Central Bank Digital Currency

Mr. Shaktikanta Das, Governor of the Reserve Bank of India (RBI), recently shared the thoughts of the Indian Government regarding all private cryptocurrencies. "RBI is very clear that all the private cryptocurrencies should be banned", he asserted at an event in mid-January 2023.  Though he mentioned that private cryptocurrency should be banned, he also said that the blockchain technology on which it is based needs to be supported. The RBI governor also clarified that, apart from the known dangers of money laundering, terror funding, etc., there is no underlying in the case of crypto. He added that "anything without any underlying, whose valuation is dependent entirely on make-believe, is nothing but 100% speculation or, to put it bluntly, gambling". Mr. Das stated, "If 20% of the transactions occur in crypto that the central bank does not issue, the RBI will lose control over 20% of transactions in the economy. The central bank's ability to decide monetary policy and the money supply level will get undermined. This will lead to dollarization of the economy."  RBI's concern and, similarly, the concern of central banks of all other countries that are exploring or introducing CBDC in their respective economies is more to do with losing control over a sizeable amount of money transactions in the economy it governs than about addressing the structural defects of the private cryptocurrency market.     Whether cryptos are a threat to the control exerted by Governments and their Central Banks over their economies. Cryptocurrencies are an 'in the face' loud statement about the decentralization of currency — a currency that is not controlled by a government or central authority.  Every Central Bank in the world is wary of cryptocurrencies wresting control of the creation and transfer of money from them (central banks), leaving them without the tools they currently have for preventing their respective economies from heating up or going cold. Experts tracking the development of digital currency and the evolution of the market believe that, at the most basic level, a digital currency is indeed about control or, somewhat, the lack of centralized control. The experts also have clarified that, until this day, all of these threats remain entirely hypothetical. <h2 style="text-align: justify;">CBDC</h2>A Central Bank Digital Currency (CBDC) could be the perfect tool for Governments to track a person's transactions, irrespective of the amount.  While it is admitted that this could serve as a powerful disincentive in using these currencies for crime or fraud, it could also allow new kinds of social control, especially in countries with already-scant protections for human rights. The potential downsides of tracking digital currency transactions could be profound.PrivacyThen, there is the obvious issue of privacy that is most likely to get compromised with the use of CBDC. While Governments keep clarifying that they shall not track what purpose their common citizens use the digital money for, it goes without saying that there is almost an invisible line between exerting control and tracking, and there is no guarantee, at least for now, that Governments won't breach that line, ever. <h2 style="text-align: justify;">Are Cryptocurrencies Assets?</h2>If cryptocurrencies do not have any underlying, are they assets? When we go back to the recent statements made by the RBI Governor, the absence of underlying in private cryptocurrencies, what he implied was that CBDC is a unique type of cryptocurrency known as 'stablecoin', whose value is pegged to an asset or a fiat currency like the Indian Rupee (INR). While private cryptocurrencies run on distributed-ledger technology, i.e., multiple devices worldwide, not just one central hub, are constantly verifying the accuracy of the transaction. It is different in the case of a CBDC, where a central bank issues the digital currency and records it on the liability side in its books. According to the RBI Governor, this is underlying for the CBDC, which is absent in private cryptocurrencies. However, contrary to the RBI's position on private crypto assets, most countries, including India, treat cryptocurrency as a capital asset regarding the taxation of crypto transactions. Merely because there is no underlying doesn't establish that cryptocurrency itself is a sham or make-believe. At the moment, governments are opting for the easier option of exerting their control over digital currency and its circulation by simply banning privately generated and publicly circulated digital currency and introducing its own CBDC. Suppose any country proceeds to ban cryptocurrency based on this proposition alone before introducing CBDC in its economy; in that case, this is akin to throwing the baby with the bathwater merely because the cryptocurrency market is prone to fraud and instability. There are better solutions than this that Crypto markets hope for in the near future.  Regulate cryptos by all means, but certainly don't ban them.    At the levels of regulation and stability that stock markets are today across the world, including in India, the cryptocurrency market, too, requires regulation and guidance until it matures in the next few years.  Institutions such as the SEC or the SEBI are needed to dictate the future course of Crypto markets.Banning cryptocurrency altogether and introducing CBDC is not the solution that Governments think they have for the problem plaguing the crypto industry. Besides, CBDC itself brings its own set of challenges. <h2 style="text-align: justify;">Challenges</h2>A large sum of money could be withdrawn from banks at once by purchasing CBDCs, triggering a run-on bank—affecting their ability to lend and sending a shock to interest rates. It is also vulnerable to cyber-attacks, as private cryptocurrencies are.     Let us hope governments worldwide join hands soon to constitute a supra-national body for regulating Cryptocurrencies. Until such time, we will witness a mad rush of countries to introduce their CBDCs in the world markets.   This article was contributed by our expert <a href="https://www.linkedin.com/in/dr-shrikant-kamat-7573b910/" target="_blank" rel="noopener">Dr. Shrikant Kamat</a> <h3 style="text-align: justify;">Frequently Asked Questions Answered by Dr. Shrikant Kamat</h3> <h2 style="text-align: justify;">1. Will CBDC replace cash?</h2>It is unlikely that CBDC will replace fiat currency (cash) in the near future since CBDC will be only used for specific purposes in the initial years for transactions between banks or financial institutions (Close User Group/CUG) and the general public (P2P or P2M) only on a pilot basis for a few years. Only when RBI is assured of CBDC as a successful alternative to fiat currency will the Government contemplate offering CBDC on a mass scale to the public. However, cash will always continue to be a mode of payment, irrespective. <h2 style="text-align: justify;">2. What are the risks of central bank digital currency?</h2>CBDC value will be initially pegged to the denominated rupee (in India) or the national currency of the respective country. However, once trading in CBDC on digital exchanges commences, its value on a given day may be less or more than the denominated value of the currency.Unlike the value of a denominated fiat currency (say a Hundred Rupee Note), which remains unchanged irrespective of the financial difficulties faced by an economy, this feature of the central bank digital currency can be a big drawback for those countries whose financial affairs are under the scrutiny of international financial watchdogs such as the IMF.Secondly, transactions in CBDC can be easily tracked. People spending huge amounts in cash in restaurants, retail stores, hotels, jewelry shops, etc., will typically refrain from using CBDC. Hence, those who want to keep their transactions confidential may prefer something other than CBDC.Also, unless there is an assured security framework around the CBDC platform, there may be frequent instances of hackers stealing confidential information and fraudsters siphoning digital money from e-wallets. <h2 style="text-align: justify;">3. Which is the most preferred technology in CBDC?</h2>The CBDC pilot launched by the RBI in the retail segment has components based on blockchain technology. However, blockchain largely supports a decentralized framework for transactions, whereas CBDC runs on a centralized framework controlled by the Central Bank. <h2 style="text-align: justify;">4. Can CBDC be the solution to the inefficiencies in payments?</h2>CBDC is not an alternative for digital money transactions, as we have been doing it online. CBDC is money we receive or pay instead of cash (fiat currency). However, the value of CBDC will keep changing daily during trading sessions on various Central Bank-approved exchanges; just like today, we have cryptocurrencies traded on various cryptocurrency exchange platforms.The biggest inefficiency in today's payment system is the cost involved in generating, circulating, and managing currency notes. This cost will significantly go down drastically once the general public adopts CBDC as the most popular mode of currency.

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