goods and service providers accept payment in Bitcoins. At present it cannot be used to buy items and services of daily necessity.
• Fluctuation in value: cryptocurrencies has seen very high fluctuation in their values because it depends on supply and demand. This results in fluctuation in the wealth of cryptocurrency holder.
• Difficulty in use by common people: it is virtually impossible for common people to recognize and use a bitcoin.
• Effect on economy and security:
– Black markets: bitcoins are often used for buying and selling illegal goods and services like drugs, arms, etc.
– Terrorism: it enables easy access of arms and weapons to terrorists.
– Money laundering: bitcoins has seen its use for money laundering.

• Speculative: cryptocurrencies are turning into speculative bubble which may crash in the future.
• Hacking: Cryptocurrencies and valets are not completely immune to the hacking.
• Energy consumption: with increase in mining of cryptocurrencies, there has been an increase in energy consumption as well. It was reported that, in November 2017, the power consumed by the entire bitcoin network was higher than that Ireland. This will have impact on power production, consumption, power prices, global warming, etc.

Present Legal Status:
• The legal status of bitcoin is still undefined and changing. Its legal status varies from country to country. Though most of the countries have not made it illegal but its status as a money or a commodity varies from country to country.
• Some countries have allowed its use and trade whereas many have banned or restricted it.
– United States: it has no clear policy on cryptocurrency. However, The Securities and Exchange Commission (SEC) of USA has warned investors of the risks involved in investing in cryptocurrency. It has also halted many ICOs (initial coin offerings)
– Canada: The Financial Consumer Agency of Canada does not consider cryptocurrencies to be a legal tender.
– Venezuela: it has recently announced its own oil-backed cryptocurrency called “petro”.
– China: China has been taking many actions to clamp down on cryptocurrency. It has banned ICOs, ordered a bank account freeze associated with cryptocurrency exchanges, kicked out bitcoin miners, etc.
– India: India has also been clamping down on cryptocurrencies although it has not banned it yet. RBI
has issued warnings related to the risk involved with cryptocurrencies.
– European Union: the EU is planning to end anonymity for cryptocurrency traders.

Future of Bitcoin:
• At present there is significant element of uncertainty with respect to cryptocurrencies.
• There are a number of technical and regulatory challenges regarding the future of cryptocurrency which often slows down and even prevent their growth.
• It includes regulatory barriers, cybersecurity, difficulty in converting cryptocurrency to fiat money, etc.
• Despite this, there is great potential for cryptocurrencies to flourish, and many even see it to even replace national currencies someday.

Way Forward:
• Bitcoin or cryptocurrency is a revolutionary technology and may have disruptive impact.
• Like every new invention and technologies, it has positive as well as negative impact.
• We should adopt a cautious approach towards it to ensure that we can take its advantage at the same time limiting its misuse.

The Institute for Development and Research in Banking Technology (IDRBT), an arm of the Reserve Bank of India (RBI), is developing a model platform for blockchain technology.

Currently, most people use a trusted middleman such as a bank to make a transaction. But blockchain allows consumers and suppliers to connect directly, removing the need for a third party.
• It is a decentralized database, or “digital ledger”, of transactions that everyone on the network can see.
• Each digital record or transaction in the thread is called a block (hence the name), and it allows either an open or controlled set of users to participate in the electronic ledger.
• Each transaction is recorded to the ledger after verification by the network participants, mainly a chain of computers, called nodes.

• Blockchain can only be updated by consensus between participants in the system, and when new data is entered, it can never be erased.

Benefits and Application:
• It becomes very useful when there is a lot of data that is shared across multiple parties with no trust mechanism among the participants.
• Blockchain eliminates huge amounts of recordkeeping, which can get very confusing when there are multiple parties involved in a transaction.
• Blockchain is the backbone technology on which bitcoins run.
• But bitcoin is just one of the applications. It is also witnessing a lot of traction within India, in banking and insurance.