Smarak Swain is an officer of the 2008 batch of the Indian Revenue Service (IRS) and currently director of the FATF Cell at the Department of Revenue. He is the author of numerous fiction and non-fiction books such as The Great Indian Fraud and The Hawala Agent. The latest of these is Digital Fortunes, which analyses new-age platform companies and cryptocurrencies.
Swain speaks to Mint about the central themes of his book. His views are expressed in a personal capacity and not as a representative of the government.
In the first part of your book, you cover two overarching concepts – platform versus pipeline companies. Could you elaborate on the differences in the two models?
Pipeline companies are traditional businesses, which are organised in the form of pipelines or supply chains. Every part of the business is responsible for producing specific goods or providing specific services. Value creation happens through application of labour and machinery in every part.
In contrast, business in the digital economy harnesses the power of user networks. Platform companies have volume without mass, in the sense that they do not produce goods or provide services. They connect users by developing multi-sided markets. The network of users they develop drives their value. Value is created when users connect through the platform and engage with each other using the platform’s digital infrastructure.
To state simply, the value creation in pipeline businesses (a feature of the traditional economy) increases linearly, whereas the value creation in platform businesses (a feature of the digital economy) increases exponentially with the increase in its network of users.
As investors, is there a thumb rule – whether a platform or a pipeline company will do better in a particular business?
Pipeline companies present lower risk and give lower but predictable returns. Platform companies work in a high-risk ecosystem but can give many multiples of capital invested as returns.
Platform companies are not ideal for passive investors because they are usually on the lookout for risk-mitigated stocks. For active investors with risk appetite, it is sane to invest in platforms as part of a diversified portfolio. Diversification itself mitigates some of the high risks.
At the same time, both active and passive investors should bear in mind that the entire economy is getting digitalised. Pipeline companies with a platform strategy, or a strategy to harness network effects, are better placed than their competitors in generating shareholder value.
What is the case for crypto as an investment given that it pays no dividend or interest?
The central theme of my book is network effects, a key source of value creation in the digital economy. It is true that crypto assets do not have any underlying value, which is why I do not see any case for most cryptos as an investment option. But certain cryptos which are adequately decentralised (which, in turn, implies that they are immune to manipulation by a promoter or administrator) and have a strong network of users (which create network effects) are valuable. Their value comes from the vast network of users… wherein the users consider it valuable.
The asset with probably the strongest network effects in the world is gold. Gold is valuable because it is generally accepted by a large number of people as valuable. It also cannot be manipulated (legions of alchemists have tried for more than a thousand years to make gold from base metals, but have failed). The network effects of gold took a long time to develop; such a large network of users or believers develop in years in the digital economy because of the ability of the internet to facilitate such networks.
There are few cryptos which are actually decentralised and the size of their user network is increasing consistently. They are valuable because so many millions of users consider them as valuable and use them as a store of value. There is a case for these specific cryptos as investment options. Just like gold, they do not yield dividend or interest, but give returns in the form of appreciation over time.
You say in the book that an advantage of Bitcoin is that it simultaneously offers ownership rights and anonymity, traditionally an impossible combination. What role will this ‘negative’ strength play in supporting Bitcoin’s value in the future?
This negative strength of Bitcoin makes it highly vulnerable to facilitating tax crimes, money laundering, and hiding stolen assets. Some of the earliest adopters of Bitcoin were users on the Silk Road, the first modern darknet market. In fact, the Silk Road could run because transactions on this marketplace were in Bitcoin. Many more typologies have come to the fore in the last decade to suggest the rapid adoption of Bitcoin by criminals.
However, law enforcement around the world has also evolved to effectively trace and locate transactions in Bitcoin. Tools used to trace transactions in Bitcoin are becoming more advanced as they learn from past experiences. Conversion of Bitcoin into fiat currency can happen on exchanges, which are subject to KYC norms. So it appears, in the future, the risk of misuse of Bitcoin for the wrong reasons will be significantly mitigated.
But even the residual risk will be significant because surveillance of ownership of private wallets holding on to Bitcoins is not possible. Private wallets will remain in a regulatory black hole, even though the wallets are very well visible on the public blockchain – because there is no way of knowing their beneficial owner.
If I have to answer your question, I think yes the corrupt and the tax evaders and the professional launderers using Bitcoin will drive part of its value in the future.
As the world fractures into rival geopolitical camps, what is the case for Bitcoin to emerge as the international currency that displaces the US dollar? How does it compare against gold for this role?
There are definitely some disadvantages that both the US dollar and gold face today in international trade finance. Because of stringent sanctions by the US on Russia, Russia is not able to conduct transactions in the US dollar. Already, Iran and North Korea face similar sanctions. While the US dollar remains the easiest and most popular anchor currency, many see the weaponisation of the dollar warily. Such weaponisation is possible because the US dollar is controlled by the US government.
Gold is the standard, but it is, after all, physical. It is not as liquid as the US dollar when it comes to international trade settlements. Choosing gold over the dollar as reserve probably makes better sense for central banks, but again it comes with the associated problems of a physical metal.
It appears that Bitcoin does not have the disadvantages of both the dollar and gold. It cannot be manipulated or controlled by any country’s central bank (its creator mentioned in a white paper that their motivation to create it was to develop an alternative to currencies controlled by central banks). It is more liquid than gold, but definitely less liquid than the US dollar as of now. It’s not physical, and can be fractionalised infinitely. It is legal tender in certain hotspots on the world map.
On the other hand, it is still very volatile (even though its volatility is decreasing with maturity) and a central bank has to be quite adventurous to hold it as part of the reserve currency basket today. However, as the asset matures and as the number of small users increases, its volatility may reduce some time in the future. That future may not be very far away, given the pace at which evolution happens in the digital world.
