Can India's Digital Rupee Succeed?

The 2022 Union Budget was a roller-coaster ride for the Indian Crypto and Blockchain enthusiast. The 30% tax on crypto income and 1% TDS on transactions made it seem like the Government of India really has it out for cryptocurrencies.

While that may be the case, and the Government might be against cryptocurrencies, it is not quite against the tech behind crypto. With blockchain on its side, the Indian Government plans to implement the Digital Rupee.

The Digital Rupee will be a Central Bank Digital Currency (CBDC from here on) based on a Distributed Ledger Technology.

Yes, that was a lot of new and strange words bunched together. Don’t worry; we will soon know as much as we need to about the Digital Rupee as we proceed with today’s article.

What is Distributed Ledger Technology?

CBDC is a sovereign currency that is available digitally using Distributed Ledger Technology (DLT). DLT is similar to blockchain in certain ways. DLT is a wider term, and blockchain is a type of DLT. The two often get mixed up because blockchain gained popularity as “the tech behind Bitcoin”.

The popularity of the term blockchain had the effect that made it more popular than and synonymous with the term Distributed Ledger Technology (think Maggi=Noodles but for decentralised technology).

To simply put it, all blockchain technology is DLT, but not all DLT is blockchain.

DLT consists of a ledger and multiple users on a network. Think of the ledger as a database or a storage of information. What sets DLT apart is that the network is created to make the same copy of the information available to all the network users. Any changes are reflected on all the copies with the various users.

Most organisations maintain a centralised, non-distributed ledger system. This exposes the system to certain threats or shortfalls that we will discuss later. CBDC is an attempt at establishing a currency on this DLT based system, similar to how cryptocurrencies are based on blockchain technology.

By employing DLT, the transaction and account details of the various holders of the CBDC will be stored on the “ledger”. Every user on this DLT will have access to this ledger.

The reason for this distribution of the data is security. When information is centralised, only one breach point is enough to manipulate and invalidate all of the said information. With DLT, since the same data is available throughout the network, multiple breaches will be necessary to make any significant change. If the number of compromised data points is low, the existing users and their data will act as proof of the correct information.

As mentioned before, in a centralised system, a singular breach can, and will affect the data belonging to multiple users and adversely affect them all.

Well, enough about technology, let’s understand its application in CBDC.

What is Central Bank Digital Currency?

CBDC is a DLT based currency. It is quite similar to stable coins in the sense that its value will be related to the currency of a country. What will set CBDC apart from stable coins and pretty much all other cryptocurrencies is the control over it by the government.

While cryptocurrencies are private and unregulated, CBDCs are controlled by the country's Central Bank and, by extension, its Government. The central bank oversees the creation as well as the distribution of CBDC.

CBDC also differs from other blockchain-based assets/currencies due to its valuation method. The value of a single unit of cryptocurrency is decided primarily by its demand and supply, among other factors. But this demand and supply are controlled by private entities on the cryptocurrency’s blockchain. Demand increases with usability, and supply increases as more cryptocurrency is injected into the system. The process of “mining” creates additional cryptocurrencies.

In CBDC’s case, however, the Government will control the value as it will control the supply of the currency.

Thus, cryptos are a private, virtual currency/asset, while CBDC is a virtual sovereign currency.

Difference between Digital Rupee & UPI

Based on what has been discussed, India’s CBDC or the Digital Rupee doesn’t seem too different from the balances held in our UPI accounts or other online wallets. Does it? However, these are two very different forms of the Indian Rupee. Let us see how.

The balances in our UPI account or digital wallet are created when you add money to said wallet from your bank account. Therefore, this balance is nothing more than a fragment of the total money owned by you, just in a different container.

The balance in your bank account itself is the electronic representation of the money you have earned or paid to your account for any other reason. All the money in your bank account exists in tangible form as well, which allows you to withdraw said money and receive physical currency in exchange.

In contrast to this, Digital Rupee will be the direct currency instead of the representative currency mentioned above.

Therefore, the Digital Rupee will be a new and alternative form of legal tender issued by the Indian Government with no physical or tangible form.

Benefits of the Digital Rupee

Following are the reasons supporting the implementation of the Digital Rupee:

• Since the Indian Rupee will be digital, the transfer of funds would be very fast, as can already be seen with existing digital transfers.

• The lack of physical currency would also be more efficient as physical material will eventually degrade. Significant costs incurred in the process of creating tangible currency can be reduced. The cost of holding and transporting the physical currency would also be saved.

• The Digital Rupee would be more secure on multiple facets. The lack of a physical form would deter theft, and DLT would make tracking and correcting fraud much easier.

Drawbacks of the Digital Rupee

These would be the reasons why the Digital Rupee could end up being more trouble than good:

• Due to the technology-heavy operation of the currency, it could be difficult to adopt as India isn’t a very tech-savvy country. This lack of adaptability to tech is not just limited to rural India but can be seen in the suburban and urban environments as well.

• Sovereign currency is different from its predecessors because the issuing government controls its valuation. Initially, an economy could only produce as much currency as its reserves of gold, silver or other assets in that economy.

These assets dictated the currency's value by controlling its supply and acting as tangible proof of its value.

This system has been rendered outdated now, as the Government controls the currency supply and value.

The current Indian currency is a sovereign one, which means that the Government controls its value by controlling its supply and deciding said value themselves. That’s right; there is no tangible asset defining the currency’s value. The currency has its value because the Government deems so, and we believe it.

This system places no limitations on the Government’s ability to produce more currency, and if this production goes unchecked, it can lead to hyperinflation.

The entire point of this little explainer was that this same threat applies to the Digital Rupee as well.

The Bottom Line

The concept of a CBDC has existed for some time now and has been gaining popularity. Proof of this statement lies in the fact that only 35 countries were exploring the uncharted territory of CBDCs in 2020. This number has grown since, and as of October 2021, 87 countries are looking into the prospects of CBDC.

14 countries, including China and Korea, have initiated the pilot stage and are gearing up to bring their CBDC soon.

The Digital Rupee is still a bit ways away, though. The idea has a lot of potential, for both good and bad. Only time will tell whether India will enter the list of the 14 countries soon, if at all and which of these potentials, as mentioned earlier, will be explored.

That’s it for Digital Rupee and this article. See you on the next one.