The Case For Bitcoin In Pakistan

Executive Summary

This paper is an attempt to highlight Bitcoin’s ever-increasing importance to Pakistan’s socioeconomic future. For purposes of our discussion, Bitcoin refers to the decentralized digital asset with a market capitalization of approximately $900 billion and growing as well as its blockchain-powered monetary network that enables peer-to-peer transactions without relying on a trusted intermediary.

Before we proceed, let us be clear on what this paper will not set out to achieve. Although we are very bullish on bitcoin as an asset class over the long term, our commentary will not include any price forecasts. We will not be conducting a technical review of the blockchain technology in this study. Notwithstanding their importance, these topics have been studied in detail by experts more qualified than our team. Furthermore, a deep dive into a pricing and technical discussion will detract us from the main message: Why should Pakistan adopt bitcoin now?

Cryptocurrency adoption has started to gather momentum in the country. Chainalysis’ 2021 Global Crypto Adoption Index has Pakistan ranked in third place globally. Earlier this year, the province of Khyber Pakhtunkhwa announced plans to build pilot cryptocurrency mining farms. At the federal level, a committee has been formed to study cryptocurrency regulation. These are promising developments. However, there is so much more left to accomplish and a small window of opportunity presents itself to act.

Pakistan has several ways to benefit from the Bitcoin ecosystem. Our team believes bitcoin is primed to outperform traditional assets moving forward. Before the price of bitcoin goes beyond the country’s affordability threshold, we propose the State Bank of Pakistan start by converting up to 5% of their sovereign gold reserves (approximately $180 million) into this asset. The upside scenario can have a positive material impact on the state of the country’s asset reserve balance.

Using the internet and a smartphone, here lies an opportunity for the average Pakistani investor to plug into the world’s best performing asset over the past decade. These unmatched returns will provide prosperity across investing households, boost the local economy in the form of additional demand and generate tax on capital gains. We suggest the State Bank of Pakistan and securities regulator open up access to this asset class for all Pakistani investors. Movement between the Bitcoin ecosystem and traditional financial institutions needs to be a low-cost and frictionless endeavor. A fully regulated national cryptocurrency exchange should be introduced with incentives to entice domestic participation. A bitcoin ETF trading on the Pakistan Stock Exchange will offer an attractive investment for local stock market investors desperate for diversified exposure.

Blockchain and smart contract software developers are on their way to becoming prized assets in this new decade of cryptocurrency. In a post–COVID-19 world, remote work is quickly becoming the new normal. We may not be too far from a future state where the best candidates for the role are recruited, regardless of their physical location. Government investment toward skills upgrade and setting up basic cryptocurrency infrastructure will be returned to the economy in the form of budding entrepreneurs, developers and product managers. All productive citizens would boost the local economy from their earnings and contribute to the tax base. In summary, the cryptocurrency economy has the potential to raise masses out of poverty by providing employment.

The “great mining migration” has presented Pakistan with a time-sensitive investment opportunity. Firstly, the recent reduction in the network’s hash rate makes it economically attractive to begin mining operations immediately. Next, the shutdown of Chinese miners has resulted in secondhand mining equipment flooding the market at considerably reduced prices. Finally, Pakistan now possesses surplus electric generation capacity relative to demand. It is our suggestion that the federal government take advantage of this superb timing. Bitcoin mining farms should be set up near power plants to minimize any transmission losses. If bitcoin prices continue to rise as per our expectations, this is another avenue for the federal government to generate massive revenues.

The State Bank of Pakistan has prioritized the rollout of Raast, a new instant payment system. All evidence points to a flourishing local remittance ecosystem. However, international payment remittance remains a clunky process with high fees and lengthy settlement periods. Bitcoin’s monetary network provides a comprehensive solution to this problem. Specifically, Bitcoin’s Layer 2 protocol (Lighting Network) enables transfer of micropayments on a real-time basis with minimal fees. We suggest the federal committee overseeing cryptocurrency to invite fintech players such as Strike to understand the benefits of this solution. Pakistan should begin work on seamlessly connecting Raast to the Bitcoin ecosystem.

The Bitcoin ecosystem is not without risks. China and the International Monetary Fund (IMF) have both leveled criticism against the technology. Furthermore, the Financial Action Task Force has called on the government to better regulate the cryptocurrency industry. It is imperative to involve these important stakeholders in all top-level cryptocurrency discussions.

Pakistan has multiple avenues available to participate in the Bitcoin revolution. The benefits are far reaching and greatly outweigh the costs. There is an urgency to formulate a national cryptocurrency strategy and become an early adopter of this ecosystem. The time to act is now.

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I. What Is Bitcoin?

The advent of the internet-enabled society to digitize information. In the same vein, bitcoin’s revolutionary technology (the blockchain) enables society to digitize value.

