Zulfath Saheed weighs the impact of switching to digital currency

By now many in the corporate world would be familiar with the term ‘bitcoin’ and how its value reached a three-year high in January. After all, digital currencies are not an altogether new phenomenon – they’re in regular circulation in certain parts of the world, most notably in China.

In Sri Lanka too there has been a greater focus on digital currencies such as bitcoin and their potential to stimulate economic activity. Therefore, it is worth considering some key factors before making the switch from physical to digital currency; they include the thinking behind its inception as well as its future growth trajectory.

EARLY BEGINNINGS Bitcoin was launched back in 2009 in the form of encrypted software written by someone under the pseudonym ‘Satoshi Nakamoto.’ Other digital currencies have followed in its wake but bitcoin continues to be the best-known of such mediums of exchange.

Transactions take place when encrypted codes are transmitted across a computer network, which verifies and monitors transactions through a process that seeks to ensure that a bitcoin is not spent in more than one location at the same time. As with traditional currencies, bitcoins can be exchanged for goods, services and other currencies.

Users are able to ‘mine’ bitcoins by getting their computers to run complicated and progressively difficult processes. However, only a maximum of 21 million units of bitcoin will ever be created – at present, more than 16 million units are believed to be in circulation.

DRIVING FORCES Notably, bitcoin was deemed the best-performing currency in 2016. The appreciation of the digital currency can be explained by the search for a safe haven amid global uncertainty and a strengthening US Dollar, as well as India’s recent demonetisation drive and capital controls in China.

Moreover, the rise of digital payments along with the dwindling supply of new bitcoins may have led to a strengthening of the digital currency.

As already noted, bitcoin is created through computer code. Unlike physical currency, it is neither backed by a government nor does it have a central bank – community users control and regulate bitcoin – and therein lies its key draw.

Indeed, the bitcoin network has been described as an efficient alternative to traditional currencies because it isn’t subject to the whims of a state that may for instance wish to devaluate its currency to reduce debt obligations.

STATE SANCTIONS However, the digital currency isn’t without its problems. Most recently, China’s central bank – the People’s Bank of China (PBOC) – announced it would launch investigations into exchange platforms trading in virtual currency, negatively impacting the rally in bitcoin prices.

The move sparked fears that China was cracking down on the digital currency in a bid to combat money flowing offshore. A PBOC statement claimed that it was targeting foreign currency exchange, market manipulation, money laundering and financial security risks.

A few days later, PBOC announced that it had completed a trial run of its own digital currency based on blockchain technology. The trial reportedly took place on a shared distributed ledger that involved the participation of a number of major commercial banks.

POTENTIAL PROBLEMS In August last year, news of a major bitcoin theft by hackers sent the currency’s price down by over 20 percent, highlighting its apparent vulnerability to theft when stored in digital wallets.

Virtual currencies such as bitcoin also face questions about their legitimacy because they’re exposed to anonymous transactions.

For example, critics point to the use of bitcoins on the Silk Road online black market where the currency could be used to purchase drugs or weapons.

Meanwhile, experts contend that wider acceptance of bitcoin could also lead to greater government regulations, negating the pull factor of the bitcoin concept.

GROWTH TRAJECTORY According to some analysts, bitcoin price volatility would reduce along with higher volumes and simultaneous growth in the digital economy.

Here at home, the Information and Communication Technology Agency (ICTA) and the Central Bank of Sri Lanka are said to be considering the possibility of introducing digital currencies such as bitcoin to the nation’s financial system.

Addressing a forum early last year, ICTA Managing Director and CEO Muhunthan Canagey reportedly stated that “we as a country need to start looking at this very seriously; and for that, we have to create an enabling environment to bring [cryptocurrencies] into the system. ICTA will take this seriously; but as far as implementation is concerned, it is the markets that will take this forward.”

It remains to be seen whether these plans will see the light of day in the near future or whether they will be relegated to the realm of pipe dreams.