The Future of Money: CBDC
While the Budget 2021 is the talk of town, let us bring to the surface a bill that was silently dropped on 29th January: a bill that will change the fate of money in India. ReadOn.
The government dropped a bomb on 29th January 2021.
When most of us were discussing the life of bitcoins before the budget, the government quietly came in and listed the new bill: The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021.
What is it?
A bill that prohibits private cryptocurrencies in India.
We felt the weight of a million hearts (and wallets) sink on that day. But, why is the government deciding to ban crypto? And what exactly is crypto? What did they mean when they said they’re planning an official digital currency instead? What’s the difference?
Let’s calm down for now and sit back. We’re going to dive into the future.
But before that, we need a dramatic recap of the past.
Imagine your screen’s changing to vintage for the next 30 seconds. Magically, you are pulled into, let’s say, 10,000 BC.
Here, you find yourself trading your homemade bangles for some goatskin to keep yourself warm and comfy. But, you need milk today. How do you know the value of the goatskin in terms of barrels of milk sold by your neighbour? How many pieces of bangles will you exchange for a barrel of milk or a packet of rice? Who is deciding the individual value of all these goods?
The world, over time, grew tired of going with their gut feeling – undervaluing and overvaluing their items constantly (who are we kidding, we still do that). Empires then stepped up to handle this commotion. They carved their kings' faces on round-cut gold and silver. People crossed their kingdoms for trade, carrying bags filled with their old kings’ faces on their new gold coins.
But, the weight of these coins grew heavier over time. People needed a way to exchange things with something that’d fit easily into their newly stitched pockets. The governor then said, ‘Wait, I promise you this piece of paper will be worth your goat.’ He took the coin reserves and signed his promise on promissory notes. Enter: Cash.
Okay, let’s fade away from vintage and glide back to the present.
The Present Payment System
Today, most of our transactions flow between bank accounts. Banks have done a brilliant job of eradicating both the weight and time it took to carry large amounts. They keep our cash safely vaulted in their systems and now with easy digitalization, they can transfer it around with a click of our finger. It’s a fairly efficient system.
Until, it’s not.
Problems in the existing payment system
Banks depend on intermediaries like VISA cards, settlement institutions, and clearinghouses to transfer and redirect funds amongst each other. Which, drumroll, takes time. A lot of it. And time, as we know, is money.
Not just that, here are a few important shortfalls of the current system that desperately calls for a (disruptive) change:
Parts of the world remain unbanked. Data suggests that globally there are 1.7 billion people unbanked who do not have access to financial services. The fact of the matter is, access to financial services need not be a complex process of opening and maintaining a bank account. Especially when statistically, out of the unbanked 1.7 billion, 2/3rd have access to a mobile phone. Does that not mean that there itself lies a huge scope for innovation that’s just waiting to happen?
The remittance is costly. Digitally, it costs an average of 6.75% of the transacted amount. Basically, if we transfer Rs. 100 to you, we’d have to bear a cost of Rs. 6.75. Which is a lot.
To give you a perspective, the World Bank states that cutting remittance by 5% will save up to $16 billion a year (imagine using that money to build large statues).Cross border complexity. UPI has blessed our lives with instant domestic transactions but internationally, we are still stuck in the loop of time zones, regulations, third parties, jurisdictions, politics, yada-yada. Don’t be surprised when you transfer funds digitally from India to the USA and carry the same amount on an aeroplane and your flight lands before your digital payment goes through! Yes, that’s true. Data says that it takes 3-5 working days for online, cross-border transfer. So, you get the point?
In 2020, these discrepancies became glaring. Globally, the use of non-cash transactions has increased by 12.5% CAGR (year-on-year growth) from 2014-19. In the Asia Pacific, it’s increased to 24%. In fact, cash payments in Sweden are now just less than 10% of all transactions.
Today, as digital payment increasingly becomes the norm, physical cash as a currency starts to look a little outdated. Don’t forget that even in the digital era, cash is the currency we use. It doesn’t always clink in our pockets but it lies silently in all our digital wallets, bank accounts, bonds, shares, and more. In this 21st century, cash becomes the weak kid in the back of the room who once was the class bully.
