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Is It the End of Cryptocurrency?

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The budget pricks the bubble

There is nothing so disturbing to one’s well being and judgement as to see a friend get rich
- Charles Kindleberger economic historian

The bubble of Bitcoin, like all bubbles, began with this kernel of truth. Cryptocurrencies were to mark a revolutionary moment in the financial history of our world. They were a new type of global currency independent of governments and Central banks, their validity based on ‘crypto-proof’ or a peer-to-peer network that would administer each to perfection, ensuring it was both plentiful enough for utility and scarce enough not to lose its value and suffer debasement. What Central bankers often struggled with, smart software free of politics would do better. Satoshi Nakamoto, the anonymous coder who created the Bitcoin, launched his—or her?—jeremiad against the monetary system back in 2009 right after the global recession of the preceding year with these words: ‘The root problem with conventional currency is all the trust that’s required to make it work... The history of fiat currencies is full of breaches of that trust.’

But the vast majority who entered the Bitcoin market over the past few years did not do so to use this digital currency as a medium of exchange. They bought it in the expectation that someone else will come along and buy it from them at an even higher rate. Eventually, at some point, the supply of larger fools was going to run out.

Nothing has appreciated quite as much as the Bitcoin in the last few years, barring a few odd rival cryptocurrencies that arose in its wake to ride the frenzy it had stirred among investors and coin ‘miners’ (the geeks who are awarded newly minted currency online for playing a role in its administration). All of last year, the very concept of digital currency was marked by an irrational exuberance of buying. Everyone wanted in on the action, even though there were multiple questions about its legality and how its trade was beginning to exhibit all the traits of a classic bubble, its value inflated way beyond what it could reasonably be worth. But its circle of fans continued to expand, from digital evangelists and cypherpunks to—more and more—the common Joe.

The Bitcoin’s value soared to a peak just shy of $20,000 for a single coin by mid-December 2017.

By one estimate, the electricity now consumed globally to ‘mine’ Bitcoin is more than all of what Nigeria uses. Such was the bullishness on it that the famed cybersecurity-turned-cryptocurrency expert John McAfee bet on Twitter that he would eat his own penis if the value of a single Bitcoin did not reach $1 million by 2020.

At its peak, Bitcoin was worth over a quarter trillion dollars in market value. More than 40 per cent of its value has been wiped out in seven days since the Union Budget of February 1

In India, it is believed that Bitcoin use shot up right after demonetisation, with people either discovering a new valuable to stash their black money in or losing their faith in the rupee as a store of value. Last year, during the Bitcoin boom, when I interacted with Saurabh Agrawal, one of the founders of Zebpay, perhaps the largest Bitcoin exchange in India, he told me that in 2015 the platform used to do transactions worth Rs 100 crore annually. By 2017, it was doing over Rs 200 crore a month. “We are at that stage where the internet was back in 1994, just before mass adoption happened. This mass adoption is going to happen soon... And it is going to disrupt everything we know,” he said.

By January 7th this year, according to CoinMarketCap, which tracks the prices of cryptocurrencies at exchanges across the world, their overall market capitalisation—or the saleable value of all electronic coins in existence—stood at $835.7 billion.

A vast financial bubble had been blown, and then the inevitable slide slowly began. On February 1st, a pin appeared in the form of India’s Union Budget that left it badly deflated (if not burst). The Budget speech contained just two lines addressing cryptocurrencies. Finance Minister Arun Jaitley said, “The Government does not consider cryptocurrencies legal tender or coin and will take all measures to eliminate the use of these crypto-assets in financing illegitimate activities or as part of the payment system. The Government will explore use of blockchain technology proactively for ushering in a digital economy.” The announcement makes India one of the few countries with a stated policy that discourages the use of cryptocurrency. People, however, have interpreted that part of the speech in various ways. While some news outlets portrayed it as a signal that digital money faced a ban, local cryptocurrency exchanges have latched on to the Minister’s last line about an intention to explore blockchain technology as proof that it was business as usual.

