Pakistan’s regulatory institutions do not seem ready to deal with cryptocurrencies yet. The telecoms watchdog is under pressure to block all cryptocurrency websites. Last week, the SBP governor reiterated the central bank’s conclusion on cryptocurrencies: “potential risks far outweigh the benefits”. Risks include “widening of gray economy”, “capital flight”, usage in “illegal economic activities” and threat to “financial and monetary stability”. Such risks are real, and reducing them requires inter-ministerial and inter-regulator collaboration, which is hard. Hence, crypto is oscillating between regulatory ambivalence and an absolute ban.
For the unfamiliar, cryptocurrencies have become popular over the past decade, thanks to decentralized nature of their creation, distribution, storage and authentication. Cryptocurrencies are a form of digital currency sans a central bank, with transactions/transfers taking place via peer-to-peer networks. The blockchain technology (which has growing use-cases in automated contracts, IPR protection, commodity traceability, e-games, banking registers etc.) serves as a public ledger for cryptocurrency transactions.
Even though their usage as a medium-of-exchange is very low, cryptocurrencies (especially Bitcoin and Ethereum) have developed into financial assets, with genuine buyers and speculators both in tow. Cryptocurrencies’ value has skyrocketed in recent years (with immense volatility, however) due to the element of scarcity that drives profitable trades. The maximum number of Bitcoins, for instance, that can ever exist is limited to 21 million – the current circulating supply has reached 19 million, or 90 percent.
Globally, regulatory view skews rather skeptical than accommodative. As per the US Library of Congress, there are 42 countries – including Bahrain, Indonesia, Kazakhstan, Saudi Arabia, Turkey, UAE, Vietnam (and Pakistan) – that have an implicit ban on crypto, mainly by restricting banks to deal in those assets. Then there are 9 countries – including Bangladesh, China, Egypt, Morocco and Qatar – that have slapped absolute bans (as of November 2021). Back in April 2018, an SBP directive had prohibited banks, exchange companies and Fintech firms from using, processing, trading or holding virtual currencies, requiring them to mark ‘suspicious’ transactions.
The debate around cryptocurrencies – which sometimes sounds just as divisive as partisan talk these days – needs to be more informed among Pakistan’s public officials as well as among private-sector folks sitting in opposite camps. While this column is no expert on blockchain and its applications such as cryptocurrencies, background discussions indicate that there are three distinct features, each perhaps requiring a different policy response: i) trading of cryptocurrency (buying/selling over exchanges), ii) real-life usage of these coins (as a virtual currency), and iii) mining (earning) of these coins.
One concedes the local authorities’ argument that trading via cryptocurrency exchanges has potential to be speculative/fraudulent. But there is no solid argument against building use-cases around payments via virtual currencies (albeit you have to own/earn coins before using them). And certainly, blockchain mining (which requires hard work, computational power and active collaboration with other miners locally and abroad), can be encouraged if Pakistan is to capture a share in innovation taking place in this space.
Mining may be an area that needs a serious review to promote blockchain in Pakistan, for applications other than cryptocurrencies. As per data from the Cambridge University’s Bitcoin Mining Map (August 2021), the US is the global leader in bitcoin mining (with a share of 35%), followed by Kazakhstan (18%), Russia (11%), Canada (10%), Ireland (5%) and Malaysia (5%). Pakistan had a 0 percent share in bitcoin mining, as compared to 3 percent in neighboring Iran and less than 1 percent in India.
However, there is also a dark side to blockchain mining: its environmental toll. For instance, a single Bitcoin transaction consumes 2,200+ kWh of electricity, roughly equal to power usage of average American household over 2.5 months, producing a carbon footprint that is the same as conducting 2.3 million VISA PoS transactions, as per Digiconomist, a website that tracks economic consequences of digital trends. Is there a workaround? Some folks have set up mining farms in Northern Pakistan that run on hydropower. In-depth research is needed to find feasibility for blockchain mining in this country.
There is a need for the government to seriously weigh pros and cons of different policy choices vis-à-vis cryptocurrencies and then establish a regulatory regime that addresses opportunities and challenges from financial, technological and human resource aspects. However, based on recent events (including a cryptocurrency-linked litigation in the Sindh High Court and the alleged $100 million fraud that took place on a renowned cryptocurrency exchange), it appears that authorities will continue to have an adversarial take on cryptocurrencies, pointing out its “speculative nature”, “flight of precious foreign exchange”, and movement of “illicit funds”.
This state of affairs indicates an inability to regulate something that is new and wildly popular but also hard to understand, hence unsettling. While the central bank’s cautious stance on cryptocurrencies has dismayed some, it is good to see that the SBP governor has again expressed openness towards another kind of digital currency (the central-bank digital currency, or CBDC), so long as it helps the central bank to meet its monetary and financial goals.
With potential to bring in cost and time efficiencies to banking transactions as well as improve financial stability, CBDC – also known as ‘sovereign digital currency’ – has intrigued several central banks. In recent years, the Bank for International Settlements (BIS) has been working with central banks of Canada, Japan, Sweden, Switzerland, UK, US and the European Central Bank to set core principles for CBDCs. Last year, the BIS started a CBDC pilot with central banks of South Africa, Singapore, Malaysia and Australia, to assess whether digital currencies are feasible for international settlements.
If the BIS pilot (Project Dunbar) is successful, CBDC-led cross-border payments will compete with traditional correspondent banking model. China, meanwhile, has already taken the big leap. Last year, its central bank piloted its digital currency (digital Yuan, or e-CNY) in major cities. Almost instantly, the e-CNY reportedly came in direct competition with Alipay and WeChat Pay for online payments. Adoption is set to grow, as e-CNY is now also available in mobile wallets, thus easing registration process. Foreign athletes are reportedly using the digital Yuan for shopping and payments at the Beijing Winter Olympics.
China’s experience with CBDC is expected to provide useful insights to others central banks in pursuing innovation for digital payments. The US Federal Reserve, for one, is keeping a close eye on it, considering the impact China’s digital Yuan’s internationalization may have on the US dollar. Here at home, let’s see how soon the SBP makes tangible progress on Pakistan’s own sovereign digital currency.