Prior to bitcoin, most cryptocurrencies were exposed to a risk known as double spending. This is the risk that a cryptocurrency can be spent twice. It is a potential problem unique to “digital currencies” because digital information can be reproduced relatively easily by savvy individuals who understand the blockchain network and the computing power necessary to manipulate it (Frankfield, 2020).

Bitcoin was the first cryptocurrency to solve the double spending problem without relying on a central authority to oversee transactions.

Here is an investment letter from Miller Value Income Strategy that provides as simple an explanation of the technology (Bill Miller IV, 2021):

“Bitcoin is a decentralized network of value storage. Its core technological breakthrough lies in users’ ability to transfer value to other network participants without any central administrator or authority. This means that users can shift large quantities of value to each other around the globe almost instantly, 24 hours/day, 365 days/year, using only another participant’s ‘public key’ and little administrative hassle. ‘Miners’ verify transactions in exchange for new coins, though the reward for each mined ‘block’ decreases every 210,000 blocks, or approximately every four years. Unlike the dominant systems of account now in use (currencies), the supply of measuring units is predetermined and will never exceed 21,000,000. While aggregate participation in the network is effectively unlimited, there will never be more than 21 million spots (‘bitcoins’) on the ledger, which means that more network participation makes each spot on the ledger more valuable. Each bitcoin is divisible into 100 million units, or Satoshis.”

The decentralized nature of this technology allows users to conduct peer-to-peer monetary transactions without the need to involve a central authority (i.e., banks, currency exchanges, trust companies, etc.). Bitcoin has rules and incentives built into the protocol that are agreed to and enforced by the miners using a consensus mechanism process. Improvements to the technology can be proposed but can only be adopted if 95% consensus is reached among miners (Alex Galea, 2018). As an example, Taproot, the first Bitcoin upgrade in almost four years, has recently been approved by miners and will take effect in November 2021. However, this ecosystem does not have any rulers. There exists no one person or group that controls Bitcoin. This form of organization where there is no controlling centralized actor is known as distributed governance.

Furthermore, Bitcoin is a permissionless system. As there exists no central authority with ultimate control of the network, any individual or group has the right to transact in this ecosystem using a simple internet connection. A user can neither be banned nor suspended from using the network. No central authority has the right to determine whether a transaction can be conducted on the blockchain.

Another important feature of Bitcoin technology is its immutability. Once a transaction settles on the blockchain, it cannot be edited, reversed or replaced. This ledger of all transactions going back to the very first one from January 2009 can be viewed by anyone on the blockchain. The value of transferred bitcoin, public key addresses of both sender and receiver, along with the date and time of the transaction are all recorded on the blockchain. The high level of confidence in the truth of each transaction brings about a standard of data integrity and transparency that has not been available in the past.

Although bitcoin transaction data is transparent on the blockchain, the parties (i.e., buyer and seller) in each transaction remain anonymous. These buyers and sellers are identified on the blockchain through their unique public keys (a long string of alphanumeric characters). However, all other user-identifying information is not required to transact in this ecosystem. As a result, Bitcoin extends a level of privacy to its users that is not common in the centralized finance world.

Last but not least, bitcoin is referred to as hard currency, in large part, due to its scarcity. The protocol is preprogrammed such that there will exist a total of 21 million bitcoin. So far, roughly 18.8 million bitcoin have been mined and make up the current monetary supply. Furthermore, every four years or so, a halving event takes place. This creates a situation where the number of bitcoin entering the ecosystem reduces by 50% thereby accelerating scarcity. Unlike fiat currency value that is directly tied to the actions of its central bank, bitcoin follows through on its protocol independent of the economic situation around it. This predictability of the protocol is a strength as it ensures the current supply will not be debased due to central bank actions such as excessive money printing.

II. Current State: Cryptocurrency Ecosystem In Pakistan

The cryptocurrency boom is upon us. The unprecedented price volatility in this asset class coupled with a relatively low barrier to entry has resulted in a breeding ground for scores of risk takers willing to try their hand at short-term trading. Chainalysis’ 2021 Global Crypto Adoption Index has Pakistan ranked in third place globally, up from 15th place a year before. Specifically, the on-chain retail value transferred metric used to measure the activity of nonprofessional, individual cryptocurrency users ranks Pakistan in the top-10 globally. This ranking underscores the grassroots revolution taking place in the country as more and more Pakistanis enter the cryptocurrency ecosystem.

A. Khyber Pakhtunkhwa

In December 2020, Khyber Pakhtunkhwa provincial assembly unanimously passed the resolution to legalize cryptocurrency and cryptomining (The Express Tribune, 2020).

Soon after, in March 2021, the province of Khyber Pakhtunkhwa announced plans to build pilot cryptocurrency mining farms using hydroelectric power. The provincial government also set up an Advisory Committee on Digital Assets composed of stakeholders and experts with a goal to review various technical matters and associated revenue potential by attracting cryptocurrency-related investments. Zia Ullah Khan Bangash, then advisor to the provincial government on science and technology, sounded upbeat on the future of crypto in the province.

