Bank Notes/Fiat Currency, Cryptocurrency and Central Bank Digital Currency

1. Fiat currency does not have intrinsic value (the value of the paper material in the Rs. 500
note may be negligible or less than fifty paise) but people accept it because there is a
Government authorization that whomsoever will take it to RBI/Govt. they will give you
something (some commodity/material) worth Rs. 500. This was not the case long time back
when people used to transact with gold coins. If Rs. 500 is printed on a gold coin then after
melting the coin the gold in it would fetch Rs. 500 in the market which means gold coins
had intrinsic value and hence there was no Govt. fiat (order/authorization) was required.

2. If someday a rare earth material is recovered from beneath the earth, and everyone wants to
possess/hold that material (which is very limited in supply) then its price can increase to
any limit. In the same way, the cryptocurrency/bitcoin (let us assume it a software file) can
be mined (produced) only to a limited number and since a lot of people are willing to
hold/posses it so its price has increased. Cryptocurrencies are not issued by Central Bank
and it is not a fiat money. If the willingness to hold the bitcoin/cryptocurrency will fade
away, then the price of bitcoins would crash and that’s what we see in the market the
fluctuation in the bitcoin prices. So, just like physical commodities, bitcoins/cryptocurrency
are digital objects, or you can say digital gold.

3. Few people are using cryptocurrency for transaction purpose also and it is not illegal. For
example, if I purchased 10 gm gold and the price is Rs. 10,000 and the price of bitcoin is
Rs. 5,000, then rather than paying Rs. 10,000, I may pay in bitcoins (it is just like barter
trade of gold and bitcoins) if the other person is willing to accept, but he is not bound to
accept bitcoins as it is not a legal tender.

4. Many Central Banks are worried that the widespread adoption of these independent
cryptocurrencies could weaken their control over the financial system. This could cause
financial instability especially because cryptocurrencies do not have the legal or the
regulatory safeguard that the Central Bank money does, so why not issue a digital currency
of their own.

5. Central Bank Digital Currency (CBDCs) are conceptually no different from banknotes
(currency notes), and it will be just in digital form. So, CBDCs will also be legal tenders and
can be issued only by the Central Bank. But their introduction will require changes in the
present legal framework like RBI Act 1934 which currently empowers the RBI to regulate
issuance of banknotes/cash.

6. If I am holding cash and made payment to someone then it does not require any kind of
settlement with a third party and the RBI’s liability moves from me to the other person,
whom I have paid. But when I make payment through cheque/card then it requires inter-
bank settlement (through RBI in case of different banks). But CBDCs would just be like
cash, and I can make payment to anyone through the CBDCs and the RBI’s liability will
move to the other person. And the requirement of inter-bank settlement would disappear.
7. Like cash, CBDCs could be distributed through commercial banks avoiding too much
disruption in the financial system or the Central Bank can directly deal with many millions
of citizens and businesses.

8. Unlike your savings in a commercial bank which rely on the bank’s promise to fulfil, CBDCs
(held by people just like cash) are recognized by law (fiat currency/legal tender) and backed
by the Central Bank which cannot go bankrupt. For example, if a commercial bank
collapses, part of your savings in commercial banks could potentially be wiped out, but this
would not be the case with CBDCs, which we can hold on to our won and could be as
trusted as cash.

9. CBDCs would be as convenient as payment apps and it also benefits from the same
blockchain technology (Distributed Ledger Technology) which underpins cryptocurrency.
10. Digital currencies (CBDCs) could bring a lot of benefits like it could make payments
faster/instantaneous allowing for immediate settlement and no processing delays, more
people could have access to electronic payments, and it could also make payments cheaper.

11. India’s fairly high currency-to-GDP ratio holds out another benefit of CBDC – to the extent
large cash usage can be replaced by CBDC, the cost of printing, transporting and storing
paper currency can be substantially reduced.

12. But the Central bank would not like to replace all the traditional cash with CBDCs rather it
would complement the banknotes. This is because there is one risk associated with CBDCs
like in an extreme situation such as after a financial crash, people could withdraw their
deposits from the commercial banks and will opt to store the money in digital currency
backed by the Central Bank. If savers would shift their savings from bank accounts to
CBDCs then banks could have a problem of funding which might have an effect of financing
of the whole economy. People can shift their savings from bank accounts to CBDCs just
with a click which could be very dangerous.