Crypto craze may drive regulators to back their use – Mint

Central bankers globally are wary of rising interest in cryptocurrencies since Facebook decided to launch one of its own. Besides PayPal Holdings Inc. allowing its customers to use virtual currency on Wednesday has added to investor exuberance. Mint explores the issue.

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Hows cryptocurrency trade carried out?

Cryptocurrencies, including Bitcoin, are digital currencies, wherein the transaction records are verified and maintained on a decentralized system, which uses cryptography, replacing a central authority for maintaining records. Bitcoin is one among several such products, but is one of the most widely-known and used cryptocurrencies. The technology is based on block-chain, or a distributed public ledger. There are several cryptocurrency exchanges that allow trading using actual money essentially allowing the cryptocurrency to be converted to cash.

Where do they derive their value from?

Normal currencies derive their value by fiat and are thus known as fiat currencies. That is, a 2,000 note has a nominal value of 2,000 because of the governments fiat. However, in case of Bitcoin, there is no such central authority that determines its value. The value is determined by the cryptocurrency exchanges or markets where the forces of demand and supply interact, leading to price discovery. This is one primary reason why the cryptocurrency experience is highly volatile in terms of their value, which undermines the critical function of store of value provided by fiat money.

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What is the risk of having private cryptocurrency?

Most central bankers regulate the amount of money supply and determine interest rates to ensure price stability, but will not be able to have control over private the supply of a cryptocurrency. Besides, there are concerns over cryptocurrency use to finance illegal activities, which further makes governments wary of such private cryptocurrencies.

Will central banks look at digital currencies?

The key difference over the last few months has been in the central banks approach towards crypto-currencies. There have been talks on the possibility of central bank-backed digital currencies. The Bank of International Settlements, along with seven other central banks have published a report that lays out the norms for central bank-backed digital currencies. The key requirement is that the CBDCs must complement cash and other legal tender instead of replacing them to ensure monetary and financial stability.

How will such digital currencies benefit?

The key advantage is that it will serve as a medium of exchange, and a store of value. That will also encourage it as a means of payment and, would eventually, improve efficiency of payments. The move of interest-bearing CBDC could also be key towards improving monetary policy transmission. The benefit would be in the form of reducing transaction costs of digital transactions, which could be instrumental in financial inclusion improvement across the globe.

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Crypto craze may drive regulators to back their use - Mint