This article has been written by Gitika Jain, pursuing the Certificate Course in Banking & Finance Practice: Contracts, Disputes & Recovery from LawSIkho.
The speed at which digital currency has gained popularity over the last few decades is tremendous and has made most central banks look seriously at launching a currency wholly controlled by them. With more and more cryptocurrencies frequently being introduced, a question is popping up as to what impact will these currencies have on banks? Will the banks be forced to adapt themselves to these currencies or will they launch their own digital currency? To answer these questions, let us briefly know what crypto currency or digital currencies actually are.
Understanding cryptocurrency/digital currency
A digital or virtual form of currency that has secured cryptography and is next to impossible to be counterfeited is called cryptocurrency. No central authority generally issues cryptocurrencies which make it theoretically immune to government interferences or manipulations. Cryptocurrencies for digital currencies are a secured method of online payments. The denomination of cryptocurrency is in terms of virtual token and is represented by ledger entries internal to the system. The word krypton means various encryption algorithms and cryptographic techniques like public-private key pairs, etc.
Cryptocurrencies prevalent in the market like Bitcoin is the first block chain-based cryptocurrency that still remains popular among many players. Bitcoin was launched by Satoshi Nakamoto in 2009. Other than Bitcoin the currencies are called Altcoins which include litecoins, Peercoins and Namecoins.
Cryptocurrencies effect on the banking landscape
The release of blockchain technology and its growth has sent shock waves throughout the financial markets. As we all know that cryptocurrencies have changed the way people used to conduct their financial transactions globally, this impressive uptake of cryptocurrency banking is expected to become an integral part of the financial industry soon. Cryptocurrencies are some way or the other revolutionizing the banking industry since they are decentralized systems and offer services that even conventional banks offer, moreover provide a guarantee, reduce bureaucracy, security, transparency and more efficiency to the provided services.
Some of the ways in which cryptocurrencies are creating a positive impact in the financial industry are discussed herewith:
Cryptocurrencies are eliminating previous imperfections in the banking system
There is a convenient way of executing financial transactions which traditional banking follows. The more technologically advanced the bank becomes, the more data breaches and other governance and compliance issues pop up. Here comes into play the cryptocurrencies. Cryptocurrency transactions are anonymous so when someone makes a payment using paper crush there is a possibility of it being counterfeited but this isn’t the case with crypto cash.
The need for middlemen is eliminated
Cryptocurrencies are decentralized systems in the sense that it allows making transactions without involving intermediaries. The traditional banking system on the other hand follows the method of storing money in the bank and users can only make transactions that are sanctioned by the bank. But in the crypto world, no one holds the customer’s money except for cloud via the blockchain technology. This is the only reason why there have been rumours here and there about the fact that the traditional banking system might face serious challenges if more and more people start shifting to crypto banks.
The cost per transaction is reduced in cryptocurrency
Let’s start with an example. Suppose a person pays a vendor $2500 via credit card, then the person will have to pay some additional charges. But crypto-cash transactions are either free or incredibly low.
Ease of use
Everyone in today’s world expects financial transactions to be free, faster and easier along with the technological improvement and cryptocurrencies undoubtedly bring to the banking industry, the sought after convenience in all these matters.
Safer and fairer investment option
The traditional banking system is such that people prefer storing hard cash at home rather than banking because of which the money loses its value each year. With cryptocurrencies, the money remains secured as people even with minimal financial knowledge can make sound investments without worrying about devaluation in cryptocurrencies.
Concept of Central Bank Digital Currency (CBCDs)
Digital currency or cryptocurrency intensely gained a lot of popularity across the world which made a lot of central banks launch a digital currency controlled in order to address any flaws during the shift towards a cashless society. The central bank digital currencies (CBDC) is a legal tender for which the central bank is liable in the digital form. CBDC appears on the balance sheet of the nation’s central bank. It can be converted or exchanged at par with similar cash and traditional Central Bank deposits. The Finance Ministry Committee introduced the idea of a digital rupee in February 2019.
