A cryptocurrency escapes the control of countries’ central banks. As the name suggests, the currency is encrypted and is not accessible to anyone other than the owner. A number of computer enthusiasts get together and they solve a puzzle like Sudoku. Whoever can solve the puzzle receives a prize in the form of a currency such as Bitcoin. All other players must confirm that the winner has solved the puzzle. Only then does he receive the cryptocurrency. Control of money is not with one person. It is distributed among all the players. A new puzzle solving game begins after the previous puzzle has been solved. In this way, new cryptocurrency is made just as new paper banknotes are printed. Governments or their central banks cannot identify owners or determine the number of parts manufactured. Cryptocurrency stands and operates alongside central banks.
Central banks have been opposed to the promotion of digital currencies. The first downside, they say, is that cryptocurrency can destabilize the economy. For example, let’s say inflation is high. The Reserve Bank of India wants to reduce inflation and reduce the money supply to discourage borrowing and consumer spending and slow the economy. Cryptocurrency can continue to be manufactured in large numbers and reverse the reduction in money supply implemented by the Reserve Bank. It’s like a person paying by debit card when they don’t have cash in their wallet. In this way, governments lose control over monetary policy. The second downside is that cryptocurrencies can fail and destabilize the economy again. Prior to 1863, there was no national currency in the United States. Various private entities and municipalities have issued their own currency. Many banks went bankrupt and municipal currencies were devalued, causing chaos in the economy. The federal government enacted the National Currency Law and ensured the circulation of a single currency. We can go back to the pre-1863 chaos situation if cryptocurrencies are allowed. Cryptocurrencies can be stolen or devalued. The third disadvantage is that of supporting the crime. Recently, the computers of an oil company in the United States were hacked. Hackers demanded and obtained payment of a ransom in cryptocurrency. Part of the ransom was recovered by the police, but not a part. Cryptocurrency is anonymous. An owner cannot be identified because it is simply a number stored in the computer.
Cryptocurrency is beneficial despite these drawbacks in situations where central banks are irresponsible. For example, let’s say the government of a country prints paper money indiscriminately and the prices go up, say, 10 times in a year. In such a situation, it becomes very difficult for the businessmen to manage their affairs as the value of paper money changes from hour to hour. It is also difficult for any household to protect its income because the value of paper money can drop in a week. Digital currency can provide a secure method for transacting and storing income in such situations. It’s a bit like a person buying gold when inflation goes crazy. The advantage is that the problems of saving gold do not arise in cryptocurrencies. The presence of cryptocurrencies can serve as a check on bad policies followed by central banks. Let’s say country X has a bad government and it prints indiscriminate notes. People can switch to digital currency and force the central bank to follow more cautious policies. Overall, therefore, cryptocurrency is harmful if the central bank is careful, and it is beneficial if the central bank is reckless.
Now comes “digital currency”. A digital currency is like cryptocurrency in that it is also just a number stored on a computer. However, it is not anonymous like cryptocurrency. It can be issued by a central bank like the Reserve Bank of India. The number of digital currencies issued is determined by the central bank and ownership is also tracked. However, the value of digital currency can be determined by the market bidding process similar to bitcoin pricing by supply and demand as is the case today; or similar to determining the price of the rupee. The Reserve Bank will be able to identify the owners of the digital currency and may prevent the use of this currency for criminal, money laundering and other illegal purposes. Digital currency can be prevented from destabilizing the economy because the Reserve Bank can control the number of digital currencies issued. However, a digital currency cannot help people overcome the bad policies of the bank itself. The central bank can issue a large number of digital currencies at the same time as it prints a large number of indiscriminate paper money. The digital currency will therefore not act as a control over the central bank.
I would welcome digital currency and vote against crypto currency. A digital currency will not be able to fight against the reckless policies of a central bank by indiscriminately printing paper money. At the same time, it won’t be able to destabilize the economy like a cryptocurrency could. The other advantages of digital currency are that it cannot be used for criminal purposes like cryptocurrencies; and it can be stored safely at minimal cost. The cost of the transaction would also be lower than that of paper currencies which involve printing of banknotes etc. Thus, digital currency does not solve all the problems and can be called a halfway house. Either way, we’re caught in a Catch-22 situation. If we go for a cryptocurrency outside of the control of a cautious central bank, we can cause instability. On the other hand, if we reject cryptocurrencies then we are not providing the people with an alternative against the reckless central bank. The central bank’s cautious problem cannot be solved by technical innovations like cryptocurrencies or digital currencies. This requires improved governance.
(The author is previously professor of economics at IIM Bengaluru)