India’s tango with crypto | OPINION

Cryptos are beginning to play a critical role in Web 3.0. Given the potential negative impact of crypto, it would perhaps be judicious to create a crypto SEZ in India to enable the development of talent and tapping of the Web 3.0 global market.

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India’s tango with crypto
I now believe that it is critical to provide a safe haven for cryptos to be transacted from within the Indian borders, writes Jaijit Bhattacharya.

India is waiting with bated breath for the introduction of the 'The Cryptocurrency and Regulation of Official Digital Currency Bill'. The bill is expected to create a facilitative framework for the creation of the official digital currency to be issued by the Reserve Bank of India. The Bill also apparently seeks to prohibit all private cryptocurrencies in India. However, it allows for certain exceptions to promote the underlying technology of cryptocurrency and its uses.

Going 14 years back to October 31, 2008, the so-called 'Satoshi Nakamoto' posted the original Bitcoin white paper, 'Bitcoin: A Peer-to-Peer Electronic Cash System'. On its 13th anniversary in 2021, the price of Bitcoin has been hovering at a longtime local minimum of $53k since early October 2021 and broke its all-time high at $69k on November 10, 2021, with a market cap of $1.3 trillion; however, since then, Bitcoin took substantial losses as a sell-off in the equities market, those considered riskier assets, also spilt over and had an effect on the crypto market. It has now crashed to below $30K.

Bitcoin is the flag-bearer for all cryptos. Other cryptos have suffered even worse, underlying the fact that cryptos are anything but currencies as they do not provide a stable representative of value. They are at best commodities and hence come under the bracket of crypto assets. According to PitchBook Data, the overall market worth of cryptocurrencies hit $3 trillion in 2021. That is more than the GDP of India. This was due to global venture capital funds spending almost $30 billion on cryptocurrencies in 2021, as of December 15. Despite nations like China cracking down on virtual currencies and India sending enough signals of its unease with cryptocurrencies, the market cap had risen.

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While it is to be noted that the price of cryptocurrencies fluctuates most often during the weekend due to less volume and margin trading, which in turn causes isolated trading patterns leading to tightened liquidity, worries about geopolitical conflicts and the Russian-Ukraine war, and regulatory tightenings, has caused market anxiety leading to crypto investors to liquidate their crypto holdings.

In addition, the US Federal Reserve System's announcement on tapering its bond-buying program in November 2021 caused the crypto trade to jitter due to a sudden shift in the view on cryptocurrencies by the US Fed. With the risk-associated assets, such as stock and Bitcoin, the Federal Reserve has announced it will begin tapering the US$120 billion a month it spends on bond purchases, hoping to address concerns over BTC impact and rising inflation. This has caused unease in the crypto industry as Bitcoin adoption over the past 18 months has been driven in part by investors wishing to hedge themselves against this inflation.

However, with the widening of new use cases and applications built on the underlying Blockchain technology, such as smart contracts, decentralized apps (DeFi), and non-fungible tokens (NFTs) are gathering mainstream popularity and with proper regulation, specific use cases of cryptos have started to emerge. Such use cases are mostly in the domain of trans-border payments and applications such as gaming.

Two small countries, El Salvador and the Central African Republic have also been convinced to adopt Bitcoin as acceptable legal tender for payments. This has helped El Salvador to some extent by reducing the cost of inward remittances. One is still trying to figure out the benefits accruing to the Central African Republic.

For BTC (Bitcoin) and altcoins (i.e. cryptos other than Bitcoin) to be widely adopted, the BTC and the altcoin communities have come up with major alterations to bridge the technology gaps and introduced new applications to bring about uptake in the adoption of BTC and altcoins.

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Taproot, the latest upgrade in bitcoin, came into effect at block 709,632. It is said to be the first major upgrade since 2017. The upgrade covers the aspects of smart contracts, privacy, and making transactions cheaper (i.e. gas fee). Most importantly, it will enable bitcoin to execute smart contracts on the BTC blockchain.

