2021 has been a turning point for cryptocurrency. We’ve seen bitcoin hit an all-time high of $65,000 and the total crypto market capitalization breach the $2 trillion milestone within a few months. Besides massive institutional buy-in from corporations, the biggest news for crypto comes from El Salvador, the first of many to adopt bitcoin as a legal tender.
Amid the soaring popularity of cryptocurrency, evident through the rapidly growing user base on crypto trading platforms like CoinSwitch Kuber, and the COVID-19 pandemic pushing the usage of digital payments, the Central Banks around the world are exploring digital currencies that can be issued by them. These are popularly referred to as Central Bank Digital Currencies or CBDC.
According to the Atlantic Council, a US-based think tank, 81 countries representing 90% of the world’s GDP are exploring some form of CBDC. The People’s Bank of China (PBOC) has already launched a digital version of the Chinese Yuan while the Central Banks of Europe, the UK, and the US are experimenting with pilots.
Meanwhile, the Governor of Reserve Bank of India (RBI), Shaktikanta Das, announced recently that the Central Bank is looking to launch its first Digital Currency trial program by December. ‘The RBI is studying various aspects of a digital currency including its security, impact on India’s financial sector as well as how it would affect monetary policy and currency in circulation,’ he added.
What is a Digital Currency? And Why Does It Matter?
Digital Currency, in simple words, is essentially the digital form of traditional fiat money. ₹100 held digitally, in an app or mobile wallet, is the same as ₹100 held in physical cash.
A CBDC is the legal tender issued by a central bank in a digital form. It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different.T Rabi Sankar, Deputy Governor of RBI
Incidentally, a CBDC is similar to the way digital wallets work today. Under the new digital currency system, the banks will issue a fixed supply of digital monies, without printing equivalent cash, that can only be spent electronically. Besides the environmental benefits, this will lower the costs of printing, storing, and distributing banknotes.
Nonetheless, digital currencies are considered as ‘distant cousins’ to cryptocurrencies. Many crypto experts believe that Central Banks embracing ‘digital’ currencies is a step in the right direction. They bring the benefits of virtual currencies such as financial inclusion by banking the unbanked. Also, digital currencies will transform payment transfers making them seamless yet frugal.
James Pomeroy, Global Economist at HSBC, noted that CBDCs could “replace cash and transform the banking system globally within a generation. The benefits could include increased growth and reduced poverty in the emerging world.”
CBDC vs Cryptocurrency
Though the timing of CBDC coincides with a growing interest in cryptocurrencies, RBI’s planned digital currency is not the same as Cryptocurrency. The differences are stark in their present form.
Primarily, the first principles of a cryptocurrency are its independence and autonomy - no single individual/entity controlling it. On the contrary, CBDC will solely remain under the purview of the central bank from issuing to tracking it. Moreover, a cryptocurrency like bitcoin is hard-capped at 21 million coins making it finite. However, the supply of CBDC, just like any other fiat currency, can be infinitely increased.
Another significant feature of cryptocurrency is the technology backing it. The blockchain, a distributed ledger recording transactions, ensures that the system is decentralized and secure from privacy intrusions. Meanwhile, it is yet to be clear whether RBI’s digital currencies would rely on the distributed ledger format.
Do Digital Currencies Affect The Future of Cryptocurrency?
The writing on the wall is evident. Cryptocurrency and its underlying technology will likely disrupt the existing financial structures and is here to stay for the foreseeable future. Governments and regulators around the world are bracing in anticipation of such a change. And corporations are busy dipping their feet adding cryptocurrency to their balance sheets. However, what remains to be seen is the long-term effects of digital currencies.
Moreover, CBDC and Cryptocurrency serve two very different purposes today and there is little room for a clash. Bitcoin and other cryptocurrencies are increasingly seen as digital investment assets evident with the rapidly growing digital exchanges and investors. CoinSwitch Kuber, one of India’s leading cryptocurrency exchanges, alone is home to over 1 crore users. On the contrary, CBDC serves as a means of payment providing stability but lacks basic investment characteristics.
There is growing consensus that the implementation of CBDC will popularize the concepts of digital money and wallets. This in turn will lower the entry barriers to crypto assets for an average person and usher in a new era of crypto adoption among the masses.