Digital Currency

Digital Currency

 

Introduction

  • The digital age has brought with it a new form of digital currency. Cryptocurrencies, virtual currencies, and other forms of digital money are becoming increasingly popular and prevalent in today’s times. It’s essential to understand what these types of currency are and how they work. In this article, we explore what digital currency is, how it works, and the potential benefits of using it.

 

About the Digital Currency

  • A sort of money that can only be obtained digitally or electronically is known as a digital currency.
  •  A central bank digital currency (CBDC) refers to a type of digital currency issued by a nation’s central bank.
  •  It shares similarities with cryptocurrencies, but unlike them, its worth is determined and guaranteed by the central bank, aligning with the value of the country’s traditional fiat currency.
  • Digital Currency is typically stored and transacted electronically, using digital devices such as computers, smartphones, or other electronic devices. It allows for quick and convenient transactions, as well as seamless online payments.
  • Other names for it include cybercash, electronic currency, digital money, and digital money.
  • It has no physical characteristics and can only be acquired digitally.
  • Digital currency transactions are carried out through the use of computers or electronic wallets linked to the internet or specific networks.
  • In contrast, tangible currencies have distinct physical properties and characteristics, such as banknotes and coins that have been produced.

 

Features:

  • Both centralized and decentralized digital currencies exist.
  • Fiat currency is produced and distributed centrally by a central bank and other governmental organizations and exists in physical form.
  • Decentralized digital money systems include well-known cryptocurrencies like Bitcoin and Ethereum.
  • Types: The electronic world uses a variety of currencies. There are primarily three types of currencies:

Cryptocurrencies

  • Digital currencies known as cryptocurrencies use cryptography to safeguard and validate network transactions.
  • The development of such currencies is managed and regulated through the use of cryptography.
  • A couple of instances of cryptocurrencies include Bitcoin and Ethereum.

Virtual currencies

  • Virtual currencies are unregulated digital currencies that are managed by developers or a founding organization made up of different process participants.
  • A predetermined network protocol can likewise be used to algorithmically govern virtual currencies.
  • A gaming network token is an illustration of virtual money, and its economics are established and managed by developers.

Central bank digital currency

  • Central bank digital currencies (CBDCs) are regulated digital currencies that are issued by a country's central bank.
  • A CBDC can be used in addition to or in substitution for conventional fiat money.
  • A CBDC only exists in digital form, in a contrast to fiat currency, which also exists in physical form.
  • A few of the countries considering introducing a digital version of their domestic fiat currencies are Uruguay, England, and Sweden.

 

How is digital currency used?

  • The digital currency has exploded in popularity in recent years and is now being used for a variety of different purposes.
  • One of the most popular uses of digital currency is to use it as an investment tool. Many people have started investing in digital currency, as the potential to make a significant return on investment is very high. However, since any physical currency does not back such currencies, the risk is also very high.
  • Digital currency can also be used for anonymous purchases, as it does not require any personal information to be revealed in order to make a purchase. This means that people can make purchases without leaving a digital footprint.

 

Advantages and Disadvantages of Digital Currencies

Advantages

  • Fast Transfer and Transaction Times: The amount of time required for transfers involving digital currencies is extremely fast. As payments in digital currencies are made directly between the transacting parties without the need for any intermediaries, the transactions are usually instantaneous and low-cost. This fares better compared to traditional payment methods that involve banks or clearinghouses. Digital-currency-based electronic transactions also bring in the necessary record-keeping and transparency in dealings.
  • No Physical Manufacturing Required: Many requirements for physical currencies, such as the establishment of physical manufacturing facilities, are absent for digital currencies. Such currencies are also immune to physical defects or soiling that are present in physical currency.
  • Monetary and Fiscal Policy Implementation: Under the current currency regime, the Fed works through a series of intermediaries (banks and financial institutions) to circulate money into an economy. CBDCs can help circumvent this mechanism and enable a government agency to disburse payments directly to citizens. They also simplify the production and distribution methods by obviating the need for physical manufacturing and transportation of currency notes from one location to another.
  • Cheaper Transaction Costs: Digital currencies enable direct interactions within a network. For example, a customer can pay a shopkeeper directly as long as they are situated in the same network. Even costs involving digital currency transactions between different networks are relatively cheaper as compared to those with physical or fiat currencies. By cutting out middlemen who seek economic rent from processing the transaction, digital currencies can make the overall cost of a transaction cheaper.
  • Decentralized: Digital currencies may be decentralized. This means they are not controlled by any government or financial institution. Decentralized digital currencies make them more resistant to government interference, censorship, and manipulation. Decentralization means true control over the digital currency is spread over a broader range of owners or users.
  • Privacy: Because transactions with digital currencies are not linked to personal data, users are given a high level of privacy and anonymity. They are therefore very helpful for those who want to protect the confidentiality of their financial dealings.
  • Accessible Around the World: Anyone with an internet connection can utilize digital currencies from anywhere in the globe. These services are therefore particularly helpful for people who do not have access to conventional banking institutions. In addition, many of these banking services only need access to an internet connection; for geographical areas that are not as developed with a strong financial infrastructure, digital currencies may be a stronger option.

