Introducing National Digital Currency in India – Explained, Pointwise

Introduction

There is uncertainty over the legal status of digital currencies in India. An unofficial estimate mentions that Indian investors holding around $1.5 billion (Rs 10,000 crore) in digital currencies. The inter-ministerial committee (IMC) suggested a ban on private digital currencies, but it favors RBI-backed National Digital Currency or central bank digital currency (CBDC).

The draft Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 aims to prohibit all private cryptocurrencies. The Bill also aims to lay down the regulatory framework for the launch of an “official digital currency”.

What is the CBDC or National Digital currency?

A Central Bank Digital Currency (CBDC), or national digital currency, is simply the digital form of a country’s fiat currency. Instead of printing paper currency or minting coins, the central bank issues electronic tokens. This token value is backed by the full faith and credit of the government.

T. Rabi Shankar, a deputy governor of the RBI, defined a CBDC as – “a legal tender issued by a central bank in a digital form, which is the same as fiat currency and is exchangeable one-to-one with the fiat currency”.

The Bank of England defines CBDC as – “an electronic form of central bank money that could be used by households and businesses to make payments and store value”.

CBDC would need an entirely new centralized payment system. This system would be linked to electronic wallets that reside on prepaid cards, smartphones, or other electronic devices.

According to the Bank for International Settlements, more than 60 countries are currently experimenting with the CBDC. There are few Countries that already rolled out their national digital currency. Such as,

• Sweden is conducting real-world trials of their digital currency (krona)
• The Bahamas already issued their digital currency “Sand Dollar” to all citizens
• China started a trial run of their digital currency e- RMB amid pandemic. They plan to implement pan-china in 2022. This is the first national digital currency operated by a major economy.

National Digital Currency in India

With the growth of digital currencies worldwide, various start-ups dealing with cryptocurrency have come up in India, such as Unocoin in 2013 and Zebpay in 2014. Further, their volatility is a cause of concern for India.

So the government-appointed SC Garg Committee for suggestions. The committee recommended banning cryptocurrencies and allow an official digital currency. Further, the committee also drafted a bill Banning of Cryptocurrency & Regulation of Official Digital Currency Bill.

Important recommendations of the panel:

1. The panel recommended banning anybody who mines, hold, transact or deal with cryptocurrencies in any form. Further, the panel recommend a jail term of one to 10 years for exchange or trading in digital currency.
2. The panel also proposes a monetary penalty of up to three times the loss caused to the exchequer or gains made by the cryptocurrency user whichever is higher.
3. The panel also recommended completely banning all private cryptocurrencies in India.
4. However, the panel said that the government should keep an open mind on the potential issuance of cryptocurrencies by the Reserve Bank of India.

Post submitting the panel report and the draft bill the government held discussions with stakeholders and conduct Inter-ministerial discussions. The government decided to provide a 3-6 month exit period prior to banning the trading, mining, and issuing of cryptos. The RBI also already started working on CBDC.

Challenges with non-state digital currency

1. Safety and security of cryptocurrencies: This is one of the key issues with cryptocurrency. Mt Gox bankruptcy case is a highlight of this. Mt gox is a Tokyo-based cryptocurrency exchange. After the cyberattack, several thousands of bitcoin went lost and the company is yet to settle the claim.
2. No investor protection: Since the cryptocurrency transactions are anonymous in nature, there is no investor/consumer protection in cryptocurrencies.
3. Conflict of interest: Globally, crypto-currency exchanges act as both custodian and a regulator. So, their own interest and consumer protection get into conflict.
4. Non-regulation: There are some cryptocurrency regulators who often indulge in money laundering and terrorism financing. Further, they are immune to the Central Bank regulation of various countries.
5. The volatility of cryptocurrency: Many cryptocurrencies have only a limited amount of coins. For example, Bitcoins fixed the maximum possible number as 21 million. This creates an increase in demand with each passing day and creates instability in exchange rates. This made the cryptocurrency more volatile in nature.

