Central Bank Digital Currencies: Making Crypto-Investors Nervous?

Cryptocurrency is one of the most widely known speculative assets these days. It is a decentralized currency, developed to be free from government oversight or influence and is monitored by peer-to-peer internet protocol. These currencies are based on BlockChain Technology (BCT), allowing the users to secure their monetary affairs against government interventions. BCT is essential to ensure integrity and secrecy of the transaction data. Cryptocurrency acquires cryptography, a process of transforming information into inaccessible codes to secure transactions. There are thousands of cryptocurrencies available in the market, on which several big players are betting.

Bitcoin is the first known decentralized cryptocurrency, launched in the year 2008. Other well-known cryptocurrencies include Dogecoin, Ethereum, Bitcoin cash, Litecoin, Ripple and more. These currencies are used more as a form of investment than a method of payment. Such types of digital currencies have not been widely accepted by businesses and consumers, and are currently too volatile to be suitable as a method of payment. This brings the question of the future of cryptocurrency.

According to the Future Payments Report 2021 by PwC, private sector currencies are predicted to have the biggest disruptive impact over the next 2 decades. These currencies have the potential to disrupt many industries such as finance, banking and accounting. BCT has the potential to disrupt the financial sector as it improves financial security, brings in smart contracts, has a potential to multiple security and improves financial sector efficiency.

Recently cryptocurrencies are in limelight due to the returns they have provided to the investors over the years, along with that, the market faced a sharp dip in a day’s time last month as it saw big corrections with prices of major cryptocurrencies, namely Bitcoin, Ethereum, BNB and others crashing down by 30%. These corrections came in the backdrop of China banning financial institutions and payment institutions from providing services related to cryptocurrency.

Digital revolution

Over the years, there has been a digital revolution demanding all possible services to move on digital platforms, demanding the payment system to move online so as to make services easier to access and utilize. A significant amount of transformation in the financial service sector was under process in the previous years, which got accelerated due to the COVID pandemic. This digitalization has reshaped the economies and the way people make payments. Though cash still seems to be preferred as a mode of payment, over the time there has been a shift in the payment habits of people and they have moved on to digital methods. This shift in payment habits is the reason why digital currencies are so famous these days.

Views of the proponents and opponents on cryptocurrency

The proponents of cryptocurrency believe that it is the future of the financial world, though extremely volatile right now. Once cryptocurrencies reach their maximum capacity and start getting used by maximum users for transactions purposes, its volatility will be bearable. In their opinion, the future of cryptocurrency is bright, as it will be anyhow accepted by all with time.

But the future of the cryptocurrency highly depends upon its acceptability by the countries as a legal tender, and this is in question as several countries such as Bolivia, China, Algeria, Morocco, North Macedonia, Saudi Arabia, India and a few more have banned cryptocurrency many times.

Its opponents believe that these currencies can be used for illegal activities such as drug exchange, money laundering, tax evasion and other illicit functions. According to a few economists, it is even a short lived speculative bubble. These currencies are also not immune to the threat of hacking.

It is interesting to see that both sides have valid points which require thorough research and thinking in order to create a better and more efficient digital payment system. The future of cryptocurrency will depend upon how the issues faced by both sides are solved in an efficient manner.

Since the economies are moving online, digital currencies are going to be the future of financial systems and require timely attention, keeping that in mind several Central Banks of economically advanced countries like Russia, Japan, U.S., China and UK are coming forward in order to develop an efficient system of digital transactions. Central Banks of asian countries like China, Japan and India have already opposed cryptocurrencies due to their highly volatile nature which can affect financial stability of their respective countries. These countries are now looking at a new way other than private sector currencies, which is Central Bank Digital Currency. Many central banks around the world are developing sovereign digital currencies as there is a need for a fast and cheap payment system. The actions taken by the Central Banks will possibly disrupt the cryptocurrency market.

Central Bank Digital Currency

A Central Bank Digital Currency (CBDC) is a digital form of a country’s fiat currency backed by a government’s central bank which holds the liability. Instead of printing money, the central bank issues digital coins.

CBDCs are not the same as cryptocurrencies as they are controlled by the regulatory authorities of the respective countries. The value of one digital currency unit equals the value of one real currency unit. For example, one unit of India’s digital currency would be the same as the value of one unit of rupee. This is in contrast to cryptocurrency, who’s price isn’t linked to any currency and is only affected by supply and demand.

Recent survey showed that nearly 80% of the central banks around the world are working on the research and development of Central Bank Digital Currency. Cryptocurrency sceptics say that there are good reasons to believe that the governments around the world will eventually ban cryptocurrency and they will not dilute their monopoly power over money. If many countries start banning cryptocurrency, the market will be in danger.

Currently Indian government is planning to introduce the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, which contains provisions to completely ban cryptocurrency. The decision regarding the same is yet to be finalized and is under discussion.

Many countries believe that CBDCs will promote financial inclusion and make cross border transactions fast and easy.

According to the Atlantic Council CBDC tracker, there are 19 countries which have started a pilot project to test CBDCs, 28 are in the phase of doing research for proper understanding of the functioning and building an efficient digital currency system, 14 are in the phase of development and 3 have cancelled the plan to work on the development of CBDC.

El Salvador is now the first country in the world to adopt Bitcoin as legal tender. This step by a country is the first step to legally use a private sector currency. The results and experiences from the same will possibly be of use for other countries to decide what steps they should take.

It will be too soon to predict the possible future of cryptocurrency as of now, as there is a lot more that needs to be explored about its technology. But it will highly depend upon the acceptability by the people and how the market reacts to uncertain situations. Since few countries have started accepting cryptocurrency, while the others are in favour of banning it, this marks the future of cryptocurrency even more uncertain. Now it will be interesting to see which direction the countries will choose in order to build an efficient digital payment system, whether it will acquire the Central Bank Digital Currency or Cryptocurrency.