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The RBI recently ruffled some feathers when it announced its intention to completely ban all private cryptocurrency. In response, two schools of thought sprang out. Monetary authorities who believe the central bank ought to hold complete control over money supply commensurate with desired long run growth stand against next-gen globalists who argue crypto is the new tomorrow and India will lack competitiveness if it doesn’t jump on the digital bandwagon.

After all, Bitcoin alone has gained a whopping 1,95,000 per cent since its market debut in 2012. Today, total crypto market has ballooned with over 10,000 different currencies and stands at $2.05 trillion, or equivalent to the 8th largest economy globally.

Undoubtedly crypto enjoys incredible popularity even in India as it stands 7th globally in terms of population owned crypto at least once (over 10 crore). Should it then be classified as ‘money’? With increasing advancements in technology, the definition of what constitutes money is blurring.

The commodity theory of money classifies it as a unit of account, medium of exchange and store of value.

Crypto has it all! It can be (i) traded in fractions e.g., 0.0001 BTC, (ii) universally traded as a mode of payment without any transaction fee, and most important of them all, (iii) a speculative asset hoarding value.

However, it is a cause of serious concern precisely for the last reason. The fluctuations in its prices make crypto too volatile to bank on; given it is not backed by any reserves or credible authority.

Bringing in the credit theory adds the perspective of an abstract entity which can be used as a standard of deferred payment, requiring credibility in the money and creditworthiness of the issuer. This is where the issue becomes contentious!

‘Fiat’ money problem

While cryptocurrency can be issued for credit, its existence is decentralised, i.e., the central bank can no longer play the role of monetary authority and hence, cannot ‘print this as fiat money’ of today that makes them legal tender.

In fact, crypto currency as a decentralised digital alterative to state-backed currency was meant to bring sanity to the ever-expanding money supply at the will of central banks to repose social trust.

This sentiment was furthered with diminishing trust in the global banking system post-global financial crisis as central banks stood helpless to witness carnage of institutional insolvency.

Thus, the key features of cryptocurrency include its (i) transparent blockchain network that can control transaction information, (ii) easy-to-verify complex algorithm driven codings, and (iii) limited supply protecting its underlying ‘value’ to keep it ‘predictable’.

Speculation problem

However, while doing so, it also lends itself into a highly speculative asset! Indeed, crypto has been mimicking the equity market ever since the pandemic. Should crypto then be classified as a financial asset instead? Notwithstanding the public’s rising interest in crypto, the strength of the underlying promise is too volatile to be accepted as money in Emerging Markets, especially India. Perhaps, brought under effective regulation, this volatility might in fact stable down.

What happens when it is volatile? As an extreme case, El Salvador became the first country to make Bitcoin legal tender citing financial inclusion and transactional efficiency. For a country like El Salvador where more than 70 per cent of its population is not integrated with the banking system and over 50 per cent have no access to internet, the decision seemed ill suited as penetration remained low while S&P and Moody’s downgraded the highly indebted country’s ratings to ‘Caa1’ indicating excessive investment risk.

Even among those who transacted in BTC, more than 86 per cent exchanged them to US dollars immediately to avoid exchange rate headwind risk. This brings out the social acceptance of money as yet another function!

Given this, should cryptocurrency be accepted by economies or not? If yes, should it be money? What would be the implication of that? The monetary authority as a ‘forward looking’ agent holds sovereign ownership over money supply to regulate it as desired. After all, money supply should move in tandem with macroeconomic fundamentals. However, since cryptocurrency would be limited in supply and cannot be created easily, its credibility gets inflated as a ‘store’ of value. Besides, cryptocurrency’s network makes it ideal for financing terrorism and facilitating illegal cross border transactions. But banning it altogether runs the risk of isolating India from global trends and furthering a black economy which will be even tougher to regulate.

Digital rupee

Rather, accepting cryptocurrency allows scope for effective regulation. RBI has already expressed interest in blockchain technology and is even planning to introduce its own Digital Rupee, much like the Digital Yuan. This entry in e-money market could well be a balancing act by the RBI, perhaps making it a more acceptable fiat than crypto, while being well within the ambit of regulation.

One major inference would then be the possible redundancy of commercial banks altogether, as the main objective will be to reduce cross border transaction fees (essentially what these for-profit banks earn). One solution could then be commercial banks acting as middlemen instead, sanctioned by the RBI to ‘print’ the Digital Rupee by payment of a license fee towards the RBI.

Is the digital Rupee a new form of cryptocurrency? In essence, no! It will probably be more like the electronic modes of money we see today. If the RBI allows cryptocurrency, the loss of seignorage is an even bigger concern then for an asset whose supply the RBI has zero control over. However crypto will pose no inflation tax to the public even with an increase in supply; the caveat being supply is highly limited in alignment with macro fundamentals. The RBI could then consider providing certificates of crypto issuance instead of trying to control its actual minting, where individuals could reach out to the RBI directly.

In essence, cryptocurrency opens great opportunities for the economy. It poses an intriguing ‘regulator’s dilemma’ – striking a balance between technological progress ushering financial innovation while remaining as sovereign authority. The central bank can look into what constitutes crypto and technologies like blockchain to assess its role in the value chain instead of banning it altogether.

D. Tripati Rao, Senior Professor, Business Environment Area, IIM Lucknow. Riya Mathur, Management Graduate, IIM Lucknow

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