Is crypto mania more a symptom than a cause?

It is at the confluence of faith, politics, and psychological mania. It is about faith in that value is largely a matter of belief; about politics because money is always about the allocation of power; and mania because the alchemy of conjuring something out of nothing is always deeply alluring. The fascination with crypto is what it reveals about our society, more than about what it can achieve.

Crypto currencies are a fascinating technological innovation. Part of their initial attraction was that they promised a new governance order. As one of the most insightful political theorists of money Stefan Eich had pointed out in a paper, “Old utopias, new tax havens: The politics of bitcoin in historical perspective,” there was a political background to the interest in crypto. Faced with the inflation of the 1970s, thinkers like Friedrich Hayek theorised about reasserting the dominance of private currencies, protected from the state.

But this project crucially depended on solving the problem of “trust” on which every currency depends. Crypto seemed to solve that problem, with its decentralised architecture and community and self-verification protocols. Perhaps a libertarian utopia could be created.

This was a fantasy. No state was going to let go of its power to assert control over the monetary system. The sustenance of state-sponsored fiat money is one of the great achievements of modern state formation, and the foundation of its power and legitimacy. Second, there was a delusion, as if crypto is conjured out of thin air: It actually requires substantial material infrastructure, which a state could always control. States can shut down mining as China has done.

The money itself may not be material, but it is still embedded in a materiality. The fact that money is subject to politics is actually the advantage of money. It allows a modicum of collective control over our future, and allows distributive questions to be posed.

As Easwar Prasad’s bracingly comprehensive book, The Future of Money, points out, the ambitions of the crypto revolution have not been met even on their own terms. As he puts it, “while each crypto currency might have specific strengths, neither Bitcoin, nor any other crypto currency can boast the blend of stability, efficiency, privacy and safety that would allow it to dominate central bank money.” The revolution heralded by digitisation will continue in different forms, ironically facilitating even more centralised and hierarchical monetary architectures.

The ideological claims of crypto have been deflated. It is now considered more like an asset. Some financial products bring genuine gains for the economy or development, others pose a risk. In the literature, a convincing case has not been made for the concrete development benefits crypto brings.

The underlying technology can be harnessed for potential benefits even without crypto. From a development point of view, no one should lose sleep if it is banned. The argument then shifts to the value of choice. We allow people to invest in all kinds of things. Why ban this, especially now that so many investors are in it? The answer to this question depends on how much risk the existence of crypto assets pose to the stability of the rest of the financial system.

One answer is if you can insulate the financial system from the crazy gyrations of crypto markets there are few systemic risks. Which is why it was a good idea of the RBI to prohibit the entanglement of financial institutions with this market. You want to be in a position that if crypto markets collapse they don’t affect anything else. So then the risk of crypto is purely private: If people want to speculate so be it. There are issues about fraud. Some of this can be regulated. But this can be part of the risk assessment.

But in practice the insulation of crypto markets will be difficult to achieve. The first reason is political economy. Once you have a large number of investors, and some influential ones, they will be a vested interest in their own right, potentially demanding the socialisation or mitigation of losses. We are already seeing this. The RBI should have been more aggressive in discouraging the growth of this industry.

Now it is facing lobbying by investors as an interest group. The second reason is that it is difficult to pretend that a major new class of assets, especially if volumes grow, does not have systemic effects on the rest of the economy. In a crisis, if stable coin redemptions go up, will not the RBI have to step in? What are the opportunity costs of investments flowing into crypto on prices of other assets and monetary instruments? What are the implications of a lot of money flowing to a sector whose attraction seems to be that there is no underlying logic to the valuation of risk. Instead of just focussing on issues of fraud, money laundering, and private risks, the RBI’s case would be strengthened if it spelled out the systemic risks that crypto might pose to the stability of the real economy.

It may also be the case that there is no halfway house in this story. For political economy reasons, the RBI should avoid a scenario where it bans but then carves out exceptions. The second thing is that if it somehow allows Indians to invest then it has to ensure that trade does not go offshore. Not fully banning and allowing it offshore will be the worst of both worlds. But the central point remains: The Chinese may be motivated by considerations of control and surveillance to ban crypto. But they are not wrong in thinking that the financial system should be in the service of the real economy. But then many would argue that crypto mania is a symptom more than a cause.

The global economy is awash with cheap money. In an Indian context small savers are desperate for return. In this context it is easy for the powerful to misallocate money and the small saver to express desperation by speculation. As the RBI makes the case for banning crypto, we also need to ask, why it is alluring in the first place. What does this mania reveal about our politics and economics?

This column first appeared in the print edition on November 27, 2021 under the title ‘Cryptopolitics’. The writer is contributing editor at the Indian Express