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Friday, June 25, 2021

How likely is a digital rupee?

Several nations across the globe have rolled out, or are designing/testing their central backed digital currencies. These include Ecuador’s Dinero Electrónico, the Swedish eKrona, and the Chinese eYuan.


May 27, 2021 6:39:01 pm
Rupee, Digital Rupee, Indian rupeeIn India, while officially the fate of private cryptocurrencies is uncertain, the Crypto Bill 2021 facilitates formulating an official/central backed digital currency that will be issued by the RBI and would be recognised as ‘tender’. (Image Source: Pixabay)

Anjali Menon and Aman Agarwal 

Recent volatility aside, the valuations and popularity of cryptocurrencies like Bitcoin and Ethereum have been hitting record heights, and the array of avenues accepting these private cryptocurrencies as payment instruments are also on the rise. The regulatory landscape around cryptocurrencies has transitioned from press releases issued by the Reserve Bank of India (“RBI”) cautioning users against risks associated with private cryptocurrencies, to the RBI issuing a blanket ban on RBI-regulated entities (like banks and intermediaries) providing services to persons/settling transactions involving cryptocurrencies, to the Supreme Court of India striking down RBI’s ban as disproportionate, to the government formulating a bill (the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 that is yet to be tabled before the Parliament) to ban private cryptocurrencies. Despite the noise within government circles to ban all private cryptocurrencies, cryptocurrencies currently operate in India in a regulatory vacuum and transaction volumes continue to witness a massive surge.

In India, while officially the fate of private cryptocurrencies is uncertain, the Crypto Bill 2021 facilitates formulating an official/central backed digital currency that will be issued by the RBI and would be recognised as ‘tender’. Several nations across the globe have rolled out (or are designing/testing) their central backed digital currencies (like Ecuador’s Dinero Electrónico, the Swedish eKrona, and the Chinese eYuan) and have charged ahead in this space, with other intrigued nations close at their heels.

Sovereign backed digital currency and challenges

Centralised vs Decentralised and Volatility

The fundamental ethos of private cryptocurrencies is that they are private (user-driven), decentralised (without involving any regulator) and enable direct peer-to-peer transactions under the cloak of anonymity. The value of private cryptocurrencies is market-driven, and not regulated by any authority or based on the value of any currency/commodity or other underlying assets. This makes them volatile in nature and there is a general perception of these being less secure. Regulators across the globe have therefore expressed concerns vis-à-vis private cryptocurrencies primarily from the perspective of financial security, tax evasion and money laundering.

Any central backed digital currency on the other hand is a digital form of fiat currency (i.e., government-issued cash) which will be government authorised, transparent (leaving behind an electronic record/trail) and relatively less volatile. Central backed digital currencies will also further the government’s efforts towards financial inclusion and cashless/digital payments and will be interoperable between different banking systems making them safer and more reliable/resilient.

Distributed Ledger Technology/Blockchain

Private cryptocurrencies rely on the distributed ledger technology and blockchain to validate transactions. Distributed ledger technology is like a communal database accessible to all users that enables transparent validation of transactions and tracking of historical trades.

Transaction validation on the blockchain requires high electric power; which leads to payments through blockchain not being easily scalable to high transaction volumes. Additionally, there being a central validator of all transactions (in case of central backed digital currencies), would defy the very concept of a decentralised blockchain system.

Costs

Mining private cryptocurrencies require significant computing power which increases transaction costs and casts a shadow on their long-term sustainability. While central backed digital currency is touted as a cost-saving measure (from an interbank settlements perspective and given currency notes are expensive to mint and store), designing and implementation of a central backed digital currency, establishment and maintenance of the infrastructure to facilitate central backed digital currency payments will entail significant costs in a secure trusted environment.

Monetary Policy and Financial Stability

Before central backed digital currencies are operationalised, it is important to consider and evaluate their monetary, systemic, regulatory, and technological impact on the financial system. Ease of accessibility of central backed digital currencies and their safe and secure storage in a safe and resilient system protected against cyberattacks, system failures or disruptions, will also play a key role in their use/acceptance. In regulating central backed digital currencies, their usage in cross border transactions (like private cryptocurrencies which are inherently borderless) also needs to be evaluated, especially on account of the Indian Rupee otherwise not being a convertible currency.

Non-interest-bearing central backed digital currencies could primarily function like cash and serve as a medium of exchange between peer-to-peer and peer-to-business transactions. However, central backed digital currencies bearing interest at a rate set by the RBI could force commercial banks to provide more incentivised rates to attract businesses and financial institutions to stick with them. Moreover, this increased competition is likely to lower profitability for commercial banks which are already under immense pressure due to the surging non-performing assets and bad debts and in a scenario of financial stress at the macro level, businesses and financial institutions might consider holding central backed digital currencies as compared to bank deposits, as a potentially safer option.

Way Ahead

A coordinated approach should be adopted to consult with the various stakeholders (like banks, financial institutions, fintech players, payment aggregators, e-commerce platforms etc.) to not only ensure seamless integration of central backed digital currencies into the financial system but also ensure all relevant and practical perspectives have been addressed. A regulatory sandbox will also undoubtedly be helpful in formulating a more holistic approach, as relevant regulatory pitfalls/ must-haves, macroeconomic factors and procedural aspects can be taken into account while designing and implementing central backed digital currencies. Various governments recognise the enormous potential and penetration power of central backed digital currencies. The Indian government’s proposed central backed digital currency to be issued by the RBI is therefore a welcome move that will address the risks associated with private cryptocurrencies and instil trust in the public to make payments using such sovereign issued virtual currencies.

Authors: Anjali Menon, Partner and Aman Agarwal, Associate, Shardul Amarchand Mangaldas & Co. This article includes inputs from their colleagues, Veena Sivaramakrishnan, Partner and Sumant Prashant, Principal Associate, Shardul Amarchand Mangaldas & Co.

Disclaimer: This article is intended for general information purposes only. The views expressed in this article are those of the authors and does not necessarily reflect the views of the firm.

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