A global outlook on virtual currencies
In the monetary policy committee meeting on 5 April, the Reserve Bank of India (RBI) took two decisions which attracted wide attention. The first was constituting an inter-departmental group to guide whether the RBI can issue a central bank digital currency (CBDC). The second was prohibiting all RBI-regulated entities from offering any services to entities dealing with “virtual currencies”.
The first decision is interesting for two reasons. First, India is one of those few countries where “cashless” is part of government’s core strategy, whereas, in most others, the rise of digital transactions is more a demand-driven phenomenon. Thus, the Indian central bank should have been one of the first (if not the first) to study the impact of CBDC, but is joining the debate after nearly one and a half years of demonetisation.
Second, the timing of this decision is interesting as the world’s first such project in Ecuador has not been a success. Prof. Lawrence H. White of George Mason University, in his fascinating blog post, notes that in 2014 the government started the project amidst much fanfare. According to experts, the reason was either to de-dollarize the economy (which has followed dollarization since 1999) or to make seigniorage profits.
Under the project, only the central bank could issue electronic dollars and the state-owned mobile phone company (CNT) could facilitate mobile transactions. An individual could open bank accounts at the central bank, and it was expected that by 2015 around 500,000 accounts will be opened. However there were fewer than 5,000 accounts, making the entire scheme unprofitable. Therefore, in 2017, it was decided to deactivate the project by April 2018.
Having mentioned the case of Ecuador’s CBDC, it is highly unlikely that its failure will diminish the spirits of other central banks. First, most would have not even noticed this Ecuador experience given that it is a small country (although inflation targeting was noticed and adopted from another small country, New Zealand). Second, they might be taking a cue from most other industries where it is not the pioneer (Ecuador, in this case) but the second or third movers which eventually succeed.
The RBI cites three factors behind its decision: rapid changes in the landscape of the payments industry, emergence of private digital tokens, and the rising costs of managing fiat paper/metallic money.
The third reason is interesting as most other central banks have barely mentioned “high costs of printing” as a reason for introducing CBDC. Most other central banks have focused on the first two factors and added the decline in demand for physical cash in their economies as one of the reasons. The leader of the pack here is Sweden where usage of cash has declined considerably in recent years. So much so, there are outlets which have stopped accepting physical currency. This has led to its own set of problems as there are population groups like the elderly who are more comfortable with physical currency.
In a speech on 8 December 2017, the Riksbank (Swedish central bank) governor discussed the mechanics of issuing e-krona and called it a possibility in the future. Likewise, similar speeches and analysis have been made by other central banks such as Finland, Denmark, England, Czech Republic, Israel, Switzerland, Canada, Australia, New Zealand, Philippines and so on.
One can point to some broad themes from these other central banks. First, most central banks say much of currency is anyway digital in the form of bank deposits. Second, some have expressed concerns over how central banks issuing an e-currency will make it compete with commercial banks as individuals can open accounts with central bank as well (as seen in Ecuador’s case above). Thus, in case of any crisis, people might shift deposits towards the central bank leading to the collapse of the entire financial system. This makes the scope of e-currency much wider from monetary policy to financial regulation. Third, digital currency should have the anonymity feature, as seen in case of physical cash. This is ironical as one reason for pushing digital money is that it will help in making a trail of one’s income and expenses and track illegitimate activity.
Given this background, it will be interesting to read what RBI’s report will say on this subject.
On the second decision, prohibiting banks from offering any services to entities dealing with virtual currencies, RBI joins the chorus of other central banks which have either banned or warned against virtual currencies. Ironically, these virtual currencies are nothing but the same digital currencies issued by private or decentralized entities (think bitcoin). Prof. Vivek Moorthy argued in this newspaper that virtual currencies have risen mainly due to poor policies of central bankers. It is ironic to see central banks banning the very ideas which led to the development of the CBDC idea in the first place.
Instead of recognizing their contribution, all we see is central banks banning virtual currencies and linking them to criminal activities. We are told that the volume of virtual currencies is insignificant in world currency markets. But then how can they create instability? This is not unprecedented as the monetary history of most countries documents how monetary authorities undermined the issuance of private physical currencies using similar tactics in the past as well.
Mojmír Hampl, vice-governor of the Czech Republic’s central bank, in his speech on 27 February, sums up this point really well: “I will stress—and this is my point today—the positive philosophical influence of bitcoin on the conservative world of central banking. True, it is far from clear that anytime soon a full-fledged digital currency (be it blockchain-based or not) will be created by a central bank (some of you may be following the debate in the Riksbank in Sweden), but the last three years have seen an explosion of research on this idea in many central banks. Bitcoin must be credited for this powerful intellectual stimulus. When so many professors at the most esteemed universities of the developed world are not thinking about potential reforms of the current monetary order, we have received a stimulus from the libertarian IT guys instead. Fine.”
Amol Agrawal is an economic researcher and blogs at Mostlyeconomics.wordpress.com.