Emerging firms are building the future vision of DeFi through a strong emphasis on self-governance and forging synergies with other market participants in the crypto ecosystem.
Cryptocurrencies will not replace fiat currencies. But, ongoing innovations are forcing central banks around the world to consider a centrally-backed version of cryptocurrencies, also known as Central Bank Digital Currencies (CBDCs), or digital Rupee in India’s case.
CBDCs are fiat currency in code. They can be programmed for specific use-cases and leveraged for delivery of government benefits and financial inclusion, address concerns around inclusion errors, and strengthen regulation to counter money laundering and terrorist financing. They can aid in seamless transmission of monetary policy decisions, reduce reliance on US dollar as globally accepted means of payment, and decrease printing and transportation costs related to paper currency. These innovations can take banks and other gatekeepers to formal financial ecosystem out of the equation and do away with the need to go through unreasonable KYC and cumbersome onboarding processes. The risks associated with discretion and human interface will give way to automated transactions based on smart contracts. This will dramatically reduce exclusion risks associated with formal financial system without doing away with associated benefits, thereby making it more efficient and equitable.
However, when proponents of CBDCs suggest that they offer everything that cryptocurrencies can, and thus indicating that there is no need for the latter, they seem to push the envelope. This is like saying that it would have been sufficient if the internet or email were restricted to the US government or offered by centralised government agencies of different countries to their citizens. While such systems can offer control and security to governments, unlike cryptocurrencies, they fail to leverage the potential of global, open-source, real-time, interoperable peer-to-peer systems that do not have a single point of failure.
Cryptocurrencies are global and unrestrained by geographic boundaries. A centrally-backed digital Rupee can enable lakadong turmeric producers in Meghalaya, saree weavers in Chanderi, and shirt manufacturers in Tirrupur to obtain immediate real time payments from their customers anywhere in the country. Cryptocurrencies like Bitcoin, however, can enable them to receive real time payments from customers in the United States, European Union, and Australia, at reduced costs and risks. This round-the-clock access to global payments ecosystem is likely to open up an array of opportunities.
Further, cryptocurrencies are open-source, much like the internet. The internet is tech-infrastructure layer on top of which multiple applications ranging from email to chat services and ecommerce to digital payments have been built. Likewise, blockchains are tech-infrastructure powered by a native cryptocurrency, and on top of this infrastructure layer thousands of applications can be built. These applications can range from governance and health to building a CBDC application itself. While CBDCs are meant to be used as a means of exchange, most of the 8,000 cryptocurrencies today available are not meant for that purpose. At their core, cryptocurrencies are a technology with multiple use cases. And, therefore, they are conducive for innovation in a way that closed-systems, as most CBDCs will likely be, would not allow.
Governments are increasingly warming up to the idea of regulating cryptocurrencies. While this is a welcome step in right direction, prevailing regulatory frameworks do not do justice to the potential of cryptocurrencies, particularly its potential to democratise finance. As the world moves from collateral to cash flow and alternate data-based lending, the transformational impact of lenders from across jurisdictions, offering credit in cryptocurrency, based on global payments data, can be truly incredible. Similarly, imagine the impact that blockchain based open-source decentralised financial services (better known as DeFI), including savings, investment, credit, trading etc, can have on the traditionally excluded groups, like women, low-income individuals, and persons with disabilities.
Cryptocurrencies can be beneficial for CBDC systems as well, helping, say, a digital Rupee and digital Krona inter-operate via a cryptocurrency that has been built to operate with both. The digital Rupee will first convert into the cryptocurrency and then into digital Krona. Such innovation will happen faster with private cryptocurrencies than with centralised CBDCs.
Similarly, a cyber-attack akin to the one happened on the central bank of Bangladesh a few years ago may have a deleterious impact on CBDCs. On the contrary, absence of a centralised issuer and manager of cryptocurrencies will aid in better management of cyber security risks, and avoiding a single point of failure.
Any broad-brush regulation without understanding the nuances of cryptocurrencies may do more harm than good. Ex-ante cost-benefit analysis of proposed regulations and adoption of risk-based approach would be essential to avoid such unintended adverse consequences.
Central banks should not fear the rise of cryptocurrencies. There are several different use cases of CBDCs and cryptocurrencies, and both have immense potential to co-exist, and grow. Obviously, there are few areas of overlap, in which competition will be good to benefit the users.