But in the volatile cryptocurrency market, it was not business as usual. Prices of cryptocurrencies across the world crashed. Panic selloffs ensued. At its peak, Bitcoin commanded more than a quarter trillion dollars in market capitalisation. Now, as of February 6th, it’s barely holding on to $106 billion. A single Bitcoin is now trading at about $6,356. More than 41 per cent of its value has been wiped out in seven days, according to CoinMarketCap. The next most popular coin, Ethereum, is also trading poorly, down sharply from its all-time high of $1,425 on January 13th to about $574 now. Almost 47 per cent of its value was eroded within a week. The price graph of other coins looks similar. The value of the entire cryptocurrency market has plunged to about $293 billion in this period. Over half a trillion dollars of value has been wiped off. Given the volatility of the market, who knows where prices will be next week.

There were other reasons too. Regulators around the world have begun to talk of dealing with cryptocurrencies more harshly. Financial News, a publication closely affiliated with the People’s Bank of China, recently reported that China’s central bank will block all platforms that permit cryptocurrency trading. US regulators are investigating whether the spike in Bitcoin prices in 2017 was a result of market manipulation. South Korea has been talking of a crackdown on digital currency trading; it may ban the opening of anonymous cryptocurrency accounts and bring in legislation to enable regulators to close coin exchanges if needed. Facebook has banned cryptocurrency adverts on its platform. Meanwhile, many major banks in the US and UK have moved to block people from using credit cards to buy cryptocurrencies. In India too, banks have informed local cryptocurrency exchanges that they will no longer accept money for trades from customers via online modes such as National Electronic Funds Transfer, Immediate Payment Services and Real-Time Gross Settlement. As a result, it has become difficult to buy and sell digital currencies in India. Express transfer features at several exchanges have been disabled, and the only option in some cases is a direct bank transfer, which takes longer to process. Additional charges are now also being applied for payment gateway transactions.

On February 6th, the chairman of the Central Board of Direct Taxes revealed that the Income Tax Department has issued around 100,000 notices to people who were found to have invested in cryptocurrencies but not reported their gains to the authorities. “People who have made investments [in cryptocurrency] and have not declared [this] income while filing taxes and have not paid tax on the profit earned by investing, we are sending them notices as we feel that it is all taxable,” CBDT Chairman Sushil Chandra has been quoted as saying.

ACCORDING TO BLOCKCHAIN expert Mohit Mamoria, a ban on cryptocurrencies will be impossible to implement. Even if big countries do ban it, a small country will welcome crypto-entrepreneurs to base businesses there. “All the smartest people and smartest money will move over to that country,” he says. Late in December, once banks started making it difficult to transfer funds to local exchanges for trading, one such exchange, Koinex, put up this statement on its website: ‘Regulators [the] world over have struggled to understand the underlying blockchain technology and develop an appropriate response to it; and India is no exception. These misgivings have resultantly affected the financial services community, who find it difficult to make up their mind about supporting cryptocurrencies.’

Altcoins came into being because the Bitcoin, with its high valuations and mining difficulty, was believed to have reached its peak. Those who missed out wanted to catch the next wave

In Delhi, a youth in his late twenties, who we shall call Varun Singh—name changed on his request—is almost back to where he started. It was as a college student with an interest in new technologies that he first heard of the Bitcoin. That was 2011. On a lark, he began to use his computer at home to mine the currency. “It was really like downloading a film,” he recounts, “My friends were downloading movies and games then. And I thought, ‘Why not just mine Bitcoins for some time?’”

For the next four to five weeks, Singh did exactly that. At the heart of Bitcoin is a technology called blockchain. Put simply, it is something of a public ledger. When a person ‘mines’ a coin, it means he is using his computer to validate previous Bitcoin transactions, thereby keeping the ledger up to date. Miners are rewarded in the currency for this job. This is also the only way a new Bitcoin comes into existence.

