India has always viewed digital currencies with suspicion. In 2018, the Reserve Bank of India prohibited regulated entities from providing services to anyone who deals with or settles trades in any virtual currency, effectively banning Bitcoin trading in the country. While the Supreme Court lifted this restriction in 2020, there were rumours earlier this year that a new law was in the works that would make it a crime to possess, issue, mine, trade or transfer crypto assets in India.
Whenever I speak to my banker friends about Bitcoin, they make a number of arguments as to why it should be prohibited. They usually start with concerns over the speculative nature of cryptocurrencies and how gullible folks are being inveigled into spending their savings on these highly volatile investments. It usually ends with law enforcement concerns around how digital currencies make it hard for the police to track down criminals. I have sound counter-arguments to all these concerns. But, truth be told, I actually don’t think it is particularly helpful to think of Bitcoin as a currency at all. One of the most important attributes of a currency is that it should be a stable store of value, and Bitcoin is anything but. Instead, I believe it is more helpful to think of digital currencies as just another asset—the digital equivalent of a scarce commodity that, like gold, certain collectors prize. It is for this reason, above all else, that I believe no one should talk about banning Bitcoin any more than they should look to ban the collection of rare works of art or first-edition stamps.
But does cryptocurrency serve any purpose beyond being an exotic collectible for the digitally savvy? I believe it does. But before we go there, allow me the indulgence of an explanation.
Our financial system relies on banks to record transactions—to keep track of how much money a person has and who she has transferred it to. It is a ‘permissioned’ ledger system in that only trusted intermediaries (registered banks under the supervision of the central bank) can make changes to the ledgers to certify that a given transaction has been completed. Cryptocurrencies, on the other hand, are ‘permissionless’ systems that need no intermediary. Instead of a centralized ledger, transactions are recorded on a distributed database through a system that updates each transaction on every instance of the ledger held by all participants in the system. A purely permissionless system has no need of banks—which explains its particular appeal to those who believe our financial system is broken, as also the slightly irrational fear it tends to evoke among bankers.
As appealing as a permissionless system sounds, it ignores the realities of the modern world. Central banks are not just intermediaries managing the great big financial ledger of the country, they are responsible for its financial health. To perform this function, they need to be able to take money out of the system when required (such as to pre-empt dangerous currency fluctuations) or put money back into economic circulation (such as when needed to stimulate the economy). None of this is possible in a purely permissionless system, as the distributed nature of its financial architecture makes such central bank interventions impossible.
That said, a currency designed along the lines of Bitcoin has many advantages that we should not ignore. Digitally native currencies are programmable and capable of being incorporated into smart contracts, offering various opportunities for innovative digital solutions. Since they can be directly allotted to citizens who don’t have a bank account, they are ideal for financial inclusion, particularly in countries where bank networks are already stretched thin. Being digitally auditable, transactions can be audited, reducing the scope for illicit activity. The challenge is one of integrating the best that digital currencies have to offer into the traditional financial paradigm.
Many countries have been toying with the idea of a central bank digital currency (CBDC)—a digital currency that functions as a electronic representation of a country’s fiat currency. CBDCs are a completely re-engineered form of money that use a distributed ledger as their underlying technology layer, but are backed by suitable amounts of monetary reserves, just like normal fiat currency. They are run by central banks along with select financial entities responsible for managing the distributed ledger. The best CBDCs will converge the best of both worlds—the programability and security of cryptocurrencies and the reserve-backed stability of fiat currency.
Several countries are already testing this concept. In 2020, the Bahamas introduced the Sand Dollar, while Sweden’s Riksbank began testing its eKrona CBDC as a proof of concept. Many other central banks around the world are seriously considering it. By all accounts, however, the country that has made the most progress is China, with much of the underlying infrastructure for its new digital currency, the Digital Currency Electronic Payment, or DCEP, already built.