Since Facebook parent Meta announced in October that it was renamed to focus on the Metaverse, interest in the concept has skyrocketed and Metaverses' practicality and promise are being recognized by major tech companies, as well as entertainment companies, such as Disney, have revealed ambitions to enter the virtual reality market.

NFTs have become popular among artists, gamers, and brands across the spectrum of culture because it provides a great new possibility for artists to digitize their work and many are convinced that NFTs are here to stay with the rise of Facebook's metaverse. We already have NFT of Amitabh Bachchan’s recitals of his father’s iconic collection 'Madhushala', autographed posters, and collectibles receiving bids close to $1 million at the end of the auction.

Besides the anecdotal evidence of penetration of cryptos and NFT, it is also interesting to do a stock-to-flow model of Bitcoin to predict its pricing in future. A stock-to-flow model compares the present stock of a commodity to the rate of production over the course of a year. The stock-to-flow ratio is used to compare a resource's relative abundance or scarcity. A higher ratio indicates scarcity and therefore drives up the price of a commodity.

The stock-to-flow model (S2F or S2FX) is a popular chart that measures the existing number of BTC mined to date (stock) and pairs it against the number of new BTC expected to be mined over the next 12 months (flow).

Over 18.8 million Bitcoins have been mined so far. The average time it takes to create a new block on the Bitcoin blockchain is about 10 minutes. Miners are rewarded 6.25 BTC for each new block of transactions as a part of proof-of-work. This means that every ten minutes, 6.25 BTC are generated. Accordingly, 37.5 BTC (6.25/10 minutes × 60 minutes/hour) are generated every hour, and 900 BTC (37.5/hour x 24 hours/day) is generated daily. Therefore, the current annual flow of Bitcoin is 900/day x 365.25 days per year which equals 328,725 BTC or roughly 0.33 million.

As of fall 2021, the circulating supply of BTC was 18.8 million with a flow of 0.33 million bitcoins. This gives Bitcoin a current stock-to-flow ratio of 18.8 million / 0.33 million, which equals 57, a high SF ratio indicating BTC scarcity will help retain BTC’s value long term.

Similarly, when the second halving happens in 2024, the mining reward will be dropped to 3.125, implying that the pace at which new Bitcoin is generated will be reduced to half. The flow value of the ratio is constantly reduced as a result of halving. As a result, during the next halving in 2024, Bitcoin's SF ratio will skyrocket, reaching around 120, meaning the BTC becomes more valuable given its scarcity.

So clearly, Bitcoin’s prices will go up, given the scarcity foreseen in 2024, as long as there is demand for the same. Given that the demand is being driven by uncertainty due to the geopolitical situation, the need for cross-border remittances that bypass existing systems that are burdened by sanctions, and the rise of Web 3.0 that includes metaverse, gaming and the likes, each of which will only accentuate by 2024, it would be safe to conclude that cryptos will have a life outside of domestic transactions. Being a votary of not allowing cryptos for domestic transactions, I now believe that it is critical to provide a safe haven for cryptos to be transacted from within the Indian borders, but for transborder trade and Web 3.0 transactions. This would not only enable India to continue to develop talent in this space but would also help in being in the centre of an industry that will dominate Web 3.0.

Not having the talent in crypto would also imply that India will be hampered by Web 3.0. However, given the deeply destabilizing impact that crypto can have on the monetary framework of a sovereign nation, such activities around crypto need to be tightly ring-fenced. In tandem, the founders of crypto startups and Web 3.0 startups also need to be ring-fenced of any action from the law enforcement agencies or the regulators around the ethical use of cryptos. Perhaps one can consider the GIFT city as a place where such ring-fenced activities could be promoted, thus enabling India to play a significant role in Web 3.0 while protecting the rest of the economy from the negative fallout of crypto, while it still evolves as a technology. Hence, GIFT city (or some such crypto SEZ) could be an oasis for such technologies, fenced out of the Indian economy, while still being physically part of India. It is time to think radically about managing cryptos in a manner that India can benefit from while capping the harm it can do.