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The future of money

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No power can stop an idea whose time has come.”
-Victor Hugo

In a world where more people possess cell phones than conventional bank accounts, digital currency is definitely one such idea.

Money is considered to be one of the greatest inventions by mankind, right beside fire and wheel. The fact that some pieces of printed paper can be exchanged for something of deep intrinsic value like land, food or fiber is mind boggling. The very notion that a few chunks of a low-grade metal are believed to be worthy of a hard day of back breaking labor is no less than the notion of God itself. While money has been around since the beginning of civilization, it is interesting to study where it is headed in the 21st Century.

It is no news that, like everything else around, money too has become digital in the age of internet. In this age, the financial system is based on the existence of a central authority known as the Central Bank. Almost every country has one like the Reserve Bank of India, Federal Bank in USA, Bank of England for UK etc. Further, there is a Bank of International Settlements (BIS) situated in Basel, Switzerland which serves as the Central Bank of Central Bank. The task of these central authorities is to basically determine the monetary policies, the exchange rates and everything that goes around in the world of money. It is a high-handed, opaque, centralized system which haughtily decides who has the access to money and at what cost. Needless to say, like everything else political, this system too can get fairly unfair, fairly quickly. The ever-widening income inequalities, the perpetual death spiral of struggling economies, the crippling student loans and hypocrisies of rich nations in honoring trade deals are marked indicators of how this system has failed the vast majority of us. Hence, the need to establish an alternate system, preferably de-centralized, could not be clearer.

Digital Currency is one step towards establishing such a new-age, de-centralized financial system. Its foundational principle, in addition to de-centralization, is absolute transparency. Of the several technologies currently being explored in this field, Blockchain is indefinitely the most promising one. To understand Blockchain consider the following example. There is a group of friends A, B and C which frequently exchange money amongst themselves. They appoint one friend A as the account keeper. Whenever B transfers Rs 100 to C, the following happens:

  1. Rs 100 get debited from B’s account and Rs 100 get credited to C’s account.
  2. The role of A is to ensure that only Rs 100 get debited and credited from respective accounts.
  3. Also, A ensures that B had at least Rs 100 in his account to begin with. If not, the transaction will not complete.

The role of A in this case is similar to that of a Central Bank since only A has the power to verify transactions. In cases when the payer has lesser balance than required, A can chose to give him a loan. Similarly, it can choose not to. In every case, A is in a position more powerful viz a viz B and C. This imbalance of power is precisely what blockchain technology offers to solve. Via blockchain technology, every transaction will be verified by every participant before being completed. No single friend A, B or C will be in charge of verifying and maintaining account balances but all of them would be. Simultaneously. Let me explain how this works.

  1. B transfers Rs 100 to C. Rs 100 will be debited from B’s account and credited to C’s .
  2. The initial and final account balances will be verified not just for the participating members (B and C in this case) but for all 3 ie A, B and C.
  3. The account verification and maintenance will not be done by just one member (like A did previously) but by all 3 ie A, B and C.

Think of it as a balance sheet maintained, verified and updated by every participating member and not just one. And in case a new member joins- he would not only become equally participative; responsible in the all the subsequent transactions but would also have access to all the transactions completed before. In practice, no single participant would be more powerful than the others and each one would be equally placed. A truly de-centralized system.

This is just one manifestation of how blockchain technology works and its manifestations and applications go way beyond the world of digital currency. Several digital currencies including crypto currencies like Bitcoin, Ether, Ripple etc operate using blockchain. But it is important to understand why I mentioned digital currencies and crypto currencies separately.

Digital currency is an umbrella term which includes not only crypto currencies like bitcoin but also Central Bank backed digital currencies commonly called Central Bank Digital Currency (CBDC). But we just talked about decentralization. Then doesn’t CBDC sounds like an oxymoron? Well technically yes. A CBDC is basically a currency issued by a Central Bank but only in digital form. Understand it like the rupee printed by the Reserve Bank of India, but instead of printing notes- RBI simply creates a digital token. Like your PayTm balance. No physical existence but just as good as physical money to make transactions. So, a CBDC is exactly the same as a physical currency except it only exists in digital form. It is one example of digital currency which is not de-centralized. But why would central banks want to enter this domain of digital currencies? Well, because it is their only hope to maintain their control over the global money supply in the coming decades. With world-wide crypto currency market already valued at $2 trillion, these banks are way behind the curve.