“People have already been approaching us for investment, and we want them to come to Khyber Pakhtunkhwa, earn some money and have the province earn from that as well.

“It’s really just our government that is not participating right now, people all over Pakistan are already working on this, either mining or trading in cryptocurrencies and they are earning an income from it,” Bangash said. “We are hoping to bring this to a government level so things can be controlled and online fraud or other scams can be prevented” (Farooq, March 2021).

However, in a sudden reversal of events, it was announced on May 28, 2021, that the Khyber Pakhtunkhwa government has dissolved the Advisory Committee on Digital Assets citing that decisions on digital currency can only be taken by the federal government. No news has been announced on the cryptocurrency mining farms and associated investments in the province (Ahmed, 2021).

B. Federal

We are of the opinion that the position of the federal authorities, including the State Bank of Pakistan (SBP) on cryptocurrency is not explicit.

Although cryptocurrency itself is not illegal in Pakistan, the on-and-off ramp connecting the ecosystem to traditional financial institutions does not come without headaches. A SBP circular, issued in April 2018, advised “all banks and payment system operators to refrain from processing, trading and promoting in virtual currencies token and not facilitate their account holders to transact in VC and tokens” (Khurshid, 2020). As a result, Pakistani residents are not able to use their bank accounts or online wallets to directly transfer funds to their cryptocurrency exchange accounts.

In order to get around this restriction, most Pakistani cryptocurrency traders and investors use peer-to-peer (P2P) transactions as a method to fund and withdraw from their exchange account. Popular cryptocurrency trading apps provide a listing of verified, country-specific brokers on their platforms. A user looking to fund their cryptocurrency account would send a standard bank transfer to a verified broker’s bank account. The broker would then deposit the agreed-upon cryptocurrency to the user’s exchange account using their public keys address. A withdrawal of funds from the trading app requires a transfer of cryptocurrency from the user to the broker’s exchange account. The broker would then deposit the fiat currency to the user’s bank account using a standard bank transfer. The brokers charge a premium to the market exchange rate for the services provided. The popularity of this P2P process in Pakistan is reflected in the country’s top-10 rank in Chainalysis’ latest P2P Exchange Trade Volume survey. In essence, the P2P process levies an additional cost on Pakistanis transacting in the cryptocurrency ecosystem.

According to recent news reports, a federal committee has been formed to study cryptocurrency regulation. The members are observers from the Financial Action Task Force (FATF), federal ministers, and heads of the country’s intelligence agencies (Farooq, July 2021). This is welcome news and a necessary ingredient in bringing the cryptocurrency revolution to the mainstream economy.

State Bank of Pakistan has also expressed an interest in studying central bank digital currencies (CBDC). In a recent interview with CNN, Governor Reza Baqir cited “financial inclusion, tracking money laundering and counterterrorism measures as possible benefits of digital currencies.” To be clear, CBDC is a digital currency, however, it is under the control of the central bank. This centralized nature makes it distinct from a cryptocurrency such as bitcoin.

The SBP has already started work on Raast, a nationwide instant payment system that will enable end-to-end digital payments among individuals, businesses and government entities within seconds (Ikram, 2021).

This first step in laying down a comprehensive financial rails network is an impressive feat. Our team believes the success of this initiative can lead to on-and-off ramp connections from traditional finance to the cryptocurrency ecosystem.

C. Stacks Education Grant

Earlier in 2021, LUMS, one of Pakistan’s leading universities, was the beneficiary of a research grant earmarked to design Pakistan’s first-ever academic program for blockchain, distributed ledger technology (DLT) and associated platforms.

The grant was in the amount of 5 million STX tokens (a digital currency with an equivalent value of $2.5 million at the time of the announcement). Hiro, the organization behind the grant, builds developer tools for Stacks, the network that enables apps and smart contracts for Bitcoin.

Stacks Pakistan, the local Stacks chapter launched in late 2020, is focusing on awareness, community building and advocacy. The chapter has launched the “Stacks Developers Guild Programme,” or SDG, in seven cities across Pakistan. Through a network of ambassadors, SDG leaders are playing a pivotal role in spreading awareness across universities in Lahore, Karachi, Islamabad, Quetta, Peshawar, Faisalabad and Abbottabad (LUMS, 2021).

III. Bitcoin As A Sovereign Reserve

Economists watched with fascination as the country of El Salvador readied itself to become the global pioneer in accepting bitcoin as legal tender. The Legislative Assembly voted to accept bitcoin as one of two official currencies in the country.

