Cryptos and a CBDC are not the same thing
GS 3, Economy.
Context:
- The Governor of the Reserve Bank of India, highlighted two things. Firstly, “private cryptocurrencies are a big threat to our financial and macroeconomic stability”. Secondly, “these cryptocurrencies have no underlying (asset)… not even a tulip”.
- The RBI announced that it will float a Central Bank Digital Currency (CBDC). The Supreme Court of India has also questioned the Government whether or not cryptos are legal. The Governor calling cryptos as cryptocurrency has unintentionally identified them as a currency.
What Is a Central Bank Digital Currency (CBDC)?
The central bank digital currencies, which are analogous to cryptocurrency issued by the Central bank. They are based on the value of the country’s fiat currency.
- A CBDC is issued and controlled by a country’s monetary authority, or the central bank.
- CBDCs enhance financial inclusion and make monetary and fiscal policy execution easier.
- Because they are a centralised kind of currency, they may not be able to anonymize transactions as certain cryptocurrencies do.
- Many nations are investigating the impact of CBDCs on their economies, current financial networks, and stability.
Central Bank Digital Currencies’ Objectives:
- CBDCs’ primary purpose is to provide privacy, transferability, ease, accessibility, and financial security to companies and consumers. CBDCs might also minimise the maintenance required for a complex financial system, cut cross-border transaction costs, and give lower-cost choices to people who now utilise other money transfer methods.
CBDC Types:
- CBDCs are classified into two types: wholesale and retail.
- Financial institutions are the primary users of wholesale CBDCs. Retail CBDCs, like physical forms of cash, are used by both consumers and businesses.
Wholesale CBDCs
- Wholesale CBDCs are analogous to central bank reserves. The central bank opens an account for an institution to deposit funds or use to settle interbank transactions. Central banks can then affect lending and set interest rates by using monetary policy instruments such as reserve requirements or interest on reserve holdings.
Retail CBDCs
- Retail CBDCs are digital currencies supported by the government that are utilised by both consumers and businesses. Retail CBDCs minimise intermediary risk, which is the chance that private digital currency issuers would go bankrupt and lose the assets of their clients.
- Retail CBDCs are classified into two kinds. They differ in terms of how individual users gain access to and utilise their currency:
- Private/public keys can access token-based retail CBDCs. This validation mechanism enables users to conduct transactions anonymously.
- To access an account with an account-based retail CBDC, digital identity is required.
CBDCs Addresses Issues:
- Risk-free in terms of credit and liquidity.
- Enhancements to cross-border payments.
- Supports the dollar’s international role.
- Inclusion of funds.
- Increases accessibility to the wider populace.
CBDC is required because:
- The rise of cryptocurrencies such as Bitcoin and Ethereum has put conventional currencies under pressure.
- Along with its other weaknesses, each country’s central banks investigated the prospect of launching their own digital currency.
- According to a 2021 BIS poll of central banks, 86% were actively exploring the prospects for such currencies, 60% were experimenting with the technology, and 14% were running test programmes.
- Inter-bank settlement would be unnecessary since it would be a central bank responsibility transferred from one person to another.
Problems That Need T0 Be Solved:
- Changes in the financial framework.
- Stability of the financial system.
- Influence of monetary policy.
- Privacy and security.
- Cybersecurity.
Cryptocurrencies vs. CBDCs:
- Cryptocurrency ecosystems provide a glimpse of a different financial system in which onerous restrictions do not determine the parameters of each transaction. They are difficult to copy or forge, and they are protected by consensus processes that prohibit manipulation. Central bank digital currencies are similar to cryptocurrencies in design, although they may not require blockchain technology or consensus procedures.
- Cryptocurrencies are also uncontrolled and decentralised. Investor sentiment, use, and user interest all influence their worth. They are volatile assets that are better suited for speculation, making them unsuitable for use in a financial system that demands stability. CBDCs are supposed to be stable and safe by mirroring the value of fiat currency.
CBDCs can, but do not have to, be built on blockchain.
Way Forward:
- A Well-Evaluated Implementation: With the depletion of paper currency, there is a need to promote electronic currency systems. This becomes more efficient in countries where actual currency is widely used, such as India.
However, it is critical to implement such a critical choice in a well-planned and well-evaluated manner, since haste execution may result in more losses than profits.
- To prevent the currency from being used for terror funding or money laundering, stringent compliance with Know Your Customer (KYC) requirements must be enforced.
- RBI’s role: The blockchain technology, or whatever is utilised to power the digital currency, will have to strike a balance between the sometimes-contradictory aims of speed, scalability, auditability, security, and privacy.
- Given India’s continuing digital divide, a protocol for offline use must be developed. Rushing the execution of what should ideally be a multi-year project may expose the organisation to needless risks.
SC Garg Committee recommendations (2019):
- Anyone who mines, holds, transacts, or deals with cryptocurrencies in any manner should be prohibited.
- It recommends a one-to-ten-year prison sentence for exchanging or trading in digital money.
- It recommended a monetary punishment of up to three times the exchequer’s loss or the bitcoin user’s earnings, whichever is greater.
- However, the panel advised the government to keep an open mind to the Reserve Bank of India’s possible issue of cryptocurrencies.
Concerns expressed:
- India is already dealing with a slew of cyber security challenges. With the introduction of digital money, hackers may rise and pose a threat to digital theft, as seen in the Mt Gox bankruptcy case.
- According to a 2018 assessment by the Digital Empowerment Foundation, almost 90% of India’s population is digitally illiterate. As a result, without sufficient literary knowledge, the advent of digital money would pose a slew of new issues to the Indian economy.
- The introduction of digital money also brings with it a slew of new regulatory issues, such as tracking investment and purchase activity, taxing individuals, and so on.
- The digital currency must collect certain fundamental information about an individual in order for that person to show that he is the owner of that digital money. This fundamental information may include sensitive information such as the person’s identification, fingerprints, and so on.
Conclusion:
- There are critical considerations to be taken about the design of the money, such as how it will be issued, the degree of anonymity it will have, the type of technology that will be employed, and so on.
- There is no question that the introduction of National Digital Currency prevents the many hazards connected with privately held cryptocurrencies and propels India to the next level of its digital economy.
- However, before implementation, the government must put in place the appropriate protections. India must move on with the implementation of an official digital currency.
