Are Central Banks Digital Currencies (CBDCs), the answer to India’s gripe with crypto?

Banking relies on practicality and efficiency. This is evident from our progress as a civilisation that stored bundles of money under our beds, to ones that use debit and credit instruments with complex accounting. Over the years we have improved upon the way we bank, where we are adopting entirely digital banking services. With the dawn of digital payments and online banks; transfers, bookkeeping and other conventional services have become accessible to every customer with a handheld mobile device.

Riding the Web3 (A decentralised Peer to Peer world) wave paves the natural next step to transform the banking industry; utilising all the benefits of this decentralised technology. Banking institutions have also begun evaluating the possibility of adopting digital tokens; owing to their ability to process transactions more quickly and conveniently. However, digital currencies like Bitcoin and ETH are vulnerable to market volatility. They are seen as unreliable as a unified legal tender. For it to complement the traditional banking services, we need to have a more stable version of this digital asset.

One of the answers lies in CBDCs.

What are CBDCs?

Central banks across the world are now experimenting with a suitable alternative that could allow governments to regain control over the circulation of wealth within the country. Meanwhile, it will also allow more citizens access to the digital economy. CBDCs or Central Bank Digital Currencies are high-security digital assets. Like paper notes, it denotes a store of value, with each unit uniquely identifiable to prevent counterfeiting.

Unlike the existing cryptocurrencies, CDBCs are not subject to market volatility. Hence, they can afford to maintain price stability for fairly longer since a central entity backs them. CBDCs become part of the base money supply, together with other forms of currency. Another crucial difference is that the validity of the CBDC is independent of the digital payment systems; systems that store and transfer the digital currency.

Amidst the dithering regulations around cryptocurrencies in India over the past few years, Central Bank Digital Currencies might just be India’s segue into adopting blockchain technology for the benefits it brings. Meanwhile, we will still have a say in the supply and value of the currency. The regulations in India around crypto and its uses suggest clear merits of adopting blockchain technology. Yet, banking institutions are cognizant of the possible losses that may happen if customers moved a significant portion of their assets into crypto.

How can CBDCs help the economy?

Banks across the world have been diving deep into CBDCs. It is a relatively under-defined concept as of now. Yet a survey in early 2020 found that more than 80% of central banks were studying the concept. Some strong examples include the Bank of England, Central Bank of Sweden, Bank of Lithuania or the Central Bank of China’s digital yuan to name a few.

Organisations such as UCL CBT are also engaging with various central banks. Some names include Central Banks of Jamaica, Chile, Brazil and Columbia; to discuss the implementation of CBDCs in their respective countries. Likely implementations of CBDC have been modelled using a database operated by a central bank, Government or approved private sector entities. This database would then act as the ledger (distributed or not) maintaining a record of transactions and balances with appropriate cryptographic protections.

Apart from transparency, CBDCs can have a beneficial impact on the economy in any of the following ways:

Low-Cost Payments

Instead of relying on intermediaries such as clearinghouses, banks, payment processors etc, a payer can do money transfers and payments, making direct, real-time transfers to the payee.

Accountability

Digital Fiat Currencies (aka CBDCs) allow central banks to keep track of the exact location of each CBDC. CBDCs also make tax evasion/avoidance a very cumbersome task. Central banks have purview over each transaction and can prevent offshore banking and unreported employment/income!

Financial Inclusion

India comes second only to China among developing countries in terms of the number of unbanked individuals. According to the World Bank, India has over 190 million unbanked adults who don’t participate in the formal financial sector. In India, there have been many financial inclusion policies from the Government of India and millions of bank accounts under the policy mandate. Despite this, a study found that while 80% of Indian adults had a bank account, statistics revealed only 40% active accounts.

Could CBDCs be India’s entry into crypto?

CBDCs have the higher ground against conventional banknotes in terms of the implied costs. These costs come with printing, circulating, maintaining supply and preventing counterfeiting of the banknotes and coins. With digital fiat currencies, these costs close to zero. Further, even the costs to process transactions, set up the account etc are minimal and very affordable. So much so that it can be distributed as free or very low-cost implementations for the unbanked.

Banking the unbanked isn’t limited only to payments, citizens can get easy access to other services such as lending, borrowing, investing etc. CBDCs also address the common issues that regulators and central banks are concerned with such as control oversupply, easier accounting, easier taxation and filing.

Overall, CBDCs address the concerns that regulators have about the volatility and unreliability of conventional cryptocurrencies while at the same time reserving control and transparency over the transactions happening using the legal tender. In addition to this, CBDCs also allow mass adoption of these digital currencies, granting access to traditional financial services to the unbanked population of the country at close to zero costs, Making CBDCs the perfect segue for India into the web3 wave.