Calcutta Notebook

Central Bank Digital Currency

Bharat Jhunjhunwala

A crypto currency is outside the control of the central banks of the countries. As the name suggests, the currency is encrypted and not accessible to anyone other than the owner. A number of computer enthusiasts get together and they solve a puzzle like the Sudoku. One who can solve the puzzle is granted a prize in form of a currency such as Bitcoin. All the other players have to confirm that the winner has actually solved the puzzle. Only then he is given the crypto currency. The control of the currency is not with a single person. It is distributed amongst all the players. A new game on solving a puzzle start after the previous puzzle is solved. In this manner new crypto currency is manufactured just as new paper currency notes are printed. The governments or their central banks cannot identify the owners or determine the number of coins are made. The crypto currency stands and runs parallel to the central banks.

The central banks have been averse to promoting digital currencies. The first drawback, they say, is that the crypto currency can destabilise the economy. For example, let us say inflation is running high. The Reserve Bank of India wants to reduce inflation and reduces the money supply to discourage borrowing-and-spending by consumers and to slow down the economy. The crypto currency can continue to be made in large numbers and nullify the reduction of money supply implemented by the Reserve Bank. This is like a person paying by debit card when she has no cash in her wallet. In this manner the governments lose control over the monetary policy. The second drawback is that crypto currencies can fail and again destabilise the economy. Before 1863 there was no national currency in the United States. Various private entities and municipalities issued their own currencies. Many banks failed and municipal currencies got devalued leading to chaos in the economy. The Federal Government enacted the National Currency Act and ensured the circulation of only one currency. One may go back to the pre-1863 situation of chaos if crypto currencies are allowed. The crypto currencies can be stolen or devalued. The third drawback is that of supporting crime. Recently, an oil company’s computers in the United States were hacked. The hackers demanded and got payment of ransom in crypto currencies. Part of the ransom was recovered by the police but part was not. The crypto currency is anonymous. An owner cannot be identified because it is merely a number stored in the computer.

Crypto currency is beneficial despite these drawbacks in situations where the central banks are irresponsible. For example, let us say the government of a country prints paper currency indiscriminately and the prices rise, say, 10 times in a one year. In such a situation it becomes very difficult for businessmen to manage their businesses because the value of the paper currency is changing by the hour. It is equally difficult for any household to safeguard their earnings because value of the paper currency may decline in one week. Digital currency can provide a safe method of both making transactions and storing incomes in such situations. This is somewhat like a person buying gold when the inflation is running amok. The advantage is that the problems of safeguarding gold are not faced in crypto currencies. The presence of crypto currencies can act as a check on the bad policies followed by the central banks. Now comes “digital currency.” A digital currency is like the crypto currency in that it too is only a number stored on a computer. However, it is not anonymous like the crypto currency. It may be issued by a central bank like the Reserve Bank of India. The number of digital currencies issued is determined by the central bank and the ownership is tracked as well. However, the value of the digital currency may be determined by the bidding process in the market similar to the determination of the price of Bitcoin by supply and demand as is taking place today; or similar to the determination of the price of the rupee. The Reserve Bank will be able to identify the owners of the digital currency and it can prevent use of this currency for crime, money laundering and other illegal purposes. The digital currency can be prevented from destabilising the economy because the Reserve Bank can control the number of digital currencies that are issued. However, a digital currency cannot help the people overcome the bad policies of the bank itself. The central bank can issue large numbers of digital currencies at the same time that it is printing large numbers of paper currency indiscriminately. The digital currency, therefore, will not act as a control on the central bank.

[Formerly Professor of Economics at IIM Bengaluru]

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Vol 54, No. 27, Jan 2 - 8, 2022