If RBI removes elements which make cryptocurrencies secure and hopes to achieve the same result, it may be in for a rude awakening.
Earlier this year, the Reserve Bank of India’s (RBI’s) research arm, Institute for Development & Research in Banking Technology (IDRBT), released a report, which said that the time is ripe for blockchain technology adoption in India.
The report said that in a bid to evolve towards a cashless society, this was an “appropriate time for initiating suitable efforts towards digitising the Indian rupee through blockchain technology.”
Recently, reports suggested that the RBI may be in the process of developing a central bank-backed cryptocurrency, or a crypto-rupee.
The report said that it might be named after the Indian goddess of wealth ‘Lakshmi’.
But such expectation gives rise to more questions than it answers.
What is cryptocurrency?
In 2009, Bitcoin, the world’s first cryptocurrency, was created by an anonymous developer.
Coming in the wake of the global financial crisis, a time when confidence in government had hit rock bottom, early adopters of the instrument looked at it as a viable replacement for conventional currencies.
The appeal of bitcoins lay in the fact that it is anonymous and decentralised and is built on the mysterious, promising technology called blockchain.
Created using cryptography, bitcoin runs on a secure, distributed ledger called the blockchain, which allows transactions to be recorded and verified by a public community.
Bitcoin enthusiasts say the digital currency is an improvement on traditional so-called fiat currencies -- safe, decentralised and takes away the power of governments to print unlimited money.
Here's a quick guide.
If you can't beat them, join them
Given the explosion of interest in bitcoin and blockchain, the underlying technology that is said to have applications even more far-reaching than creation of currency, central banks seem to want to hop on to the crypto bandwagon.
The US Fed came up with the idea of a Fedcoin whereas, a consortium of Canadian private banks is already exploring the possibility of clearing and settling large value payments using blockchain using a token called CAD-coin.
But here's the twist. The premise of cryptocurrencies is based on the very fact that it is a) public and b) not controlled by governments or central banks.
Hence, several central banks have mooted the concept of a state-controlled cryptocurrency on a private, permissioned ledger based on proof of concept. (The usual option of a public, distributed ledger would make it just the same as bitcoin or any other cryptocurrency.)
Here, a token will be issued on a closed private ledger, bound by smart contracts between trusted third parties like the central bank, public and private sector banks etc, by giving them permission to access and make entries into the ledger.
It is not clear what the proposal for our homegrown RBI-backed crypto-rupee is but if it leans towards the consensus view among central banks with respect to the concept, would a marriage between cryptography and fiat currencies be a successful one?
Doubts linger over effectiveness of central bank-backed cryptocurrency
Bitcoin expert, technologist and serial entrepreneur Andreas Antonopoulos does not think that the idea of a central bank backed cryptocurrency is a good one.
Earlier this year, in a conversation with Moneycontrol, Andreas dubbed the idea of a private ledger "an oxymoron".
“A private ledger is an oxymoron, it has none of the advantages of a digital open currency like bitcoin but it has disadvantages and brings more along with it. It is a database without the advantages of a database and is not secure. If you centralise control over it, it is corruptible, mutable and not secure,” he said.
Such a hybrid, in Andreas' opinion, would achieve the worst of both of worlds -- as it would have all of the disadvantages of traditional currencies and none of the advantages of cryptocurrencies.
Further, proof of work, the method used for mining cryptocurrencies, is an extensively power-consuming process. For a private cryptocurrency, there will be little incentive for miners to provide hashing power for a currency that could potentially be inflationary.
This will leave the mining operation entirely in the hands of the state or trusted third parties. In which case, hypothetically speaking, they could overwrite the existing entries on the ledger, leading to manipulation.
Also, a private ledger will lack any transparency, anonymity will be lost and the state can exercise greater surveillance on the people listed on the ledger and the nature of their transactions.This short clip from the Netflix series Mr Robot stated it best:
— Jim (@JimBTC) September 17, 2017
The appeal of cryptocurrencies
The bitcoin blockchain is a ledger which is decentralised, distributed, and public, and gives anonymity to bitcoin holders while keeping all the transactions and money movement transparent and open to the public eye.
At first, bitcoin did not receive a warm welcome from the financial industry, which was uncomfortable with the changes it could bring about. Back in 2013, banks around the world, particularly in the US, even closed down accounts of bitcoin startups and even bitcoin-accepting businesses.
However, despite the attempts to shun bitcoin, authorities were not able to kill the network as -- much like the Internet -- bitcoin as a whole cannot be banned given that it is not constrained within the borders of a nation.
While also proving to be a scourge of shady transactions, such as those conducted on the dark web, bitcoin proved a glimpse of its potential in countries like Venezuela, which underwent hyperinflation.
As of September 15, Venezuela's annual inflation rate stood at 2200 percent and the national currency bolivar has almost lost its entire value against the US dollar.
Desperate citizens latched on to bitcoins, with many even using it to buy day-to-day items from overseas outlets that accepted cryptocurrencies and having them shipped to Venezuela.
What stood out for bitcoin was that it was immune to censorship and manipulation.
If central bank backed digital currencies remove elements, which make cryptocurrencies robust and secure, and hope to achieve the same result, they might be in for a rude awakening.
Andreas summed it best with the analogy he gave.
“It is like comparing an agricultural heavy vehicle to a formula one car," as Andreas put it. "It is like creating a hybrid between the two, you cannot hybridise two things that are the antithesis of each other, trying to mix two ideas whose core is the antithesis of each other.”
“Taking a system that is controlled, centralised and closed and a system whose very purpose is to be open, borderless and decentralised and trying to mesh the two -- you get this weird hybrid that can’t do anything,” he said.
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