Cryptocurrencies, and conversations about them, now appear to be everywhere. Crypto prices have risen sharply over the past year, attracting a slew of new investors. Despite the volatility of the sector, and the emergence of newer, and unknown financial instruments, several factors affect the stability of cryptocurrencies, including semiconductor shortages, excessive usage of energy sources that were not meant for crypto-mining, and India’s official stand (which seemingly is to outlaw cryptocurrencies).
While investors were euphoric about the recovery in the price of Bitcoin in recent months, this has also led to the problem of abundance. Across the globe, sectors have been hit by the shortages of computing chips in the aftermath of the COVID-19-induced lockdowns, and cryptocurrency mining must take some of the blame.
The rush for computing and gaming devices, especially those with better processor speeds, during the COVID-19-induced lockdowns changed the production forecasting aspect for consumer electronics, thereby distorting the demand for semiconductor chips.
For instance, the global personal computer market is estimated to have grown over 47 percent year-on-year, the highest growth in the past two decades. Additionally, during the lockdowns, smartphone makers, computing devices, and video game equipment brands saw their pre-sale item volumes grow. As the world moved to remote functioning during this period, video conferencing and streaming needs reached the clouds. Consequently, the demand for, and utilisation of data centres also grew. With semiconductor chips used in all these products and sectors, a crisis was brewing.
At the same time, the semiconductor industry was hit by a few key setbacks as well. For instance, the massive power outage in February in Texas, a major semiconductor hub, affected many semiconductor fabricators located there. These manufacturing units typically run nonstop to be economically viable; the complex photolithographic process used to make semiconductors cannot be stopped suddenly without damaging at least some of the work in progress.
On the other side of the globe, developments in Taiwan and Malaysia, which together have an over 60 percent share in global production of semiconductors, are having an impact on the industry as well. Taiwan, the global chip-making hub, is facing its worst drought in 50 years, which has affected chip production (water is an important input). In Malaysia, a major chip testing and packaging centre, worries around rising COVID-19 cases, and lockdowns dampened the sector. Additionally, with Taiwan’s production of chips slowing down, global brands are working to move their regional supply chains to Malaysia.
Mining And Demand
Another factor fuelling the semiconductor crisis is cryptocurrency mining, which has led to a lot of chip buying. For over a year, cryptocurrency miners have been working up a storm correlated to the rising value of popular cryptos such as Bitcoin. As the price of cryptocurrencies rose, so did the interest from newer financiers to invest in the digital currency. This has led to more attempts to mine cryptocurrencies, which in turn has accentuated further demand for higher processor power, and semiconductor volumes.
Cryptocurrencies are created by crypto-miners, who are issued with the cryptocurrency in return for completing massive volumes of computations to verify transactions. This requires a high energy input. But miners also require increasingly powerful computer equipment, or rigs, for the process. How quickly Bitcoins can be mined is directly correlated to how advanced the chips inside the rigs are. While some argue that the semiconductor industry had not built resilience, and scalability to its global supply chain, the reality of cryptocurrencies pushing the demand (or skewing the volumes of chips offtake) showcases the changing demand patterns for end-uses such as mining cryptocurrencies. The profitability for cryptocurrency mining has eaten into the semiconductors manufacturing capabilities meant for other computing uses.
Crucially, the semiconductor chip crisis is reshaping modern essential industries such as smartphones and computers. The launch of new models of phones and computers are being shaped by the availability of chips. In India, the number of investors in cryptocurrencies has rapidly grown over the past year, and is now distorting how semiconductors are used. Semiconductors that would have otherwise been used for other processors are not available as the components are being diverted for crypto-mining purposes.
Cryptocurrencies are mined using computers to solve complex mathematical problems, and the process is estimated to use more energy than several other countries. Cryptocurrencies have been criticised as being bad for the climate given their large energy requirements. In light of such criticism, several stakeholders are working on ways to reduce the industry’s energy consumption. Ethereum Foundation, for instance, is already working on a new way to verify transactions; by using a different process (proof of stake), it is looking to cut the energy cost of each transaction by 99.95 percent.
In April, the Energy Web Foundation, Rocky Mountain Institute, and the Alliance for Innovative Regulations formed the Crypto Climate Accord, to decarbonise the global cryptocurrency industry, and achieve net-zero emissions by 2030. Other participants include firms from energy, finance, climate, impact sectors, such as KPMG, Sun Exchange, Green Energy Solutions, Blockchain Founders Fund, Crebaco, and Macro Climate.
The fear of cryptocurrencies being used for money laundering, and terror financing is misplaced. Financing via cryptos will be on an immutable ledger that can be seen, and must be authenticated by all nodes on a blockchain. According to a report by Chainalysis, a firm specialising in cryptocurrency investigations, the ‘criminal share’ of all cryptocurrency activity globally fell to just 0.34 percent ($10 billion) in 2020, and most crypto-related crimes are ransomware attacks or dark-net market deals.
India is the fastest growing hub for cryptocurrency globally, driven by young investors. Crypto investing is not restricted to urban spaces alone, but has rapidly gained acceptance across tier two and tier three cities as well. Nevertheless, there remain multiple barriers to the greater adoption of cryptocurrencies, including concerns about liquidity, privacy, and security.
In India, there has been a regulatory tussle on the validity of cryptocurrency operations. In 2018, the Reserve Bank of India (RBI) issued orders to banks, and regulated financial entities to not allow customers to engage in buying, selling and trading of cryptocurrencies. This had a chilling effect on the industry, with multiple companies looking to move their operations to friendlier shores. However, an order from the Supreme Court in 2020 lifted the RBI’s ban, and allowed crypto-exchanges to function in India again. Adding to the regulatory uncertainty, a Bill was introduced in February that sought to outlaw any operations of ‘private cryptocurrencies’, and create digital currency backed by the RBI with the use of blockchain.
The idea of central banks floating their own digital currencies is gaining momentum across nations, and these new instruments have their respective merits and flaws. However, it is possible for cryptocurrencies and central bank digital currency to coexist. Currently, cryptocurrencies are treated as a separate asset class, and are being traded similar to commodities, and it is also unviable for cryptocurrencies to be used as a currency due to its high volatility. But there are more use cases being built such as utility tokens, non-fungible tokens, credit tokens, and other forms for decentralised finance with blockchain as the anchor technology.
At the same time, global firms such as Tesla and Square hold Bitcoins as part of their treasury operations (as assets), while MasterCard has announced that it will enable payments using select cryptocurrencies (as a currency). Such interest in cryptocurrencies from institutional investors is a good sign, and will bring accountability on the trades. Even so, asset management, wealth management, and insurance firms must ensure they get their crypto trade right before investing people’s life savings, and pension funds in such digital currencies.
India will reintroduce a Bill on digital currencies that will in effect outlaw ‘private cryptocurrencies’. It remains to be seen what the Bill defines as private cryptocurrencies, but there needs to be healthy debate, and consultations with the industry to work towards regulations. A blanket ban will hurt India in the long term as other nations adopt friendlier regulations, and allow for innovation to grow. Importantly, policy frameworks must be responsive to technological advancements and demographic shifts. Regulators around the world must address the faultlines in newer technology-led concepts (like crypto) that can reshape the global economy.
(This article first appeared in the ORF)
Srinath Sridharan is Visiting Fellow at ORF, and Shashidhar KJ is Associate Fellow at ORF’s Mumbai centre. Views are personal and do not represent the stand of this publication.