Types of CBCDs
- Retail CBCDs- Retail CBCDs are usually useful for individuals, households and corporations.
- Wholesale CBCDs- They are meant for financial institutions.
Benefits of CBDC
The usage of CBDC provides benefits in the following aspects:
- Income tax- With the introduction of CBDC, tax evasion or tax avoidance will become next to impossible because financial activities cannot be hidden from the central bank due to the existent electronic records for cryptocurrencies.
- Curbing crime- Since the Central Bank will keep an eye on all the activities related to finance, no criminal activity can take place and even if it happens it can easily be spotted and ended then and there.
- Easy tracking of currency- The Central Bank will be able to keep a track of the exact location of each and every unit of the currency.
- Real-time money transfer- All the money transactions and payments can be made on a real-time basis from the pair to the pay without depending on intermediaries such as banks.
- Alternative to physical cash- Central banks would issue digital currencies which will be considered modern alternative to physical cash. CBDC are like programmable money which enables two transactions to be done into CBDC like automatic payment of dividend to shareholders.
- Market contestability and discipline- Central Bank views CBDC is a body that has potential to offer competition to large forms and therefore it is a means to cap the rents they can extract. CBDC is a less risky and more stable alternative to Bitcoins.
- Financial inclusion- Safe and liquid government-backed means of payment to the public is what CBDC is known for and it does not even require any individual to hold any sort of bank account which acts as intermediaries. The promotion of financial inclusivity especially in developing countries is also done by CBDC. According to the data provided by the World Bank about 1.7 billion people have excluded conventional banking systems..
Need for CBDC in India
As there is a huge disconnect between the number of bank accounts and mobile phone connections in India, CBDC can most probably bridge this gap in the following way:
- The digital currency will provide India with an opportunity to establish the dominance of digital currency as a superior currency for trade with any of its partners and thereby reducing any dependency on the dollar.
- India will also be benefited as it would address malpractices, tax evasion, terror funding, Money Laundering Act as Central Bank and keep an eye on each and every unit of the digital currency.
- RBI is also empowered to monitor transaction and credit flow across the Indian economy which reduces any chances of depositor’s money being defaulted.
- Many investors are distracted with the help of CBDC from investing in current crypto assets that are of high risk.
- The need for permissions or partnership with the bank by a large technology company in a fintech company is nullified with the introduction of CBDC. It will provide financial assistance to those who have been dependent on the banks since quite long.
RBI’s thoughts on whether there is a need to issue a digital version of rupees in India
In India, the mindset of the regulator and government has been sceptical about cryptocurrencies and they have been apprehensive about the associated risks involved. Nevertheless, the need of exploring digital currencies arose as a matter of fact by RBI. It came to the conclusion that since there have been rapid innovations in the mode of payments in India, the Central Bank needs to examine whether they could leverage on technology or not. Also, the fact that RBI thought of evaluating the possibility of issuing its own cryptocurrency shows how important the digital sector is going to be in the future of currency regulations. The ban on banks dealing with crypto exchanges by RBI got turned down by the Supreme Court of India, thus allowing crypto exchanges to restart the operations in the countries and boom itself in the business of the digital market.
To fulfil all the gaps that the traditional method of banks is lacking is what the primary objective of CBDC is. A significant transition in India has been witnessed very recently towards the digital economy with the rapid advancement in technology. With more and more internet activities and easement of transactions, digital payments in India have increased by 58.8% percent during 2018-19. According to RBI, by the end of 2021 digital transactions are set to rise four times in India. RBI is also aiming for a cash lite economy with its vision document titled “payment and settlement systems in India”. CBDC seems to be a logical step towards the achievement of the same. However, there is a lot more for India to explore, engage and experiment with very cautiously before venturing into the territory of digital currencies altogether.
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