According to a research paper by BIS, 86% of the Central Banks in world have shown interest in CBDC. A few like the Central Bank of Republic of China have already issued their CBDC in form of e-Chinese Yuan (e-CNY). The highest selling point of CBDCs is that they promote financial inclusion, which is true. But at the same time, they have the capacity to encroach on the privacy of individual users. Also, exactly how would they use blockchain technology to promote de-centralization; transparency is yet not clear. The Indian government had planned to table ‘Cryptocurrency and Regulation of Official Digital Currency Bill 2021’ in the last year’s monsoon session but a tempestuous parliament session made it impossible. With this bill, the government had sought to by-pass a 2018 judgement of Supreme Court. In this judgement the apex court had over ruled the decision of RBI to ban any kind of trading in private crypto currencies in India. This essentially meant anybody in India could trade in private crypto currencies like Bitcoin, Ether etc without breaking the law. Something which RBI did not want. For the obvious reason that if the market of private crypto currencies grows beyond a limit, RBI would eventually lose control over the money supply in India. However, fast-forwarding to the budget speech of 2022, our honorable Finance Minister has now declared that

“….any income from transfer of any virtual digital asset shall be taxed at the rate of 30%

With these words, our FM has done what could not be done in the last year’s monsoon session. The FM has not only hinted at the future of taxation regime in India but has also starkly underlined the Indian government’s serious intentions of dealing with this inevitable future of money. Possible consequences of the same merit some serious attention.

The ‘Cryptocurrency and Regulation of Official Digital Currency Bill 2021’ had sought to declare all the private crypto currencies in India illegal. In addition, it had proposed bringing out a CBDC in the form of e-Rupee. Madam minister, in her budget speech, replaced ‘illegal’ with ‘30% tax bracket’ and ensured continuity in the idea of an RBI issued CBDC. The merits and demerits of this change/continuity are obvious. Taxed private crypto currencies and a RBI issued CBDC would promote financial inclusion, prevent tax evasion, disrupt the flow of black money and make data about money market more realistic. In a country with a big shadow (cash only) economy the last point is of the highest significance. Because the monetary policies can be only as effective as the data they are based on. And hence rate cuts/ hikes by RBI fail to have the same effect as those by Federal Bank of USA, on the ground reality. Thus, a CBDC is a welcome step in an economy like India. And the proposed tax regime can be a promising start too. But there is an alternate side too.

If all the private crypto currencies will be taxed at such a high rate in India, it would simply push them underground, into the domain of illegal trade and dark web. Very much like what luxury products; gold was like before the liberalization reforms of 1991. The notorious gangster Dawood Ibrahim had famously said

“Gold mein paisa khatam”

i.e. “No more money in gold” when the then Finance Minister Madhu Dandavate had abolished the ‘Gold Control Act’ and reduced the import duty on gold from 20% to 0%. The hawala rate of gold and the official rate of gold became at par, rendering the smugglers out of a job. A highly tax regime for crypto currencies would force the investors to turn to dark web like high import taxes had turned buyers to smugglers. This would not only increase cyber-crimes in India but also make India lag in this fin-tech of the future. Second, when the government would bring out a CBDC- how would it teach it to the Indians in Tier 2 and Tier 3 cities, especially outside the demography of youth. Third, what will be the quantum of CBDCs issued. Today physical rupee notes are printed keeping the money supply and inflation in mind. What parameters would be kept in mind while ‘minting’ this digital currency? How would the monetary policy be decided with two types of fiat currency in circulation? Fourth- how would we keep people’s life savings in form of CBDCs safe from ransomware attacks? Are we as a society, technologically equipped and educated enough to handle the flood gates of cyber-attacks that would open? And many more such questions that we perhaps can’t even fathom right now.

Money of the future is truly going to be different from the money present. Global financial system today stands at the same cross roads as it did after World War II. While India was too insignificant during the 1945 Brettonwoods conference, to have any voice- the tables have turned now. With dollar hegemony on the decline and Chinese honor questioned all around- the timing could not have been better for India to mark its presence. But are we smart enough to act? That is the question.

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