Route to a Central Bank Digital Currency

Bitcoin, the most famous cryptocurrency, was unleashed to the world in 2009 as a digital currency. However, it is not ideal as its value in terms of other official currencies like the US dollar and the Indian rupee keeps fluctuating. Cryptocurrencies in another form—more commonly called stablecoins like USD Tether, USDT, USD Coin or USDC—have acquired the character of an international currency.

These stablecoins tied in value to the US dollar are being used extensively for making international money transfers and payments.

The use of cryptocurrencies in crypto platforms is also becoming quite significant. Ether, the cryptocurrency of the blockchain platform Ethereum, is essentially meant for transactions on the Ethereum platform only.

Irrespective of their objectives, utility or use case, cryptocurrencies have established that it is possible to transform currencies into digital form.

Central Bank Digital Currency

Many countries have realised that it is time to issue currency in a digital form. The fact that private cryptocurrency innovators could successfully design and operate virtual or digital currencies, such as Bitcoin or stablecoins, has made many countries realise that they could launch their own digital currencies—the Central Bank Digital Currencies or CBDCs. Most are experimenting with their official digital currencies in the form of cryptocurrency.

To make sure that their CBDC is available for small payments, most central banks are experimenting with wholesale and retail versions of CBDCs. There are, however, severe design, technological and operational issues in using cryptocurrencies as the primary digital currency in any jurisdiction. The CBDCs are being designed to be carried in digital wallets in decentralised mode whereas central banks are the most centralised institutions. Thus, there is a fundamental contradiction if a decentralised cryptocurrency is issued and controlled by a central bank. The use of such a CBDC where all transactions are publicly authenticated rather than by the central bank would make it quite unsuitable for use in retail payments. For wholesale payments, there is not much of a use case for cryptocurrencies.

There is an alternative. A much better form of digital currency is the dematerialised currency issued and operated under the centralised database system by the central banks like the system of equities and bonds or for that matter bank deposits.

Right Design of CBDCs

There are three use-cases for which digital currencies are exceedingly efficient. First, for domestic retail payments, digital currencies held and used from digital wallets in place of physical wallets are far more convenient and accounting friendly than physical cash. Digital currencies can substitute and complement digital payments made through money in bank accounts. This would also succeed in phasing out physical cash.

Second, the world needs a global digital currency system for international payments and transfers. US dollar and a few other national currencies double up as international reserve currencies but with severe limitations and excessive cost in effecting transfers. Stablecoins like USDT have started filling this gap.

Third, cryptocurrencies cannot be wished away. The use of cryptocurrencies in platforms and for exchanging with other cryptocurrencies will grow. A way has to be found to exchange cryptocurrencies with the official currency.

There is a requirement for not only a domestic digital currency but an international digital currency as well. While central banks come up with their domestic digital currencies, the jury is still out whether world leaders would be able to agree upon a global digital currency or that of a country to assume the role of international reserve currency. If the world leaders fail to do so, stablecoins brought to the market by credible private partners will capture the global digital currency market.

Risks and Challenges of CBDCs

Both domestic CBDC and international digital currency present challenges and risks. Domestic digital currency might be poorly designed. At the same time, private cryptocurrencies might be banned without attention to their inevitable use in certain circumstances. If central banks go for blockchain-based decentralised cryptocurrencies for retail use, it is likely to be disastrous in populous countries like India. If the central bank opts for opening digital wallets of everyone with itself, it is also going to be disastrous as such a system would be impossible to operate. It might help avoid these risks if the dematerialised digital currency is issued in much the way paper currency is issued today— through the banks to the people.

Digital Rupee for India

RBI has probably suggested to the government that Section 22 of the RBI Act be amended to include digital rupees as banknotes. The government intimated Parliament of its intent to introduce cryptocurrencies legislation in the Winter Session. But no Bill was introduced in Parliament.

From the Bill proposed for introduction, it seems the government is keen on laying down a framework for the introduction of a digital rupee in the country and banning all private or non-official cryptos. That, however, does not appear to be the right path to take. The government and RBI would do well to do three things.

First, bring a separate law to introduce digital currency in India, preferably in the form of dematerialised digital rupee. Second, the government should bring up a sui-generis Crypto-businesses and Assets Transactions and Regulations Bill for development and regulation of establishment and operations of blockchain-cum-cryptography platforms in India and trade in crypto-assets representing the value of these crypto-platforms. Finally, the government should take a lead in establishing an international digital currency.