People find no reason to deal with it.
So, the question is, why is cash still our only currency?
Haven’t people completely gone digital now? Classes, offices, weddings (eye roll) are all online (thanks, Covid). So, naturally, should currency not shift digital too?
Central Banks think so (High5, CBs).
But wait, let’s clear the air about a few things first.
Digital payment is not equal to digital currency.
Digital payment is what Google Pay is in the business of (not taking into account its flourishing tourism business. Did everyone get Gaya and Bastar tickets?). PayTM, UPI, debit and credit cards are just the digital modes of payment fulfilling a function of currency – facilitating transactions. They’re just means of exchange. The currency behind this exchange is still cash.
Digital currency, on the other hand, is issued and controlled by the Central Bank and is lovingly called Central Bank Digital Currency (very creative, we know), or CBDC, for short. They are exactly like the present-day cash, only...digital. Imagine apes turning into humans. That’s it. Digital currency is the natural evolution of money.
Made of bits instead of atoms, digital currency or CBDC is sought to be the legal tender that holds the same value(s). Like paper notes, it will have its unique codes, will be stored in our wallets (sorry pickpockets but this one is hack-free), and can be downloaded into our wallets just like ATMs once churned out cash. It’s just like cash…..only digital. E-cash. The only difference between the present-day cash currency and the future’s digital currency will be that the latter will be end-to-end traceable, highly secured, and instantaneous and will put a lock on the doors of the clearinghouses and other intermediaries. Even our VISA & MasterCard will turn into play-antiques for our grandchildren.
Now, if your head is thinking, what about bitcoins?! Well, cryptocurrencies despite being digital, do not tick the criteria of being a currency in the eyes of the Central Banks – they are not a stable store of value, are highly volatile, and are decentralized. They’re assets (which you did not invest in 2010, let’s cry together).
In actuality, the original idea behind developing cryptos (read, bitcoins) was never to become speculative assets but to be a (disruptive) currency of the future. They were created to solve the problems in the existing payment system and be used as a means of exchange in daily transactions. That’s why it’s called cryptocurrency. Though it couldn’t become what it set out to be (just like most of us), it did make the CBs think. And now, central banks across the world are creating their own currencies. Digitally.
So, how will CBDC work?
The idea of CBDC is a sweet rip off of the cryptocurrency model – both rely strongly on encryption.
Built with blockchain and Distributed Ledger Technology, CBDC is the next best thing to attack corruption with. Every step and node of CBDC is traceable and unhackable, rendering shadow economy and money laundering absolutely redundant. With CBDC, we won’t need a demonetization. The government will legally be able to track and monitor every transaction and our politicians with black pockets will resign immediately (but let’s not daydream of utopia yet).
The beauty of CBDC is that the countries are the bar-tenders, mixing the perfect combo of tech and economics. Here’s one clear and pure model that they’re planning to taste (read, test).
The direct account-based retail CBDC, where the aam janta will hold accounts with the Central Bank and the CB will directly issue the DC into the individual accounts. Here, the operational burden will move away from commercial retail banks to the Central ones.
Countries around the world are not just debating the design of the model but also certain intricacies regarding deposits, interest, etc. Will consumers get interest (like on deposits) or will it be non-interest bearing (like cash)? A lot is still in the talks.
Here, take a look at the inefficiencies in the present system and how CBDC intends to solve them.
CBDC- Package of Offerings
However, there is no debate about the fact that CBDC brings to the table a set of offerings that will appease the hunger of convenience that we have been craving since centuries. With easy tracking of digital footprints, there’d be a significant increase in tax collection with a swift leeway into new, innovative ways of providing financial services. The governments would (finally) know how to better their monetary and fiscal policies. In fact, they could tweak them on a day-to-day, hour-to-hour basis, bringing “an unprecedented level of precision to monetary management”, according to a Bloomberg Report.
In all honesty, there is no clear definition, model, design, feature, or even consensus among the countries on what will truly constitute CBDC. All we know for sure today is that the harm-alarms of Central Banks all over the world are ringing clear and loud. Will they lose the monopoly over money?
