Columns

Why CBDC will not end bitcoin’s reign

Lokeshwarri SK | Updated on July 29, 2021

Crypto users will not switch to central bank digital currencies as they thrive on the anonymity and price volatility of cryptos

A sudden sense of emergency seems to have gripped global central banks about launching official digital currencies. This could have been prompted by China’s rapid progress in its digital yuan projects, which is currently being tested in retail outlets. A BIS survey found that 86 per cent of central banks are actively examining the potential for central bank issued digital currency and 14 per cent had already begun pilot projects.

The RBI is the latest to throw its hat in the ring. The first clear indication that the Indian central bank is serious about launching a digital currency came from the RBI Deputy Governor, T Rabi Shankar, who recently said that the central bank is working towards a phased implementation of a CBDC (central bank digital currency) and examining use cases.

However, not all central bankers are convinced about the need for an official digital currency. The US and the EU are still ruminating over this. In a recent speech titled, ‘Parachute Pants and Central Bank Money’, the US Federal Reserve’s Vice Chair for supervision put forth forceful arguments why the benefits of a digital currency from Federal Reserve are unclear and may pose considerable risk to the financial system. The Bank of Canada has also stated that it does not see a case for a retail CBDC though it is working towards it, in case cash use declines or usage of a private digital currency grows suddenly.

As Rabi Shankar pointed out, there are three reasons why central banks are moving towards CBDC. One, countries such as Sweden where usage of cash has reduced are trying to increase spending through electronic form of currency. Two, countries with higher physical cash usage such as Denmark and Germany are trying to reduce cost of issuances of fiat currencies. And three, central banks are trying to provide an alternative to the current bunch of virtual currencies such as bitcoin, etherium, etc.

The first two reasons are debatable and will be elaborated upon later. But the third reason — weaning investors away from private virtual currencies — is unlikely to be realised. For virtual currencies such as bitcoin, etherium and litecoin are in a different league altogether and cater to a different set of people, who are unlikely to switch to a CBDC.

Not the same animal

There are two types of private virtual currencies available globally. Stablecoins are tied to an underlying fiat currency such as the US dollar and are issued by the private sector. Facebook’s diem is a case in point. There is no threat to the central banks from stablecoins and these can continue to co-exist with the fiat currencies.

The other set of virtual currencies do not have any underlying asset and attract users due to their novelty, anonymity and price volatility. In fact, calling bitcoin and others as currencies is a misnomer. In the white paper on bitcoin, Satoshi Nakamoto, the anonymous creator of bitcoin, described it as an electronic payment system based on cryptographic proof, instead of trust. These cryptos were meant to be a digital payment system without the interference of any kind from third party financial institution, leave alone central banks.

The supporters of these crypto assets are ardently opposed to central bank policies that have debased fiat currencies. They have set out to establish a utopian world, without supervision by central banks or any regulatory authority, run harmoniously by the community of miners and those maintaining digital ledgers (blockchains).

It is unlikely that these people will switch over to CBDCs, which will be issued by central banks and will be exchangeable with the underlying fiat currency. Then there are others who prefer using these cryptos to make illegal cross-border deals, because these are beyond the purview of any regulators. These users will also give CBDCs a pass.

The other set of users of these crypto assets are speculators, who revel in the fact that these assets have no intrinsic worth. With a CBDC deriving its value from the related fiat currency and under close supervision of central banks, trading in these will be quite dull compared to the frenzied volatility on crypto exchanges. Traders on these crypto exchanges are also unlikely to transfer their allegiance to CBDCs.

Further, the crypto assets are currently in vogue due to the growing risk appetite among investors, thanks to the liquidity supplied by central banks. Demand for these assets will continue irrespective of a launch of central bank backed digital currencies. So, the Finance Ministry will have to decide on the current trading and mining ecosystem for the cryptos; whether they should be brought under regulatory supervision or be banned altogether.

Indian CBDC: The challenges

While a CBDC may not spell the end of the current crypto asset cohort, an official digital currency may be inevitable.

That’s because, if other countries begin using CBDCs in international trade, Indian traders should not be hampered by the fact that our central bank was slower to move.

As far as domestic transactions go, there doesn’t seem to be any urgent need for a CBDC, given the growing usage of digital payments in the country, especially since demonetisation.

Usage of cash for high-value transactions have reduced materially, thanks to higher vigilance of the tax authorities. That said, if usage of CBDC increases, leading to reduced usage of cash, it will definitely reduce tax evasion and bring down the cost of printing notes for the central bank.

The issuances of CBDC will not impact the RBI’s liability as these will be issued against existing fiat currency.

There are concerns being raised that banks’ deposits can reduce if people prefer to hold money in the form of digital currency instead of bank deposits. But that is unlikely since this digital money will not earn any interest, unlike deposits. So banks’ deposit base is unlikely to be hurt by this.

In other words, as other central banks work towards a CBDC, it will not be possible to avoid going down this path, and there are few benefits that can accrue over the long term.

Care will have to be taken to put together a robust technological infrastructure since these will be vulnerable to cyber-attacks. Many of the laws, including the Reserve Bank of India Act, the Coinage Act, FEMA, etc., will have to be amended before this becomes a reality.

But as far as the bitcoin and other cryptos go, their reign will not come to an end due to these official digital currencies.

 

Published on July 28, 2021

Follow us on Telegram, Facebook, Twitter, Instagram, YouTube and Linkedin. You can also download our Android App or IOS App.

This article is closed for comments.
Please Email the Editor

You May Also Like