Explained: Digital currencies

and how they work

What is a cryptocurrency?
A cryptocurrency is a medium of exchange, such as the rupee or the US dollar, but is digital
in format and uses encryption techniques to both control the creation of monetary units and to
verify the exchange of money. Bitcoin is considered to be the world’s best known
cryptocurrency and is the largest in the world according to market capitalisation, followed by
Ethereum. In traditional financial deals, where two parties are using fiat money, a third-party
organisation — usually a central bank — assures that the money is genuine and the
transaction is recorded. With cryptocurrencies, a chain of private computers — a network —
is constantly working towards authenticating the transactions by solving complex
cryptographic puzzles. For solving the puzzles, these systems are rewarded with
cryptocurrencies. This process is called mining.
At the backend of these transactions is a technology called ‘blockchain’.

What is blockchain?
Satoshi Nakamoto — the person (or a group of people) who is said to have conceptualised an
accounting system in the aftermath of the 2008 financial crisis — had mooted an idea where
the transactions and the value of money would be recorded digitally on a publicly available
and open ledger that contains all the transactions ever made, albeit in an anonymous and
encrypted form. This ledger is called the blockchain.
Bitcoin and the thousands of cryptocurrencies are essentially codes recorded on a blockchain
that gets longer and longer as more people use them.

There have been voices calling for stablecoins as an alternative to volatile

cryptocurrencies. What are stablecoins?
Stablecoins are digital currencies that are backed by a fiat currency such as the US dollar,
thus giving it an intrinsic value. From an investor point of view, stablecoins become easier to
understand considering the underlying reserve asset. There is also a case being made by
sovereign governments for stablecoins such as Tether, USD Coin and Diem (proposed
by Facebook’s parent company Meta) given that it could increase the reach of their fiat
currencies in the digital ecosystem.

How are cryptocurrencies bought?

There are two ways. The first is to buy it from someone and the second is to mine new crypto
coins. Buying it from someone usually happens in two ways — an exchange-facilitated
transaction or a peer-to-peer transaction. For Indians, the simplest way to invest or trade in
cryptocurrencies has been through one of the many exchanges and trading platforms
operating in India. These include WazirX, CoinDCX, CoinSwitch Kuber, Zebpay, Bitbns,
Giottus, etc.
To be able to trade or invest in cryptocurrencies using INR, users need to register on one of
the exchanges by completing a KYC process. Then, a user buying crypto for the first time
will need to load INR money in the wallet of their cryptocurrency exchange. The
cryptocurrency wallet is identified by a unique address represented by a randomly generated
combination of numbers and letters. There are two ways to load money into a cryptocurrency
wallet — through net-banking or through an e-wallet.
Here's where the first entry barrier arises. Despite the Supreme Court order that quashed the
RBI directive prohibiting banks from allowing their systems to be used for virtual currency
transactions, several large banks don’t offer their financial infrastructure for investment or
trade in crypto. Among the e-wallets that operate in the country, only MobiKwik is supported
on platforms such as WazirX and CoinDCX. Once the transaction is through, the purchased
cryptocurrency holding is reflected in the exchange’s wallet.

How are they sold for INR?

The Indian exchanges allow sale of cryptocurrencies in exchange for INR as well but given
that many of the smaller banks that support the transactions do not have the necessary digital
infrastructure to handle the volumes of withdrawal and the volatility experienced by these
virtual currencies, disruption in withdrawal services is a common occurrence.
The government plans to bring a Bill to prohibit “all private cryptocurrencies”. What are
private cryptocurrencies?
While there is no clarity yet on how private cryptocurrencies are defined, indications are that
any digital currencies that are not issued by the State will be banned.