In recent years, cryptocurrencies have taken the financial world by storm. Spearheaded predominantly by Bitcoin, there’s been a phenomenal rise in the price of cryptocurrencies. Today, there are over a thousand cryptocurrencies in existence. Not just individuals, big firms and businesses are also getting into the cryptocurrency business. This topic is of very much importance for IAS aspirants.

TOPICS

  • virtual currencies
  • Digital Rupee
  • CBDC
  • Inter-Ministerial Committee on Virtual Currencies

VIRTUAL RUPEE

  • Virtual currency is a digitally tradable form of value, which can be used as a medium of exchange, or a stored value which can be utilised later.  It does not have the status of a legal tender. A legal tender is guaranteed by the central government and all parties are legally bound to accept it as a mode of payment.

  • Cryptocurrency is a specific type of virtual currency, which is decentralised and protected by cryptographic encryption techniques(or blockchain technology). Bitcoin, Ethereum, Ripple are a few notable examples of cryptocurrencies.  Decentralisation implies that there is no central authority where records of transactions are maintained.  Instead, anyone can create a transaction.  This transaction data is recorded and shared across multiple distributor networks, through independent computers as shown in Figure.  This technology is known as Distributed Ledger Technology/blockchain technology.

CRYPTOCURRENCY

  • It is a digital or virtual currency that uses cryptography for security.

  • Cryptocurrencies use decentralized technology to let users make secure payments and store money without the need to use their name or go through a bank.

  • They run on a distributed public ledger called blockchain, which is a record of all transactions updated and held by currency holders. The most common cryptocurrencies are Bitcoin, Ethereum, Ripple, and Litecoin.

  • Facebook has announced a digital currency called Libra that will roll out for use in 2020 and allow the platform’s billions of users across the globe to make financial transactions online.

DIGITAL RUPEE

A digital rupee is nothing but a digital currency issued within the monetary framework of the Reserve Bank of India. The government has been examining the feasibility and operationality of digital rupee along with the regulatory authorities. The concept of digital rupee seemed to have got the attention of the RBI and other regulators such as the Securities and Exchange Board of India (SEBI), MeitY (Ministry of Electronics and Information Technology) after witnessing the instability of private cryptocurrencies and the people being duped due to the irrational volatility in the prices.

The idea of digital rupee is under discussion by an inter-ministerial panel constituted by the former Union Finance Minister Arun Jaitley which was incorporated to study the issues related to virtual currencies and propose a specific action. The high-level panel was inducted under the chairmanship of Subhash Chandra Garg, Secretary, Department of Economic Affairs, Ministry of Finance, and panel members including Ajay Prakash Sawhney, Secretary, MeitY, Ajay Tyagi, Chairman, SEBI and B.P. Kanungo, Deputy Governor, RBI.

Can digital rupee can replace private cryptocurrencies? 

The digital rupee, if launched under the regulated environment by the central bank, can replace all the privately-held cryptocurrencies. The panel is working towards providing comprehensive recommendations to introduce the digital rupee or CBDC by using distributed ledger technology (DLT). Blockchain is an application of DLT which has grown so far due to the introduction of all private cryptocurrencies including bitcoin.

Distributed ledger technology allows the recording, sharing and transfer of data or value without the need for a central record keeping as in the case of a traditional ledger. Trade finance, mortgage loan applications, digital identity management or KYC requirements, cross-border fund transfers and clearing and settlement systems are some of the operations in which the usage of DLT is being explored internationally. The Reserve Bank of India has also formed an inter-departmental group to study and provide guidance on the desirability and feasibility of introduction of a CBDC.

CENTRAL BANK DIGITAL CURRENCY (CBDC)

The committee has proposed the concept of central bank digital currency (CBDC) which is the digital form of fiat money. “The concept of electronic central bank money is not new and has existed for a very long time, in the form of reserves deposited by commercial banks and certain other financial institutions at the central bank,” the committee noted.

The better potential for retail transactions and greater accessibility of central bank liabilities are some of the factors that distinguish the central bank digital currency from the existing concepts and tools.

According to the panel’s report submitted to the Department of Economic Affairs (DEA), the rapid surge in the interest in technological innovation in the financial sector, declining use of cash in a few countries and the emergence of new entrants in the payments landscape are the prime motivators which triggers the interest of CBDCs across the world.

The committee has been designated to assess the policy and legal framework for the regulation and issuance of virtual currency in India as the subject itself is complex owing to its unique features and varying degree of understanding in different jurisdictions.

INTER-MINISTERIAL COMMITTEE ON VIRTUAL CURRENCIES

  • Ban on all forms of private cryptocurrencies.

  • Impose a fine of up to Rs 25 crore and imprisonment of as much as 10 years for anyone dealing in them.

  • RBI and the government may look at the introduction of an official digital currency in the country.

  • Establish a specific group by the department of economic affairs with participation by the RBI, department of financial services and the ministry of electronics and information technology (MeitY) for examining and developing an appropriate model of digital currency in India.

  • The panel backed use of distributed ledger technology (DLT) or blockchain for selected areas. It has asked the department of economic affairs to take the necessary measures to facilitate the use of DLT in the financial field after identifying its uses.

  • It has also suggested the use of DLT to reduce compliance costs for know-your-customer (KYC) requirements.

  • Data localisation requirements proposed in the draft Data Protection Bill may need to be applied carefully, including with respect to the storage of critical personal data so as to ensure that there is no adverse impact on Indian firms and Indian consumers who may stand to benefit from DLT-based services.

Why has the Committee recommended banning cryptocurrencies?

  • Fluctuation in prices:

    • Cryptocurrencies are subjected to market fluctuations and the lack of centralised authority makes it difficult to regulate them. For instance, in December 2017, the value of Bitcoin cryptocurrency was around USD 20,000 per coin, which reduced to USD 3,800 per coin by November 2018.

  • The risk to consumers:

    • There are several vulnerabilities in the design of cryptocurrencies which leave consumers open to the risk of fraud.  These include phishing cyber-attacks and Ponzi schemes. Further, cryptocurrency transactions are irreversible, which means once a transaction is done, there is no way to remedy it.

  • Impact on power consumption:

    • Validating transactions in a distributed network involves high electricity consumption and requires high computation power.

    • The Committee noted a study which estimated that 19 households in the USA can be powered for one day by the electricity consumed in a single transaction of the bitcoin cryptocurrency.

  • Potential use for criminal activity:

    • The Financial Action Task Force, an intergovernmental organisation to combat money laundering, in its report (2014) observed that virtual currencies provide greater anonymity than traditional payment methods.This makes them more vulnerable to money-laundering and illicit funding for terror financing.  The Committee noted that the decentralised nature and the anonymity which cryptocurrencies provide makes it difficult for law enforcement authorities to track down people involved in illicit activities.

BLOCKCHAIN TECHNOLOGY

  • It is a specific kind of DLT that came to prominence after Bitcoin, a cryptocurrency that used it, became popular.

  • Cryptocurrencies such as Bitcoin use codes to encrypt transactions and stack them up in blocks, creating Blockchains. It is the use of codes that differentiates cryptocurrencies from other virtual currencies.

Government of India has been working towards eliminating all the private cryptocurrencies and launching a digital currency which is to be operated and maintained by the Reserve Bank of India (RBI). To know more about Indian governments reforms in the economics click here