The uncanny mystery behind India’s cryptocurrency policy has made several cryptocurrency experts and traders nervous. While all eyes focus on the policy concerning the regulation and status of private, open-source cryptocurrencies such as Bitcoin and Ethereum, the scope of this article is to focus on an important stand of the RBI - the research and development of its own ‘Central Bank Digital Currency’ (referred to as CBDC hereon). It is speculated that the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, will provide a framework for creating an official digital currency to be issued by the Reserve Bank of India (RBI).
Central Bank Digital Currency is a legal tender and is the central bank liability in digital form, denominated in a sovereign currency. It uses distributed ledger technology, or blockchains, to provide its services. It is in the form of electronic currency which can be converted or exchanged with cash and traditional central bank deposits.
With the exponential rise of cryptocurrencies in the last 5 years, the inherent problems in their structure also became apparent. Open-source cryptocurrencies are not widely accepted, are highly volatile, and do not provide any legal recourse in the face of fraudulent transactions, if any. CBDCs solve these problems by providing authority to the Central Bank of the country to control, regulate and govern digital currency.
CBDCs have the potential to create a seismic effect on the banking and financial systems. Digital currency would enhance electronic transactions through ease of e-transfers, reducing the high transaction costs involved in liquid exchanges. Similarly, extending this micro benefit to macro features such as the provision of credit would expand the borrowing ability of individuals and lead to economic growth through investment. It provides consumers with a safer way to deposit and store their money.
CBDCs can empower the government to carry out direct transfers with reduced errors and scope of interference. With the rise of technology, it is important to realize that mobile phones are available in areas where a physical bank is not. Building a strong infrastructure for transacting CBDCs would expand financial inclusion in our country. It would also enhance safety, security, and speed in cross-border transactions. The RBI maintains a positive outlook towards the potential of CBDCs and their utility. In a recent report, the RBI stated, “CBDC can be designed to promote non-anonymity at the individual level, monitor transactions, promote financial inclusion by direct benefit fiscal transfer, pumping central bank ‘helicopter money’ and even direct public consumption to a select basket of goods and services to increase aggregate demand and social welfare.”
There are many benefits of having a centrally-governed cryptocurrency when viewed from the perspective of the industry or the consumer. However, commercial banks are crucial stakeholders that form an important pillar in the banking hierarchy. They are already in a fragile state, and introducing CBDCs could weaken their structure further. If consumers store their money in a digital format, cash deposits with commercial banks decline. This would force them to increase deposit rates to attract deposits. If deposit rates go up, a necessary domino effect would lead to an increase in borrowing rates. An entire cycle ensues which might harm businesses, as well as on the profit margins of commercial banks. A necessary hurdle of educating the masses in a country like India must also be addressed in the CBDC policy.
Competitor success fuels RBI’s overwhelming speed in research. Sweden was the first country in the world to test a CBDC known as ‘E-krona’. The stronger concern is speculation of China becoming the first country to launch CBDCs on a large scale. They too have already experimented by paying the salaries of their government employees as CBDC to their wallets.
The analysis of the pros and cons of adopting CBDCs leads to a simple conclusion - CBDCs are the future. The ever-evolving technology urges central banks across the globe to evolve with it. Cryptocurrencies and the freedom they come with raise questions over the ability of central banks to control and implement the monetary policy of the country.
There is a need for India to carry out extensive research to map out the intricate workings of CBDCs and create a mechanism for its smooth integration into the existing complex banking system without wreaking havoc.
Written by: Ananya Dhanuka (firstname.lastname@example.org)
Edited by: Divij Gera