The Inevitable Digital Currency in India

The Reserve Bank of India announced the intention to experiment with 'Digital Currency' or the 'Central Bank Digital Currency'. Instead of paper or metallic currency, the currency will be completely digital and cannot be converted to hard currency meaning that it will work only through phone or digital wallet or computer.

Hyderabad: The Reserve Bank of India (RBI) recently joined the growing list of countries that have announced their intention to experiment with “Digital Currency” or the “Central Bank Digital Currency” (CBDC). Unlike the Cryptocurrencies traded in the international markets, a CBDC is a legal tender that is underwritten and guaranteed by the central bank of the country.

In other words, instead of paper or metallic currency, the currency will be completely digital and cannot be converted to hard currency meaning that it will work only through phone or digital wallet or computer. This may seem worrisome for many because paper currency has been around for more than 200 years in many countries.

Sweden and China are the countries that are leading the race to implement digital currencies; Sweden is considered the “world’s most cashless society”. There is little doubt that the move towards digital currency has speeded up the phenomenal rise of “BitCoin”, which has often been mistakenly claimed to be a currency rather than another speculative asset. The push for CBDC is more urgent since RBI and the Government of India (GOI) are not keen on allowing cryptocurrencies and the GOI has even proposed to regulate if not ban Cryptocurrencies like Bitcoin in India.

Cryptocurrencies

Cryptocurrency is nothing but a digitally held form of assets which is often called “private currency” and one that is based on a “distributed ledger technology” like Blockchain. In simple terms, this means that it is easy to verify the authenticity and difficult to forge. Since the quantity in the circulation of Cryptocurrencies is limited, even a small increase in demand can lead to large price rises. Among the Cryptocurrencies, Bitcoin is the most dominant and the top 10 Cryptocurrencies make up about 95% of the total trading in Cryptocurrencies. Bitcoin is the most famous of these Cryptocurrencies. The other important ones are Ethereum, XRP, Tether, Bitcoin Cash, Bitcoin SV and Litecoin. The history of Bitcoin is unknown and is expected to have come into vogue around 2009 and first propounded by a person who goes under the name “Satoshi Nakamoto” - but one whom nobody has seen. Today (29-03-2021) each BitCoin is worth more than Rs.42 lakhs or US$58,000. There is an estimate of 6223 Cryptocurrencies with a cumulative market value of about US$1.80 trillion - or larger than the size of the Indian economy. The fact that the market value of these has grown from almost zero to the present in about 12 years means that there is a compulsive reason for the central banks to start looking at this form of digital assets which can move across boundaries using the internet in a matter of seconds. Such digital forms of assets or money tend to have immense implications for the national and global economies.

Significance

Any currency held in non-hard currency format has immense problems and implications. The recent growth in digital payments only shows that with the growing use of technology and importance of convenience electronic payments are becoming increasingly attractive and that has economic and other implications from a policy maker’s perspective and includes advantages and risks. The advantage of electronic payments and electronic currency is that it is very difficult to have fake transactions (unless they are consensual) and they reduce the cost of cash to the overall economy. Hard currency is actually costly because there is a cost of printing, moving it, protecting and preventing counterfeiting. RBI had to spend nearly Rs.4400 crores in 2019-20 for printing and security of currency. Problematically, the average life span of a currency note is less than 2 years. In contrast, a digital currency that is based on Distributed Ledger Technology may be difficult to counterfeit and can theoretically exist forever. An important consequence of digital payments and digital currency that is often overlooked is that just like most technology-enabled features, it has the potential to speed up the economic cycle - something about whose consequences central banks may not have sufficient idea.

There is no need to worry about possibility of CBDC replacing paper currency in the foreseeable future. On 9 October 2020, Bank of International Settlements (BIS) or the “Central Banker’s Central Banker” has laid down the principles related to digital currencies and one of it was that CBDC should coexist with all other forms of money and should complement each other. And, it is not as if India is the only country to experiment with CBDC; China is far ahead. Instead the focus of central banks seems to be gradually move people away from Cryptocurrencies and to increase the use of CBDC instead of third party payment providers. The importance of digital payments was visible in the aftermath of COVID induced lock downs in 2020. CBDC will not only mean better supervision and regulation of the financial sector but will also reduce the cost of transaction while protecting “monetary sovereignty”. China’s central bank has clearly stated that by 2025 they would like to see 9% of the transactions that now take place through mobiles.

Concerns

It is not like as if CBDC will mean the disappearance of Cryptocurrencies or even other forms of payments or that they will immediately replace cash. Instead the road to CBDC is likely to be difficult, especially in the first few decades since there will fears about how these will work in areas where there is no internet, fears about cybersecurity, privacy, etc since digital currencies are wholly dependent on technology.

A more important concern will be the acceptability (interoperability) of different CBDC’s across national boundaries or national jurisdictions. Today, Cryptocurrencies are acceptable because they can be converted to any national currency and that they can move across national boundaries in seconds and are as liquid as cash. This may not be so easy for CBDC, which means it becomes more cumbersome and costly to carry out transactions using CBDC because the same rules related to currency convertibility, money laundering regulations and permissions will continue to remain and they will continue to slow down businesses.

Lastly, it is unlikely that those who would like to undertake transactions in secrecy will want to use CBDC since unlike Cryptocurrencies, the Central Banks and governments will be able to track each and every step of the movement of digital currency since they leave an electronic footprint that is under closely watched by governments. Of course, for any of these things to happen, Digital Currencies need more clarity on the laws governing them - something which do not exist today in most parts of the world. Nevertheless, CBDC is the area in economy and technology to watch in the next decade.