RBI to issue official digital currency; ban crypto

The government of India this week listed the “Cryptocurrency and Regulation of Official Digital Currency Bill” for introduction during the winter session of Parliament. The bill seeks to:

• Create a facilitative framework for the creation of official digital currency to be issued by RBI
• Prohibit all private cryptocurrencies in India, but allows for exceptions to promote underlying tech of cryptocurrency

According to the Bank for International Settlements (BIS), 85% of the central banks in the world are studying or piloting central bank digital currencies (CBDCs). They will be legal tender.

China has banned cryptocurrencies. UK, Singapore, and Japan allow cryptos to operate within a regulatory framework, but w/o recognizing them as legal tender. Some countries have prohibited regulated institutions from dealing in cryptos without explicitly clarifying their legal status - RBI had tried this option, but it was struck down by the Supreme Court of India. El Salvador is the only country to permit cryptocurrency as a legal tender.

?Crypto

Cryptocurrencies are not legal tender (except in El Salvador), but are increasingly popular with digital natives. In Nov 2021, m-cap of cryptocurrencies crossed $3 trillion (= GDP of India, UK, or France). Bitcoin hit an all-time high of $69,000, though it has now corrected by 20%.

In an article titled “Crypto, Not Currency,” D Subbarao, former Governor of RBI says, “the biggest fear of central banks, RBI included, is that cryptos will erode their monetary sovereignty. A second big fear is that cryptos would become conduits for capital outflows as investors put domestic money in the crypto exchange and exit abroad in hard currency.” Trading will allow it to be used as a store of value, although officially it will not be a medium of exchange. China is reported to have lost as much as $80 billion via cryptos last year before it banned all crypto transactions this September

Crypto prices fluctuate rapidly. High volatility makes it unfit as a medium of exchange. Bitcoin mining is slow and energy-intensive. Some leading investors have warned against investing in cryptos comparing it to historic bubbles.

Diem & Stablecoins

A serious challenge to modern banking emerged from Facebook (now Meta) when it announced plans for a cryptocurrency Libra (now Diem). This was to be backed by a reserve currency and with a user base of few billions, Facebook could undermine the monetary sovereignty of central banks, particularly in emerging and developing countries.

Stablecoins or unregulated digital currencies backed by a reserve currency represent a serious worry for lawmakers.??

CBDCs

The future of money is digital. Alipay & WeChat in China, unified payment interface (UPI), Google Pay, Amazon Pay & Paytm in India, MPESA in Kenya, PIX in Brazil and nearly cashless economies in Europe represent this megatrend. Covid-19 accelerated move towards touchless transactions. Over 90% of all money globally is digital.

According to BIS, 85% of the central banks in the world are studying or piloting CBDCs. A CBDC would operate just like cash, except that it would be stored and accessed digitally. The user experience of CBDCs will be like the existing digital systems. They will be legal tender.

China has begun rolling out the e-renminbi and could launch it during Beijing Winter Olympic Games 2022. Australia, Malaysia, Singapore and South Africa are cooperating on the world’s first cross-border central bank digital currency exchange program led by BIS.

Remittances (global or local) are expensive. As per a PWC report, CBDCs can bring down delays, prices, and complexities, increase financial inclusion, provide mass benefits, and curtail illegal activities such as money laundering and drug trafficking. Digital currencies could accelerate ‘tokenization’ and encourage the hassle-free exchange of value between investors and consumers of all classes, including fractional ownership of real estate or other high-value assets w/o high fees or complex negotiations.

Why are central banks not moving fast on CBDCs?

According to D Subbarao, apart from complex technology, design issues, and cyber security concerns, a potential downside is the impact of CBDCs on commercial banks. They are in the business of financial intermediation – taking money from savers and lending it to borrowers at a higher rate of interest. This has historically driven growth. The fear is that CBDCs will erode the deposit base of commercial banks and raise the cost of credit. CBDCs may precipitate bank runs. Loss of privacy is another major concern.

The opposition is also coming from commercial banks. “Banks are centralized middlemen with respect to financial transactions.” The more popular the cryptocurrency or digital currency becomes, the fewer profits the banking system can reap from traditional services and verification methods that allow them to hold, take or use their customers’ money, and the more financial power they tend to lose as a result.” Says Nomi Prins, former Goldman Sachs Managing Director, in an article in TIME Magazine.?

As per PWC, “some current legal frameworks are not comprehensive or modernised enough to deal with the new forms of money. In the absence of robust legal systems, the issuance of CBDC poses legal, financial, and reputational risks for central banks.”

?Geo-politics of digital currency

According to TIME, “…dollar dominance has rankled much of the world for decades; other countries, both adversaries and allies, are interested in finding ways to decrease their dependence on the dollar…. Many nations—especially those with testy relations with the U.S., like Russia and China—would also prefer to settle accounts directly via digital currencies. This is not least because the U.S. has increasingly weaponized the dollar for geopolitical gains; it has twice put pressure on the SWIFT banking network to block all transactions with Iran.”

In 2016, the Bank of England started deliberations on CBDC. The central banks of Sweden, China, Canada, and Singapore were followed by many others.

Being the first major economy to roll out a digital currency is part of China’s geopolitical ambitions. China should “actively participate in formulating international rules on digital currency and digital tax to create new competitive advantages,” President Xi Jinping wrote last year in?Qiushi,?an ideological journal of the Chinese Communist Party (CCP). Beijing has been working hard to establish common global rules for digital currencies. China was the first to contribute digital-currency content to ISO 20022 protocols—a new global standard to cover data transferred between financial institutions.

Digitalization promises to democratize international payments by allowing settlement between currencies without exchanging to the dollar first. JP Morgan, DBS, and Temasek have announced the creation of a wholesale digital-currency clearinghouse. CBDCs could make?the SWIFT?system obsolete.

The road ahead

Crypto already has a large investor base globally, including India, and is popular with digital natives. Authorities fear that a ban may be tough to enforce and could simply move it to the darknet. Subbarao argues, “recognizing cryptos as an asset class and regulating them will allow the government to monitor the trading activity, tax the capital gains of investors and enforce some standards of transparency and a code of conduct.”

Physical money isn’t?going to vanish; no central bank is advocating its complete abolition.

As per PWC, “…it is apparent that the potential benefits of CBDCs are now firmly on the radar of most policymakers… It is highly probable that the future of money will be a mix of centralised, decentralised, account-based and token-based with CBDCs, stablecoins, and cryptocurrencies co-existing alongside traditional digital and physical currencies…. Most countries are currently looking at wholesale CBDCs as a first step, since retail CBDCs may be associated with greater risk. However, with ongoing research and piloting one can anticipate that safe and efficient retail CBDCs will also be rolled out in due course.”

Disclaimer: Apart from inputs from subject matter experts, this article has multiple?references to open-source material available on the internet, including but not limited to:

1. Multiple articles, research papers, and videos on the subject published by PWC, TIME, and The Economist
2. Article titled “Crypto, Not Currency” by D Subbarao published in Times of India dt 24 Nov 2021 and an earlier article on the subject in the same paper
3. Quishi, an ideological journal of the Chinese Communist Party (CCP)