Road to a central bank digital currency

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Bitcoin, the most famous cryptocurrency, was launched to the world in 2009 as a digital currency. However, it is not ideal as its value in terms of other official currencies like US Dollar and Indian Rupee keeps fluctuating. Cryptocurrencies in another form – more commonly known as 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 widely used to make international money transfers and payments.

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

Regardless of their purpose, usefulness, or use case, cryptocurrencies have established that it is possible to transform currencies into digital form.

Central Bank Digital Currency

Many countries have realized that it is time to issue currency in digital form. The fact that private cryptocurrency innovators can successfully design and operate virtual or digital currencies, such as Bitcoin or stablecoins, has made many countries realize that they can launch their own digital currencies, the central bank digital currencies or CBDC. Most are experimenting with their official digital currencies in the form of cryptocurrency.

To ensure that their CBDC is available for small payments, most central banks are experimenting with wholesale and retail versions of CBDCs. There are, however, serious design, technological, and operational issues with the use of cryptocurrencies as the primary digital currency in any jurisdiction. CBDCs are designed to be carried in digital wallets in a decentralized mode while central banks are the most centralized institutions. Thus, there is a fundamental contradiction if a decentralized cryptocurrency is issued and controlled by a central bank. Using such a CBDC where all transactions are authenticated publicly rather than by the central bank would make it entirely unsuitable for use in retail payments. For wholesale payments, there really isn’t a use case for cryptocurrencies.

There is an alternative. A much better form of digital currency is dematerialized currency issued and mined under the centralized database system by central banks like stock and bond system or for that matter bank deposits.

Good design of CBDCs

There are three use cases for which digital currencies are extremely effective. First, for domestic retail payments, digital currencies held and used from digital wallets instead of physical wallets are much more convenient and accounting-friendly than physical cash. Digital currencies can replace and supplement digital payments made with cash in bank accounts. This would also allow physical species to be phased out.

Second, the world needs a global digital currency system for international payments and transfers. The US dollar and a few other national currencies double as international reserve currencies, but with severe limitations and excessive costs to make transfers. Stablecoins like USDT have started to fill this gap.

Third, cryptocurrencies cannot be deleted. The use of cryptocurrencies in platforms and to exchange with other cryptocurrencies will grow. A way must be found to exchange cryptocurrencies with the official currency.

Not only a national digital currency is needed, but also an international digital currency. As central banks come up with their national digital currencies, the jury is still out on whether world leaders would be able to agree on a global digital currency or one country to take on the role of international reserve currency. If world leaders fail to do so, stablecoins brought to market by credible private partners will take over the global digital currency market.

CBDC Risks and Challenges

National CBDCs and international digital currency present challenges and risks. The national digital currency can be poorly designed. At the same time, private cryptocurrencies could be banned regardless of their unavoidable use in certain circumstances. If central banks opt for decentralized blockchain-based cryptocurrencies for retail use, it could be disastrous in populous countries like India. If the central bank opts to open everyone’s digital wallets with itself, that is also going to be disastrous as such a system would be impossible to operate. It could help avoid these risks if dematerialized digital currency were issued the same way paper money is issued today – by banks to the people.

Numerical 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 has notified Parliament of its intention to introduce cryptocurrency legislation during the winter session. But no bill has been presented to Parliament.

From the bill proposed for introduction, it seems that the government wants to establish a framework for the introduction of a digital rupee in the country and ban all private or unofficial cryptos. However, that doesn’t seem like the right way to go. 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 dematerialized digital rupee. Secondly, the government should introduce a sui-generis Crypto Asset Dealing and Dealing Bill for the development and regulation of the establishment and operations of blockchain-crypto platforms in India and the trading of crypto -assets representing the value of these crypto-platforms. Finally, the government should take the initiative to establish an international digital currency.

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