Singh was good at it. He would go to college in the morning and later hang out with friends and return to his room at night to check his computer, which he left on. In all, he mined a total of 77 Bitcoins. “And then I just forgot all about it,” he says. “It kind of got boring.” Singh didn’t just forget it. For the next four years, it seems, he vanished under a rock. He woke up one day, sometime in 2016, to the news of an incredible surge in Bitcoin value. By then, a single unit was already worth $450 and its value hit $750 that year. He managed to retrieve 44 of his stash. He could not remember the private key to recover the rest. In mid-December, Singh’s 44 units were worth Rs 5.6 crore. He used some to purchase other cryptocurrencies, while the rest he kept. Although Singh does not reveal the details of his current cryptocurrency portfolio, more than half his Bitcoin wealth has been wiped out over the first week of February.

While Bitcoin hogs the spotlight in the cryptocurrency rout, it is not the only game in town. A new cryptocurrency, it is joked, was born every day during the boom. CoinMarketCap lists over 1,500 digital coins on the internet. According to estimates, the Bitcoin itself now accounts for only about one-third of the overall cryptocurrency market. The rest are alternate coins or altcoins, as they are popularly known. There are popular altcoins like Ethereum, Ripple and Litecoin, and also a wider array of less- known coins with names like Sexcoin, InsaneCoin, UFO Coin and Faceblock. There are some endorsed by celebrities like Paris Hilton (Lydian Coin) and new ones in the works being put out by old companies like Kodak (KodakCoin). Even Reliance Jio, it was rumoured, was working on its own version (Jio Coin). The company has denied it since.

Altcoins came into being because the Bitcoin, with its high valuations and difficulty of mining, was believed to have reached its peak. Those who missed out wanted to catch the next cryptocurrency wave at its onset.

In Gurugram, two cousins who set up a large Ethereum mining facility in their basement, Abhyajeet and Nikhil Yadav, just 18 and 20 years of age, appear to have gotten out just in time. Ethereum is considered the second-most valuable cryptocurrency after Bitcoin. Its value grew 13,000 per cent just in 2017, though it is now trading at about $615, a steep fall from $1,425 on January 13th.

The cousins had set up a facility of 55 rigs, which they called Foxtrot Infotech, thanks to a generous investment of Rs 75 lakh from one of their fathers. These rigs are powerful machines with strong computational abilities. The two spent all of last year mining Ethereum and Zcash, another popular altcoin, but then the complexity levels rose. As the popularity of a currency goes up and more miners join in and transactions increase, the time and effort taken to mine coins also goes up. What it took for the cousins to mine Ethereum, Nikhil says, was no longer worth it. “It was just getting too expensive,” he says. “The costs were adding up.”

The duo had begun with a bang, though. They first borrowed Rs 90,000 from Abhay’s father (who runs a warehouse management and leasing company), and returned Rs 4.5 lakh in just a few months. “All the money we made was by Bitcoin trading,” Nikhil says. “So uncle understood the potential and he loaned us the rest of the money so we could mine instead of just trading.” The two installed CCTV cameras, a generator on standby and six air-conditioners in all—running three at a time in 12-hour shifts to keep their high-powered machines cool—and put together a team of four people to monitor operations. The monthly electricity bill alone would run up to over Rs 2 lakh. Over time, other expenses mounted, mining got difficult and power failures proved disruptive.

The Yadavs managed to sell their rigs to buyers just before the cryptocurrency bust. They still made a healthy profit on their investment, Nikhil says. The two now plan to move to Canada, where they expect to trade and set up rigs for other altcoins.

MAMORIA HAD RECENTLY launched what can best be described as a crypto hedge fund. Called Authorito Capital, it invests capital pooled from several people into a portfolio of crypto assets. According to him, market volatility is the biggest challenge here. “Crypto assets are not at all like your regular assets,” he says, “One can never predict what will happen tomorrow. They are very high risk, but have very high returns too.” An optimal mix, however, could work very well. “There are more than 900 Bitcoin-like currencies out there in the wild,” he says. “Some are great, but a lot of them are just bullshit. You need to be able to tell the difference between them to bet on the right ones.”

