Why CBDC may not be a panacea for tackling crypto-asset risks

Why CBDC may not be a panacea for tackling crypto-asset risks

The RBI Concept Paper on Central Bank Digital Currencies does many things: it points out the central bank’s many motivations behind the digital rupee (or ₹), it points out the design choices that RBI tends toward to pursue these motives, and it succinctly outlines What follows—searching for the path until the launch of ₹e— pushes the policy debate into the next gear—from speculation to claims about the merits of motives, design, and outcomes. However, there are many misunderstandings – particularly about what the RBI expects from e ₹ and what can reasonably be expected. One example of this is the impact that a central bank digital currency can have on the broader adoption of crypto-assets and stablecoins.

Globally, central bankers are divided on whether the rise of crypto-assets has accelerated their crypto projects: in a survey conducted by the Bank for International Settlements in May 2022, six out of ten respondents agreed.

This may be because a clear assessment of the adoption of crypto assets for different use cases and their impact on the economy seems to have eluded policymakers thus far: the same survey indicated that the majority of central banks have been largely distinguished by the use of crypto assets in their jurisdictions – both with regard to domestic and cross-border payments. Boundaries, as ‘use by specialized groups’ and ‘trivial or useless use’.

Earlier in February 2022, the Financial Stability Board (FSB) acknowledged the existence of significant data gaps that made it difficult to identify and assess the impact of crypto assets on financial stability.

The stated RBI expectation is that ₹ will provide the benefits of virtual currencies but at the same time protect financial consumers and avoid the “harmful social and economic consequences” of crypto assets. If it is too good to be true, it usually is, and this appears to be the case with the RBI dropping ₹e as a panacea for the many risks associated with crypto assets and stablecoins. There are many motives driving the adoption of crypto assets, which do not overlap with e ₹ alone. Customers who feel the distress of the rupee’s depreciation (according to current exchange rates) are more likely to turn to asset-backed stablecoins linked to global currency reserves such as the US dollar.

This leads to direct dollarization risks, as identified by the G7 Working Group on stablecoins. It is unlikely that ₹e would provide compelling reasons to prevent this state of dollarization by converting the Indian rupee into stable currencies denominated in US dollars.

Stablecoins can also provide a faster, cheaper, and easier channel for cross-border transfers that largely bypass the formal financial system (and, by extension, foreign exchange laws). e ₹ may not directly address this until India becomes a member of the many cross-border conversion projects that are built around CBDCs and the projects come to fruition.

Retail investors in private (unstable) crypto assets usually do this for potential gains arising from extreme volatility and arbitrage opportunities between different cryptocurrency exchanges. The promise of relatively higher returns in terms of de-fi betting (bluntly similar to fixed deposits) or de-fi lending (similar to P2P lending) that incentivizes retail investors in private crypto assets cannot be matched by a non-interest bearing instrument such as e ₹.

For the Reserve Bank of India and the government to deal with the risks that crypto assets bring to the economy, there is still a need for a legal framework to control the various aspects of crypto assets. Regulation of crypto assets in India remains highly uncoordinated and scant: it is the circular CERT-In (Indian Computer Emergency Response Team) that requires virtual asset service providers to follow KYC standards set by the Reserve Bank of India, Securities and Exchange Board of India (in the Cyber ​​Security Service) ).

In parallel, government law enforcement agencies have taken action against crypto-asset exchanges under the Foreign Exchange Management Act of 1999 and the Prevention of Money Laundering Act of 2002, even if there is ambiguity about the nature and extent of the application of these laws to crypto assets.

It is unlikely that a single legislation will govern all these aspects of crypto assets and stablecoins – but without a framework that defines and enables different regulators and agencies to operate, and delegated legislation – the rules and regulations by specialized agencies needed to implement the provisions of the legislation in practice, it cannot move forward. There is a fundamental problem with all of this: the fundamental question of whether to ban or regulate both crypto assets and stablecoins has not yet been resolved. This comes with more than a fair set of challenges.

The duty of the Reserve Bank of India under the Reserve Bank of India Act 1934 is to secure monetary stability in India and to operate the currency system in its favour. This duty may cause stablecoins and crypto assets to be viewed in a harsher light that may not necessarily align with the Ministry of Finance’s views, which arguably may have broader macroeconomic objectives. In this potential difference between the role of the regulator and the state, the nature of the outcome remains unclear.

But it could also mean that the Reserve Bank of India and the government are reaching a more conservative stance on stablecoins, arguably a more direct threat to the currency, unlike cryptocurrencies, which may be subject to regulation, provided there are adequate regulatory interventions such as registration/licensing measures Exchanges, business continuity requirements, KYC, token listing rules, disclosure requirements, circuit breakers during volatility, governance standards, etc. to target potential points of market failure.

This approach is not new, and the FSB, in particular, has provided impetus toward solving this puzzle: On October 11, the FSB and other standard-setting organizations reviewed the FSB’s previous high-level recommendations for regulation, supervision and supervision of “global stablecoins” where it was likely that These presented assets are approved for use cases such as payments and as a store of value.

On the same day, the FSB separately published its reports to the G20 on the approaches to regulation, supervision, and adequate supervision of the activities of crypto-assets and markets that were published.

While the Federal Security Council leaves room for regulators to decide independently on a regulatory approach (including a conservative approach such as ban or ban), it broadly sets out high-level principles intended to help regulators and governments craft regulations based on proportionality and regulatory harmonization.

The principles of the FSB are intended to guide governments to frame appropriate laws

Regulators with the right powers and tools help regulators design comprehensive governance frameworks and direct intermediaries to implement effective risk management frameworks. In some ways, the messages are clear: if the government decides to embark on a regulatory approach (as opposed to ban), the FSB guidelines show that there is a pathway to regulation that satisfactorily mitigates the damage associated with stablecoins and crypto-assets.

However, it remains to be seen whether the RBI sees this message through the same lens: in any case, ₹ would be an inadequate answer.

Arjun Goswami, Head of Public Policy; and Ganesh Gopalakrishnan, Senior Associate, Cyril Amarchand Mangaldas

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