The adoption of bitcoin in the mainstream economy is an interesting case study and not without risks. We feel it is still too early for Pakistan to go the route of accepting bitcoin as an official currency. However, the SBP and Ministry of Finance should pay attention to El Salvador’s rollout. The recently created federal committee should capture the learnings from this public policy experiment, understand the risks and, perhaps, initiate contact with relevant El Salvadoran government officials to remain close to this situation.

An easier way to dip their toes in the cryptocurrency ecosystem would be to consider adding bitcoin to the country’s sovereign reserves. As of July 2021, Pakistan holds $3.795 billion worth of gold reserves (CEIC, 2021).

Gold has been a preferred sovereign reserve asset for most countries going back centuries. There exist two major reasons for this favoritism. First is gold’s globally perceived strength as a store of value. In the event of a fiat currency devaluation or an outright collapse of the local economy, central banks can take refuge in the uncorrelated value of their gold reserves. Finally, gold has a long track record as a valuable global commodity. There are ready buyers available at market prices in the event immediate liquidation is required. For this reason, gold is considered a means of exchange.

Chart 1.1. Gold Price Performance, 10-year time frame.

In order to be classified as a store of value, the asset (or currency) should be worth the same or more in the future. At first glance, the price of gold denominated in USD over a 10-year period seems to have held its value. However, if you account for the 21% cumulative U.S. inflation rate over this time period, the price performance of gold has been abysmal. This data points to gold’s failure as a store of value as it has generated negative real returns (US Inflation Calculator, 2021).

Chart 1.2. Bitcoin Price Performance, 10-year time frame.

Conversely, bitcoin has been the best performing asset class over the past decade. Bitcoin generated a compounded annual growth rate of 230% over this time period. As far as store of value goes, you will be hard-pressed to find an asset class better suited than bitcoin.

It is a mathematical impossibility for bitcoin to replicate these returns over the next 10 years. However, our team believes it is primed to outperform traditional asset classes moving forward. The fixed supply of 21 million coins coupled with accelerating scarcity sit at the core of this investment thesis. Moreover, the institutional demand of bitcoin bodes well for future price appreciation and helps to create a price floor. Publicly traded companies in the United States such as Tesla, Square and MicroStrategy have purchased bitcoin as a corporate treasury reserve asset favoring it over the U.S. dollar. Bitcoin exchange traded funds have been approved in Canada and trade on the Toronto Stock Exchange (TSX), thereby creating further retail demand. Even MassMutual has purchased $100 million in bitcoin for its general investment fund.

Chart 1.3. Pakistan’s Gold Reserves, 10-year time frame

Pakistan’s gold reserves weigh roughly 64 tons. The storage and transfer costs for this quantity come with costs. Fortified locations with armed security personnel would not be uncommon. If the gold is stored in bank vaults outside the borders of the country, a management fee is likely paid for this service. In this second scenario, the country’s gold would be in the control of foreign actors. This is not without risks as these foreign powers hold influence on the sale and transfer of these sovereign reserves (World Gold Council, 2021).

Bitcoin has significant advantages over gold when it comes to storage. As bitcoin is a digital asset, it does not require the same level of physical security needed to protect gold reserves. Cold storage and multisignature wallets are examples of bitcoin storage options. In both cases, the costs associated with storage are immaterial. Additionally, the control over the bitcoin rests entirely with the owner of the coins. No central authority can influence the purchase, sale or transfer of these assets. MicroStrategy has created the Bitcoin Corporate Playbook that not only provides guidance on safely storing bitcoin but also how to purchase significant amounts without materially impacting market price (MicroStrategy, n.d.).

Finally, bitcoin is a relatively new asset class with a growing spot and futures market. The bitcoin market has a market capitalization of approximately $950 billion with a three-month average daily traded volume of $32.98 billion (Yahoo Finance, 2021). The market trades round the clock with no days off on weekends or statutory holidays. There exists ample liquidity in the market for Pakistan to consider initiating a small yet calculated position. Furthermore, the daily traded volume points to a ready market of buyers in the event liquidation of position is required. The purchase and sale of this asset is seamless through the use of established global market exchanges. For the amounts in question, bitcoin provides a means of exchange no different than gold.

El Salvador is the first country to make public its adoption of bitcoin as a sovereign asset. We believe more countries will follow suit as they begin to understand the benefits of this digital asset. The current price of bitcoin still falls within Pakistan’s affordability threshold. This may not be the case for too long as adoption increases over time. Therefore, it is vital Pakistan be a first mover among nation states. We propose the State Bank of Pakistan start by converting up to 5% of their gold reserves (i.e., approximately $180 million) to finance their first bitcoin purchase. As it is, these growing gold reserves sit idle and unproductive. Bitcoin satisfies the store of value and means of exchange requirement and offers diversification to the sovereign reserve asset portfolio. We feel this allocation is low enough to not cause panic during price volatility. However, the upside scenario can have a positive material impact on the state of the country’s asset reserve balance.

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