Innovation

Managing the cryptocurrency challenge

Treating cryptocurrencies as a banking product and an investment vehicle rather than a ‘store of value’, might be the answer.

Cryptocurrencies are giving sleepless nights to many sections of our society. The Central Banks are worried that their monopoly in issuing and managing currencies is getting undermined. The Commercial Banks are worried that increasing financial transactions based on Cryptocurrencies outside the traditional banking channels can impact their business model and deprive them of their daily bread. The taxman is concerned that unaccounted movement of funds through Cryptocurrencies is not reported in their databases and escapes the tax net. The Anti-Narcotics and Anti-Terror agencies are worried that criminals may be trading in illegal goods and services and routing payments through Cryptocurrencies, thus escaping the dragnets laid by them.

The Economists are worried that when citizens invest in foreign Cryptocurrencies, wealth is going out of the country to foreign shores. The common man is worried that his investment in poorly understood and volatile Cryptocurrencies may result in heavy losses. Worse, if they get cheated by a foreign entity, there is no legal recourse that can be taken. Even the smart investor is worried about the wild fluctuations in the value of the Cryptocurrencies overnight without any apparent reason.  

If a new technology is so troublesome, the default response is to ban it. Many Central Banks have tried this approach but whether such a course is sensible or not is debatable.

People have not stopped investing or trading in private Cryptocurrencies. On the contrary, it has only increased their attraction. It is not possible to ban a technology and its byproducts in a world that is so interconnected and evolving at a fast pace. With a smartphone with access to encryption-enabled tools in every hand, banning technology or its products is simply not feasible. It may even not be desirable and prove to be counterproductive by driving innovation underground. Such an approach is bound to fail in a world full of increasingly empowered citizens. So, what are the options to deal with it?  

Many Central Banks across the world are thinking of launching CBDGs or Central Bank backed Digital Currencies. These will obviously be under a regulatory framework and backed by the Sovereign. These will promote digital payment systems and in future may even replace paper currencies. In essence, they will still be fiat currencies as we have now, and their market value will be linked to the economic strength of the issuing country. They will remain a store of value, and unless a Central Bank launches multiple Cryptocurrencies that are differently structured and moves away from the idea of ‘Sovereign backing’ consciously, there will be little to differentiate CBDGs from paper currency except for ease of use.

It will be difficult for a Central Bank to drive innovation in a Cryptocurrency market without competition. Competition will not be possible unless competing CBDGs of foreign Central Banks are allowed a level playing ground, a farfetched possibility. This will also mean Central Banks taking over the many roles that now commercial banks play and this may hurt the banking sector in the long run. This will also not eliminate the allure of investors opting for private Cryptocurrencies as an investment option.  

We need a solution that enables competition in the domestic Cryptocurrency market, stops the outflow of national wealth through foreign based Cryptocurrencies, works within a well-regulated and transparent environment, drives innovation, reduces volatility, brings taxes to the government and is also a viable investment option. We also should promote legal transactions in Cryptocurrencies. To achieve these objectives, it may be more advisable to allow strong Commercial Banks to launch Cryptocurrencies governed by a clear regulatory environment. This will mean that these Cryptocurrencies are treated as a banking product and an investment vehicle rather than a ‘store of value’.

In such a scenario, banks can bring all their innovation and technology skills, reach, brand value and marketing heft to differentiate their currencies from one another and thus create, widen, and deepen the market. The Currencies can be traded in domestic markets, again regulated properly within a stock market like arrangement.

The strength of the bank, the structure of its Cryptocurrency or currencies and their market acceptance will create value and drive innovation to enhance it further.

We could even imagine IPOs of such currency products from established banks hitting the market at some future point in time, providing an alternate avenue for investment to the citizen. This will unleash innovation at an unprecedented scale and create wealth for the nation while protecting the domestic investor. This does not preclude the Central banks from launching their own currencies with sovereign backing, a form of digital fiat currency, a store of value, not an investment product.  

This article is authored by Mutha Ashok Jain IPS. The author is a serving officer and the views expressed are personal.

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