They have no underlying basis, and are too volatile to be a store of value. Can they truly take the place of cash?
Across the world, the interest in cryptocurrency is not showing any signs of abating. India, too, is witnessing such a trend. Recently, the cryptocurrency market crossed the $3 trillion mark for the first time. However, with promising returns, cryptocurrencies are also generating their fair share of concerns. The asset is seen with suspicion, as its volatility often discourages investors from putting their money on it.
In India, the RBI plans to roll out a Central Bank Digital Currency (CBDC), a form of crypto. Without foolproof governmental regulation and provision for legality, investors and consumers are unsure about its role in the economy.
Such digital currency may not be accepted as a medium of exchange, store of value or a unit of account — essentially de-recognising the three key functions of money. What it basically says is by the time you have consumed a bottle of beer in a restaurant, paying in cryptos can mean a substantial change in the price of the beer due to the high volatility of cryptos. That would make the store value unreliable.
So long as cryptos are confined to a small coterie of investors, it doesn’t really matter. This is a digital asset which has no intrinsic value like gold or even cash; all it has is the trust of the people who are closely associated with it or trading in it.
Hence, its multiplication entirely hinges on belief. This reliance may not last long among partners or traders as it is too personal in nature and doesn’t have any strong legal backing.
Even if dealing in cryptos is done at a minimal scale, it could have a spiral effect in the financial system, because a large amount of wealth in terms of debt funds might have gone into their making. Any calamity can hence wipe out a substantial part of the global wealth.
So, the RBI must pay attention to the following downsides of cryptocurrencies.
First, CBDCs will disturb the sovereignty of the central bank. When the crypto is introduced, other governmental departments such as IT and telecom will need to be involved for its smooth functioning. This may, initially at least, create coordination and implementation issues.
Second, monetary policy of the RBI, which plays a critical role in providing direction to major macro variables, will be significantly challenged as it won’t be able to monitor such digital money supply. Therefore, the RBI may find it difficult to predict inflation.
Third, access to digital currency transactions is expensive because those interested will need to have a computer, tech gadgets and internet connectivity. The Indian diaspora, especially in the Gulf, Australia, Canada and the US, still need to pay a hefty fee for remitting their money home once adoption of digital currency takes effect. This may restrict India receiving huge amount of remittances from abroad.
Fourth, such digital currency asset could weigh heavily on the business of commercial banks, which have for long been acting as the financial intermediary, assisting in India’s economic growth. Nationalisation of banks in 1969 could help mobilise the savings of customers which were given out as loans at reasonable interest rates to the needy borrowers.
With the introduction of CBDC, the deposit base of such commercial banks will erode. This could result in lending rates going up, which, in turn, will be a drag on an economy that is trying to recover to its pre-pandemic level. Also, low-cost bank loans may not be easily available for new start-ups, MSME and entrepreneurs.
Fifth, uncertainty in financial markets is quite common now. Many public sector and private banks have been hit by huge number of fraudulent transactions. The situation could worsen when there is an increasing shift to digital currencies without having proper regulation.
Finally, transaction with CBDC will mean compromising on privacy. While transacting in cash in a retail store, you may not leave any trail whereas with crypto you will. This could make the ordinary citizens feel uncomfortable.
When ushering in such an innovation, what is desirable is to continue with cash while introducing crypto as a legal tender. In a developing economy like India where access to internet and digital literacy are still a challenge, coexistence of cash and crypto will be a realistic option.
The writer is Professor & Area Chair, LBSIM, Delhi.