Cryptos and CBDC are different 

(Mains GS 3 : Government policies and interventions for development in various sectors and issues arising out of their design and implementation)

Context:

• During the Budget discussion in Parliament the Finance Minister signals to discourage cryptocurrency via taxation and capital gains provisions. 

Dilemma of Central bank:

• The Governor of the Reserve Bank of India, in February, highlighted that the private cryptocurrencies are a big threat to our financial and macroeconomic stability” and “these cryptocurrencies have no underlying asset”.
• Soon thereafter, a Deputy Governor of the RBI called cryptos worse than a Ponzi scheme and argued against “legitimizing” them. 
• Yet, the RBI announced that it will float a Central Bank Digital Currency (CBDC) which creates serious concerns about understanding of cryptocurrency and its nature at policy level.

Character of cryptos:

• The proliferation of cryptos threatens the RBI’s place in the economy’s financial system. 
• This threat emerges from the decentralised character of cryptos based on blockchain technology which central banks cannot regulate and which enables enterprising private entities (such as Satoshi Nakamoto who initiated Bitcoins in 2009) to float cryptos which can function as assets and money.
• Cryptos which operate via the net can be banned only if all nations come together, however tax havens still may allow cryptos to function, defying the global agreement.

Cryptos as currency:

• A currency is a token used in market transactions; thus, commodities (such as copper coins) have been used as tokens since they themselves are valuable.
• But paper currency is useless till the government declares it to be a fiat currency and it is only then that everyone accepts it at the value printed on it; thus, paper currency derives its value from state backing. 
• But cryptos are a string of numbers in a computer programme with no state backing but their acceptability to the well-off enables them to act as money.

Cryptos acquire value:

• The RBI Governor’s statement that cryptos have no underlying asset, not even a tulip, refers to the time when tulip prices rose dramatically before they collapsed. 
• But, tulips cannot be used as tokens while cryptos can be used via the Internet and further the supply of tulips can expand rapidly as their price goes up while the number of Bitcoins is limited.
• So, cryptos acquire value and can be transacted via the net which enables them to function as money. 

Validate each transaction: 

• For the CBDC to be in central control, the CBDC will require the RBI to validate each transaction and solve the ‘double spending’ problem.
• Generally, once a currency note is issued, the RBI does not keep track of its use in transactions thus keeping track will be horrendously complex which could make a crypto such as the CBDC unusable unless new secure protocols are designed. 
• So, CBDCs at present cannot be a substitute for cryptos that will soon begin to be used as money.