Advantages of a CBDC

1. Improving efficiency in the financial system: As the currency in digital form, it can provide an efficient way for financial transaction. Further, digital currency also solves the challenges with Cash and coins. Cash and coins require expenses in storage and have inherent security risks, like the recent heist in the RBI currency chest.
2. Reducing systemic risk:  There are about 3,000 privately issued cryptocurrencies in the world. According to IMF, the key reason for considering national digital currency is to counter the growth of private forms of digital money. There is a possibility of these companies going bankrupt without any protection. This will create a loss for both investor and creditor. But the National Digital currency has government backing in case of any financial crisis.
3. Opportunity to private players: As the state-backed digital currency can provide investor/consumer protection, the private can confidently invest in the associated infrastructure without any doubts over its regulation. This will improve the services to people.
4. Reduce volatility: The national digital currency will be regulated by the RBI. So, there will be less volatility compared to other digital currencies.
5. Helps in better macroeconomic management: Current RBI’s work on inflation targeting can be extended to national digital currency also. Since India is planning to ban other cryptocurrencies, the RBI can better regulate digital and fiat currency. Thus upgrading to digital currency and balancing the macroeconomic stability.
6. Prevents counterfeiting of currency and a boost to the war on black money and corruption.
7. Negative interest rate: In tough times, a Central Bank might want people to spend money, hence the concept of the negative interest rates. But, presently it can’t do so as people will simply withdraw their money from the banks. CBDCs will solve this problem. A negative interest rate could be easily mandated on CBDCs kept in the wallets.

Challenges/issues with CBDC

1. Potential cybersecurity threat: India is already facing many cyber security threats. With the advent of digital currency, cyberattacks might increase and threaten digital theft like Mt Gox bankruptcy case.
2. Lack of digital literacy of population: Introduction of digital currency is technological advancement. But as per Digital Empowerment Foundation in 2018 report, around 90% of India’s population is digitally illiterate. So, without creating enough literary awareness introduction of digital currency will create a host of new challenges to the Indian economy.
3. Challenge in regulation and taxation: Introduction of digital currency also creates various associated challenges in regulation, tracking investment and purchase, taxing individuals, etc.
4. Threat to Privacy: The digital currency must collect certain basic information of an individual so that the person can prove that he’s the holder of that digital currency. This basic information can be sensitive ones such as the person’s identity, fingerprints etc.
5. Fiscal policy and the monetary policy would get mixed up even further, blurring the line between the independence of a central bank and the government.
6. Bank runs: It is a situation where many depositors want to withdraw money from a bank if they perceive it to be fragile. People can move money from their commercial bank accounts to their CBDC accounts if they perceive a bank to be in trouble or if there is macro financial instability.

What is the way forward?

1. The government can follow the western concept of treating digital currency as property and imposing capital gains tax.
2. Enhance digital literacy: The government has to create enough awareness campaigns and inform people about identifying fraudulent methods. This will reduce India’s digital divide.
3. Creation of adequate cybersecurity methods: Before the introduction of National Digital currency, the government has to create certain important things, such as,
   • Training of law enforcement agencies on handling any threats
   • Creating a policy of basic information assessed while issuing, verifying someone’s digital currency.
4. Preventing Bank runs & extent of disintermediation: Limits on individual holdings of CBDC could help ensure that CBDC is used primarily for payments and not for large savings. It will also reduce the extent of disintermediation of the banking system.
5. Two-tiered approach by RBI: RBI is a regulating entity and not compete with commercial banks. So, a two-tiered approach would be useful wherein, under Tier 1: RBI creates the digital version of its currency, and under Tier 2:  distribution of currency and the maintenance of CBDC wallets is left to existing financial intermediaries

Introduction of a CBDC or a National Digital currency prevents various threats associated with the private-owned cryptocurrencies and will take India towards a progressive digital economy. But the government has to create necessary safeguards before rolling it out.