Central Banks are scared. Why, you ask?
a) Facebook has decided to issue its own currency.
Yes, you heard that right. Enter Libra, now renamed Diem (they just jumbled Dime, we know, but all we hear is dayumm). A real currency backed by ‘stable coins’ or coins pegged by the central bank, built on the blockchain model and/or Distributed Ledger Technology which can be used as ‘direct’ payment without the involvement of any third-party intermediary. Central Banks are aware that this will solve a lot of their existing problems with cheaper remittance and faster transactions but Central Banks are not ready to let go of their primary function. What will happen if people shift to private-issued currencies, especially one that comes from a giant social media with data and influence over billions around the world?
b) Few countries want to go global with their digital currency.
Zero bonus points for guessing which country is racing to be the first.
Eyeing the position of the world superpower, China has sped up its process of creating its digital currency to gain the first-mover advantage (and to overtake the current currency medal holder, the US Dollar). In fact, China has started offering its Digital currency to nations that fall in its One Belt One Road network. And, with the pandemic shifting everything digital, there’s no surprise that China wants to be DC’s forerunner. And of course, after 2020, we understand why no country would want that.
The Big Disrupter
A lot of companies will either go out of business or their business model will end up changing. Banks, clearinghouses, ATM operators, credit card, and settlement institutions will need to pack up their bags when CBDC enters our lives. Accounts will be held with the Central Bank, or in the wallets of third-party payment providers of fintech companies. With absolute transparency and traceability, people in power (cough high-misters and ministers cough) will lose a big chunk of their pocket money. (Exactly why they do not wish to implement the pure model of CBDC and are looking for a middle ground to keep as many people stuffed and happy).
With CBDC, money in the economy will move from commercial bank deposits to the Central Bank’s balance sheet. This will be glaring and disruptive, especially during a financial crisis, when people stop trusting banks (when they are known to be on, what we call, a bank run) and just like that, a bank’s primary and cheapest source of lending would be snatched away. This will increase the cost of financing, reduce the loan that banks could offer, and mess up the established system of credit creation in the economy. Not just that, our cards will become redundant and companies will lose the remittance fees they charge. It will be a never-seen-before economic disruption.
The very job of the Central Bank is to stabilize the banking system. CBDC, ironically, will collapse it.
However, we are still jumping the gun here. CBDC is fairly new and incredibly complex, both in terms of its technology, its practical implication, and its effect on the economy. The world will need to find a fine balance and the countries may just need to, for once, come together instead of racing ahead.
The global race for a vaccine currency
Breaking news, some are in the development stage and some have already started testing the pilot.
Bahamas was the first to launch CBDC nationwide. It termed its CBDC Digital B$ or sand dollar. Pretty cool. Sweden is also on its way to completely switch to e-krona (a currency, not a virus).
And China is working very hard to develop and implement the Digital Yuan – Digital Currency Electronic Payments – whose trial ended in September. They’re rolling it out on their e-commerce platforms as we speak. China, to kickstart the operation, is giving away 200 Digital Yuans on a lottery basis (we hope that lottery works better than G-Pay’s tickets).
As of today, every country is racing to pocket their digital currency as fast as they’re racing to end the pandemic. Huawei, in fact, has gone as far as to launch cell phones that support their CBDC without the internet.
The million rupee question is, when will we see our own Indian digital currency? Even though the government had listed the bill to be presented in the parliament in the upcoming session, no such development has been seen, except for a few periodic statements made by RBI to show continued interest in this concept.
Also, with India still figuring out a way to provide its 1.3 billion people with access to banks and the internet, it is safe to assume that it will take us a minimum of half a decade to launch and implement our CBDC.
Till then, let’s juggle the idea of a future with a 10G network, of hosting meetings with holograms, of carrying digital currency called e-rupee (okay, but what would you call it?) and listen to many budgets with our team.
Till then, ReadOn!
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Mohit, our extensive researcher who leaves no stone unturned in his efforts and Aastha, who can make any random event both funny and beautiful, attained ‘aatma ka parmatma se milan’ while creating this piece.