According to Mamoria, investing in cryptocurrencies is not as simple as buying the best performing or most famous. “Just like MySpace isn’t the best social network to socialise or AltaVista the best search engine to look for information. They were among the first to introduce these new concepts in our lives, but they were far from being the best,” he says. “I believe Bitcoin will go down the same story eventually. It made us discover [the concept], but it is far from being the ultimate cryptocurrency.”

Authorito Capital doesn’t just trade in crypto assets, it also offers software that lets investors mine their own cryptocurrencies. A software will let consumer devices lying around idle—like mobile phones and personal computers—talk to each other and cluster themselves in various groups, Mamoria explains, so that they can identify and mine what is identified as the most worthy currency at a given point in time. As for his fund, he says he is only keen on long-term investors. “We don’t want nervous, panicky traders,” he says. “No people looking to make a quick buck and exit. We want people who are in it for the long haul.”

Santosh Kumar, a Bengaluru resident, started mining Ethereum late in 2016. He had grossly undervalued the potential of cryptocurrencies in the beginning, he says. Kumar began churning out Bitcoin and Dogecoin sometime in 2014. But once the Bitcoin fell in value that year, he began to spend his reserve indiscriminately. The Dogecoin started in 2013 as a Bitcoin parody, a joke on what it saw as a joke, and had as its mascot a popular internet meme, the Japanese shiba inu dog. But the line between irony and sincerity is often blurred these days. Earlier this year, the value of all Dogecoins in circulation reached $2 billion. Kumar, of course, knew none of this back then. “In 2014, there were very few exchanges in India where we could convert Bitcoin into Indian rupees, and then there was such a big fall in its value,” he recalls with some bitterness, “So I spent it all online, on stupid games and gambling sites.”

When Kumar returned to mining in late 2016, he was intent on getting things right. He set up a rig that cost him around Rs 1.5 lakh to mine what was being touted as the next big thing, Ethereum. His room was almost as hot as an oven, he says, and the noise from the rig would vibrate throughout the house. But he carried on, sweating in his room, and within two months, he says, he had mined enough Ethereum to recover the cost of his rig.

At first, Kumar would take about 10 days to mine a single Ethereum coin. Now, with difficulty levels rising, it takes him at least three months. So he has now moved to mining other altcoins like Monero and Zencash.

For a long time, it was hard to access altcoins in India. The Bitcoin was the only cryptocurrency available here, and units of it had to be swapped for altcoins on an international exchange. The lack of exchange platforms for Ethereum had got Zakhil Suresh, a 23-year-old Chartered Accountancy student and cryptocurrency trader, and two friends to start an Ethereum exchange in Thrissur, Kerala. They began trading in Bitcoin and other cryptocurrencies in 2015, but last year’s Ethereum boom convinced them of the need for a platform to trade the latter. “There was this big boom,” says Suresh, “but here in India you had no mechanism to buy Ethereum.” Last year, several such domestic platforms emerged to cater to a variety of altcoins. There is Koinex, perhaps the most popular of them, that allows trading in Bitcoin, Litecoin, Bitcoin Cash, Ethereum and Ripple. There is Ripple Labs, the San Francisco-based blockchain startup that has tied up with the Indian cryptocurrency exchange BTCXIndia to help users trade Ripple in rupees. There are reports that the Polish cryptocurrency platform Bitbay will also soon begin operations in India. What happens to these plans after the crash might depend on how soon prices achieve some stability.

There are economists like Nouriel Roubini who believe that the Bitcoin’s price could collapse to zero. On the other hand, cryptocurrency evangelists like McAfee have no doubt that this is just a blip, and, just as the Bitcoin has bounced back stronger from tumbles in the past, it will zoom right up again. He has also not changed his mind on eating his penis if prove wrong either. ‘Lot’s of people asking me over the past two days whether my bet is still on (that I will eat my dick if Bitcoin does not reach $1 million by the end of 2020),’ he tweeted, ‘ABSOLUTELY!!!’ But with less than two years left and a price appreciation of almost $1 million needed, he might have to eat more than his words.