 

Disadvantages

  • Storage and Infrastructure Issues: While they do not require physical wallets, digital currencies have their own set of requirements for storage and processing. For example, an internet connection is necessary as are smartphones and services related to their provisioning. Online wallets with robust security are also necessary to store digital currencies.
  • Hacking Potential: Their digital provenance makes digital currencies susceptible to hacking. Hackers can steal digital currencies from online wallets or change the protocol for digital currencies, making them unusable. As the numerous cases of hacks in cryptocurrencies have proved, securing digital systems and currencies is a work in progress.
  • Volatile Value: Digital currencies used for trading can have wild price swings. For example, the decentralized nature of cryptocurrencies has resulted in a profusion of thinly capitalized digital currencies whose prices are prone to sudden changes based on investor whims. Other digital currencies have followed a similar price trajectory during their initial days. For example, Linden dollars used in the online game Second Life had a similarly volatile price trajectory in its early days.
  • Limited Acceptance: Digital currencies are still not commonly used as a means of payment by retailers and other enterprises. Because of this, using them for routine transactions may be challenging. Though digital currencies have gained in popularity, there are still limited functionalities in everyday transactions in many places.
  • Irreversibility: On a digital currency network, transactions are irreversible. This means that once a transaction has been completed, it cannot be undone. In circumstances where a mistake or fraud has taken place, this may be a disadvantage. This is also a tremendous disadvantage for those new to the digital currency space, as there is a substantial learning curve. Because there is no central oversight area for many digital currencies, new users can't simply go to their local branch to receive help for many digital currencies.

 

Why is the RBI promoting Digital Currency?

  • Reduced Central Bank Costs: It may decrease the expenses associated with printing and circulating physical currency and diminish the reliance on intermediaries in payment processes.
  • Enhanced Security and Privacy: It ensures secure transactions and offers increased privacy, thereby mitigating the risks of fraud and identity theft.
  • Potential for Economic Growth: It facilitates faster and more efficient payments, potentially stimulating economic activity and fostering growth.
  • Facilitation of Cross-Border Transactions: It can simplify and lower the costs of international transactions, reducing the necessity for foreign exchange conversions and intermediaries.
  • Mitigation of Illicit Activities: It can potentially decrease illegal activities such as money laundering and tax evasion by meticulously recording and tracing all transactions.
  • Simplified Tax Collection: It could streamline tax collection procedures due to the comprehensive recording and tracking of transactions.
  • Increased Transaction Efficiency: It can streamline payment systems, shorten settlement times, and facilitate quicker and more convenient transactions.
  • Enhanced Financial Inclusion: It can broaden access to financial services for individuals and businesses underserved by traditional banks, thus fostering financial inclusion.
  • Improved Monetary Policy Control: It offers central banks improved tools for managing inflation, interest rates, and other macroeconomic indicators, thereby aiding in economic stabilization.

 

Future of Digital Currencies

  • Cryptocurrencies like Bitcoin have exploded in value, but they are largely used for speculation or to buy other speculative assets. Although there have been some signs of merchant adoption in countries like El Salvador, the high volatility and complexity of these currencies make them impractical for most daily applications.
  • Many companies have tried to reduce volatility by introducing stablecoins, whose value is fixed to the price of fiat currency. This is usually done by depositing an equivalent amount of fiat, which can be used to redeem the tokens. However, stablecoin issuers such as Tether have used these deposits on more speculative investments, raising concerns that they are vulnerable to a market crash.
  • Another possible application is in central bank digital currencies, which could be issued by a country's bank or monetary authority. These would be used and stored in online wallets, similar to cryptocurrencies, but allowing the central bank to issue and freeze tokens at will. Several countries, such as China, have proposed digital versions of their currencies.

 

Examples of Digital Currencies

Some major central banks around the world have looked into issuing their digital currencies. Some of the larger, more notable examples include the countries below.

  • China: The People's Bank of China (PBOC) has been testing the digital yuan, also known as e-CNY, in Chinese localities. Millions of Chinese citizens currently utilize the digital yuan, which is intended to be used for retail transactions.
  • Sweden: Also since 2020, Sweden's Riksbank has been testing the e-krona digital currency. The e-krona is being created to complement Sweden's diminishing use of currency and to give the general public access to a safe and effective payment system.
  • EU: A digital euro that may be issued by the European Central Bank (ECB) and used for retail transactions within the Eurozone is being investigated.
  • England: The Bank of England is looking into the prospect of launching the Bitcoin cryptocurrency. The U.K.'s payment system would be backed by a digital currency, which could also reduce the nation's dependence on cash.
  • Canada: The Bank of Canada has conducted research and consultations on the idea of creating a CBDC.

 

Challenges

  • Lack of Consumer Protection: No Dispute Settlement Mechanisms and control of Securities and Exchange Board of India (SEBI).
  • Digital Illiteracy: The population of India is currently not equipped to deal with cryptos.
  • Security Risks: Cyberattacks on wallets, exchange mechanism (Crypto jacking).
  • Shield to Crime:  If not regulated and monitored properly, it can be used for illicit trading, criminal activities, & organised crimes.
  • Popularity of Cryptocurrencies: RBI has repeatedly flagged concerns over money laundering, terror financing, tax evasion, etc with private cryptocurrencies like Bitcoin, Ether, etc.

 

Conclusion

India is poised to take advantage of the next wave of the digital revolution by deploying its human capital, skills, and resources to make a significant impact. All that has to be done is to properly formulate policies. Indians should not be made to just ignore the Fourth Industrial Revolution’s role in blockchain and crypto-assets.

 

 

What is Digital Currency? And Why is the RBI promoting Digital Currency?

 

 

1)With reference to Central Bank digital currencies, consider the following statements:

1.It is possible to make payments in a digital currency without using the US dollar or SWIFT system.

2.A digital currency can be distributed with a condition programmed into it such as a time-frame for spending it.

Which of the statements given above is/are correct?

 

a) 1 only

b) 2 only

c) Both 1 and 2

d) Neither 1 nor 2

 

Answer C