The most popular phrase we have heard recently is a cryptocurrency, and central banks are concerned about how digital currencies may influence their country’s economics. Several Central banks, notably the united states, the European Union and China have been working diligently in recent years to issue their own Central Bank Digital Currency (CBDC).
The Bahamas introduced the world’s debut Central Bank Digital Currencies in October 2020. Digital currencies are gaining popularity by the day and nations such as Ecuador, Tunisia, Senegal, Sweden, Estonia, China, Russia, Japan, Venezuela and Israel have introduced or planning to introduced digital currencies. The central bank of china also tested their digital yuan- the programmable money, Beijing has introduced expiration dates to spend it quickly.
This is mainly due to the increase in the use of cryptocurrencies which are highly volatile and unregulated like bitcoin and the increase in the use of digital payments as examples of a secular trend. The central bank also believes that issuing digital currency is much lower than the cost of printing and distributing physical cash. The Central banks can also track the transactions of digital currency, unlike the physical currency which may be a hurdle to adopt for people as it may affect their privacy concerns.
The Reserve Bank of India (RBI) may unveil a model of a Central Bank Digital Currencies (CBDC) by the end of the year, Deputy Governor T. Rabi Sankar without providing further details described.
These are extremely evolving technologies and business choices that one has to makes, and therefore it is difficult to put a date, but we should be able to come up with a model in the near future, probably by the end of this year.
“We are evaluating the issue of scope, technology, distribution and validation mechanism etc.”
According to a recent, 81 countries, representing over 90% of global GDP, are exploring launching their own central bank digital currencies. Meanwhile, the International Monetary Fund (IMF), the world Bank and the Bank of International Settlements (BIS) say Central Bank Digital Currencies “have the potential to enhance the efficiency of cross-border payments, as long as countries work together.”
Origin of Idea:
The idea of Central Bank Digital Currencies (CBDC) is not a recent development. Some attribute the origins of Central Bank Digital Currencies to Nobel laureate James Tobin, an American economist, who in the 1980s suggested that the Federal Reserve Banks in the United States could make available to the public a widely accessible ‘medium with the convenience of deposit and the safety of currency.’ It is only in the last decade, however, that the concept of digital currency has been widely discussed by central banks, economists & governments.
How would that work?
The Central Bank Digital Currencies should not be mistaken with a cryptocurrency or Bitcoin.
A Central Bank Digital Currencies is a central bank-issued digital currency backed by some kind of assets in the form of either gold, currency reserves, bonds and other assets, recognised by the central banks as a monetary asset.
This guarantee from a central bank reduce the Central Bank Digital Currencies risk, volatility and ensure a larger acceptance across the globe.
On the other hand, a cryptocurrency is issued by a network and backed by a crypto asset which may or may not have the backing of any monetizable asset or physical asset.
A Central Bank Digital Currencies can definitely increase the transmission of money from the central bank to commercial banks and end customers much faster than the present system.
Specific use cases, like financial inclusion, can also be covered by Central Bank Digital Currencies that can benefit millions of citizens who need money and are currently unbanked or banked with limited banking services.
Central Bank Digital Currencies could significantly improve monetary policy development in India. The enhanced surveillance and real-time situational monitoring enabled by the central bank digital currencies can go a long way in stimulating these processes.
Central Bank Digital Currencies could allow the government to effectively tackle illegal activities such as payment fraud, giving people a greater sense of security with their money.
Digital flat currencies create greater barriers to illicit activity, as physical cash can help conceal and transfer funds outside of regulated financial systems.
With the growing adoption of Central Bank Digital Currencies, payments and transfers will be easier to identify and trace to previous sources, significantly reducing the risk of fraud and money laundering.
Digital currencies have all the intrinsic advantages of fiat currency like it is durable, portable, fungible and divisible. Being digital, it will make easily verifiable, more secure and traceable.
Hence, improving upon the existing advantages of paper currency.
The government and the central bank have to access and analyse every possible scenario to build robust control and framework around the evolving blockchain technology.
But these changes cannot be done overnight as consequential amendments would also be needed in the legal framework i.e. in the Currency Act, the Foreign Exchange Management Act (FEMA) and the Information Technology act.
But all not that simple:
The main challenges would always be user adoption and security. If government adopt the technology and find a way to regulate digital payment flows, we can expect more competition in the coming years.
At the same time, the cryptocurrency community is feeling uncomfortable with the emergence of Central Bank Digital Currency mainly due to misconceptions in regards to Central Bank Digital Currencies.
There is still a lot of ambiguity in the regulatory environment for private virtual currencies like Bitcoin, Ethereum etc and hopefully, this is one step forward to recognise how these currencies can co-exist with a sovereign backed currency.
There is a huge opportunity for India to take a lead globally via a large-scale rollout and adoption of digital currencies and hopefully, this announcement brings a lot more room for debate into how we can move forward.
The clarification from the RBI, which is developing its own virtual currency, is expected to give some relief to customers who have invested in cryptocurrencies. As many Indians have invested in cryptocurrencies like Bitcoin and Ethereum, the RBI move will be a big respite from their money- estimated to be around Rs.10,000 crore won’t be blocked.
What are Banks expected to do now?
Earlier, on a circular, the Reserve Bank of India on 31 May 2021 clarified that all banks and other entities can not cite its 2018 order on virtual currencies as it has been set aside by the Supreme Court of India in 2020. Further clarification from the central bank will come as a sign of relief for all investors and crypto exchanges in India who invested in virtual currencies(VCs).
Banks, as well as other entities, address above, may continue to carry out customer due diligence process in line with regulations governing standing for-
Know your customer(KYC), anti-money laundering(AML), Combating of Financing of Terrorism(CFT) and obligation of laundering act, (PMLA), 2002
In addition to ensuring compliance with relevant provisions under Foreign Exchange Management Act (FEMA) for overseas remittances.
In other words, a bank can’t take action against investors in virtual currencies following the court and RBI directives.
“In view of the associated risks, it has been decided that, with immediate effect entities regulated by the RBI not deal in virtual currencies or provide services for facilitating any person or entity in dealing with or settling virtual currencies,” the RBI had said in 2018.
Such services include maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them and transfer/receipt of money in accounts relating to purchase or sale of virtual currencies.” the RBI had said.
RBI has indicated it is “very much in the game” and getting ready to launch its own digital currency.
“Central Bank Digital Currency is a work in progress. The RBI team is working on it, technology side and procedural side...how it will be launched and rolled out” Governor Shaktikanta Das had said recently.