Digital currencies backed by various central banks may become a reality in future. Many of the world’s central banks are toying with the idea of issuing digital currencies.
Late last month, the Reserve Bank of India (RBI) had called a central bank-supported digital currency “a mixed blessing”. In a new report on currency and finance, RBI had stated that such virtual tokens increase financial inclusion and transparency.
At the same, RBI, however, doesn’t seem to have faith in cryptocurrencies. A couple of weeks ago, in an interview with CNBC TV-18, RBI governor Shaktikanta Das had said the central bank had a few major concerns about cryptocurrency and its impact on financial stability.
In fact, the Indian government, too, is scheduled to table a bill in the Parliament to ban private digital currencies. That apart, the government also seeks to launch a framework for an official digital currency issued by the RBI.
Even in other countries, there is a rush for a central bank backed digital currency. In China, trials of ‘e-yuan’ have started. In Europe, the authorities want to launch a digital Euro by 2025. In Bahamas, ‘sand dollar’ is already in circulation.
So, are digital currencies a threat to cryptocurrencies? Let’s take a look.
What is a central bank’s digital currency?
A central bank digital currency is the electronic equivalent of cash in a banking system. So, automatically, it offers a very high level of security as a central bank can never run out of the currency it issues.
How is digital currency different from a private cryptocurrency?
Unlike cryptocurrencies, digital currencies come with less volatility and have greater security. Take Bitcoin, for example. It has given stellar returns since its inception, and has been on a bull run since the beginning of this year. Despite that, no matter how much its value surges, it will always remain a speculative bet.
On February 8, the value of the cryptocurrency surged after electric car maker Tesla stated that it had bought Bitcoins worth $1.5 billion. However, it dropped 10 percent a few days later when Elon Musk tweeted that the price of Bitcoin was high. So, the value of cryptocurrencies will always be dependent on what an investor is willing to shell out for them, making them extremely volatile.
Second, digital currencies have the support and backing of their respective financial institutions. Once introduced, they will allow people to make payments via the internet and possibly even offline, competing with cryptocurrencies.
Third, cryptocurrencies are rivals of central banks, as they are unable to control them like money. On the contrary, because an official digital currency will always be backed by the central bank, it will remain risk-free like banknotes.
What are the risks?
If a central bank digital currency is introduced, it would deprive commercial banks of a stable source of funding such as retail deposits. In the event of a crisis, this would expose them to vulnerability of running on their coffers as clients would prefer the safety of an account guaranteed by the central bank.
So, are digital currencies a threat to cryptocurrencies?
An investor who wants to play safe will opt for a central bank digital currency, just because the risks are nil. Such investors don’t have deep pockets to hold on to their losses, and, so, will find the kind of kind of volatility associated with private cryptocurrencies tough to handle.
Second, private cryptocurrencies’ value fluctuates drastically within short periods of time. So, if goods and services are traded using private cryptocurrencies, and if the value changes frequently, it can create huge uncertainty for buyers and sellers.
Considering these aspects, a central bank digital currency is much safe compared to cryptocurrency, and can be a threat to it.