The RBI’s proposals to launch a  Central Bank Digital Currency (CBDC)  is generating a debate on whether such a fiat currency in digital form will be able to effectively counter the rising usage and popularity of cryptocurrencies as medium of exchange.

Cryptocurrency/ Crypto

• It is a virtual currency secured by cryptography, designed to work as a medium of exchange.

• It’s monitored and organised by a peer-to-peer system that can enable anyone anywhere to send and receive payments.

• Cryptocurrencies run on a distributed public ledger called blockchain, a record of all transactions updated and held by currency holders.

• Units of cryptocurrency are created through a process called mining, which involves using computer power to solve complicated mathematical problems that generate coins.

• Users can also buy the currencies from brokers, then store and spend those using cryptographic wallets.

• It is decentralized, i.e., not issued by the governments or other financial institutions of a country making it immune against any interference and manipulation.

• The first cryptocurrency was Bitcoin, which was founded in 2009. Other examples are - Ether, Ripple and Litecoin.

Cryptocurrency is gaining worldwide acceptance

• An alternative asset during the pandemic: As investors rushed to secure their money in safe havens like gold during the pandemic, some opted to bet on the less conventional Bitcoin. The four times higher gains than gold led to increasing number of global investors contemplating to invest in the digital coin.

• Cryptocurrencies are secure: Apart from the value, the other thing that attracts investors is its privacy feature. Cryptocurrencies are built on blockchain technology, which is touted for its security and privacy.

• Cryptocurrency charges are comparatively low: Banking and financial institutions levy charges on everything, like account maintenance fee, fee to use credit card when travelling overseas, etc. The fee for using cryptocurrency is very low, which makes it an ideal choice for all kinds of transactions.

• Significance of crypto in Russia-Ukraine war:

• Russia kelptocrats have been using cryptos to escape sanctions.

• Ukraine has been a centre of cryptos trading due to its lax rules and is using them to raise funds for its war with Russia. 

Concerns with Cryptocurrency

·       Extremely volatile investment: The cryptocurrency market fundamentally thrives on speculation, making them highly volatile.  For instance, the value of Bitcoin fell from USD 20,000 in December 2017 to USD 3,800 in November 2018.

• Absence of regulation: The absence of effective supervision and regulatory frameworks can create regulatory arbitrage and curtail enforcement. This could pose a risk to the financial stability of the country if their use becomes widespread.

• Cybersecurity issues: As a digital technology, cryptocurrencies will be subject to cybersecurity breaches, and may fall into the hands of hackers.

• Ties to Illegal activity: Cryptocurrency is a favoured conduit for criminals for financial transactions – be it money laundering or terror financing. The most famous example of a crime involving Bitcoin was the Silk Road case. Briefly, Silk Road was a marketplace for guns and illegal drugs, among other things, on the Dark Web. It allowed users to pay in Bitcoins. 

• Environmental consequences: The vast amounts of electricity used in the mining of cryptocurrency raise concerns about the allocation of resources and environmental consequences of these payment systems. 

Position of key stakeholders in India on cryptocurrency

• The Indian Finance Minister, during the Budget speech—announced stringent taxation and capital gains proposals on cryptocurrency. Some analysts are suggesting that these proposals will serve to discourage cryptocurrency in India.

• The Governor of RBI recently highlighted two things:

• Private cryptocurrencies are a big threat to our financial and macroeconomic stability.

• These cryptocurrencies have no underlying asset.

• The Deputy Governor of RBI called cryptos worse than a Ponzi scheme and argued against legitimizing them.

• The Supreme Court of India has also questioned the Government of the legality of cryptocurrencies. 

Difficulty in banning cryptocurrency:

• The total valuation of cryptos recently was upward of $2 trillion- more than the value of gold held globally.

• Cryptos which operate via net can only be banned only if all nations come together.

• Even then, the tax havens may allow cryptos to function, defying the global agreement.

RBI''s proposal to launch CBDC:

• Recently, the Reserve Bank of India (RBI)  proposed amendments to the Reserve Bank of India Act, 1934, which would enable it to launch a Central Bank Digital Currency (CBDC), thus enhancing the scope of the definition of ‘bank note’ to include currency in digital form.

• It seeks to prohibit all private cryptocurrencies in India with certain exceptions.

Central Bank Digital Currency (CBDC)

• A central bank digital currency is the digital form of a country’s fiat currency.

• It is considered a form of legal tender that can be used to exchange goods and services.

• It is issued and regulated by a nation’s monetary authority or central bank.

• It promotes financial inclusion and simplifies implementation of monetary and fiscal policy.

Examples of CBDCs

• The Bahamas has launched the Sand Dollar, a digital version of the Bahamian dollar.

• China is testing a digital Yuan, also known as the digital Renminbi or digital RMB.

• Nigeria is rolling out the eNaira, which records transactions on a centralized blockchain ledger.

Challenges with CBDCs

• The increased threats to privacy of individuals:

• Digital currencies will not offer users the level of privacy and anonymity offered by transacting in cash

• The data stored with the central bank in a centralized system will hold grave security risks, and robust data security systems will have to be set up to prevent data breaches

• Choosing the privacy and security-enhancing technology that needs to be employed:

• The choice of technology employed for CBDCs is critical as it should be scalable, with almost zero latency, secure and, needless to add, privacy preserving.

• The regulatory architecture that has to be set up to combat an issue such as a data breach:

• The regulatory architecture that India needs to start issuing a digital currency is not in place.

• India is yet to pass the Data Protection Bill and set up the Data Protection Authority that would oversee the range of privacy compliance by institutions, including grievance redressal in case of violations of personal data.

• Consequential amendments would also be needed in the legal framework.

• In the Currency Act, the Foreign Exchange Management Act (FEMA) and the Information Technology Act.

• Limited population’s access to digital currencies:

• It will take time for CBDCs to catch on. Some members of the population won''t have the means to access digital currencies. Others may be reluctant because they don''t trust digital currencies.

CBDC may not be able to counter the rise of Cryptocurrency?

• Though the idea for CBDCs came from cryptocurrencies, they are two very different types of digital currencies.

• Blockchain enables decentralisation, i.e., everyone on the crypto platform has a say. But central banks want a fiat currency to be exclusively issued and controlled by them.

• Theoretically, everyone can mine and create crypto unlike the centrally controlled CBDC.

• CBDCs can only be used for payment, and any sort of stockpiling or investing is outright prohibited.

• For the CBDC to be in central control, solving the double spending problem and being a crypto (not just a digital version of currency) seems impossible.

• A centralised CBDC will require the RBI to validate each transaction, which at present it doesn’t do.

Road ahead

• CBDCs at present cannot be a substitute for cryptos that will soon begin to be used as money. This will impact the functioning of central banks and commercial banks.

• A ban on cryptos requires global coordination, which seems unlikely.

• Rather than putting a blanket ban, the Indian Govt should take steps to regulate cryptocurrency, making it safer, transparent, and more trustworthy.