Official, private digital currencies can coexist, say IMF experts

The blog suggests a central bank digital currency may be designed to encourage the private sector to innovate on top of it

At a time when India is contemplating a ban on private cryptocurrencies, a blog by two International Monetary Fund (IMF) experts may provide a piece of advice to the government. The title of the blog — Public and Private Money Can Coexist in the Digital Age — says it all.

The blog, written by Tobias Adrian and Tommaso Mancini-Griffoli — both working at IMF’s monetary and capital markets department — says today’s world is characterised by a dual monetary system, involving privately-issued money by banks of all types, telecom companies, or specialised payment providers, built upon a foundation of publicly-issued money by central banks.

“While not perfect, this system offers significant advantages, including innovation and product diversity, mostly provided by the private sector, and stability and efficiency, ensured by the public sector,” it says.

These objectives — innovation and diversity on the one hand, stability and efficiency on the other — are related.

“More of one usually means less of the other. A trade-off exists, and countries — especially central banks — have to navigate it. How much of the private sector to rely upon, versus how much to innovate themselves? Much depends on preferences, available technology, and the efficiency of regulation,” the two writers say.

Keeping pace with technology change, user needs, and private-sector competition will be challenging for central banks. However, they need not be alone in doing so, says the blog.

First, a central bank digital currency may be designed to encourage the private sector to innovate on top of it, much like application (app) designers bringing enticing functionality to phones and their operating systems.

By accessing an open set of commands (app programming interfaces), a thriving developer community could expand the usability of central bank digital currencies beyond offering plain e-wallet services, it says.

For instance, they could make it easy to automate payments, so that a shipment of goods is paid once received. Or they could build a look-up function, so that money can be sent to a friend on the basis of phone number alone. The trick will be vetting these add-on services, so that they are perfectly safe, cautions the blog.

Some central banks may even allow other forms of digital money to coexist — much like parallel operating systems — while leveraging the settlement functionality and stability of central bank digital currencies. This will open the door to faster innovation and product choice. For instance, one digital currency might compromise on the settlement speed to allow users greater control over payment automation, say the two authors.

This new form of digital money will be a stable store of value, if it was redeemable in central bank currency (digital or non-digital) at a fixed face value. This will be possible if it was fully backed by central bank currency, suggest the authors.

This form of digital money will be an efficient means of payment, as settlement will be immediate on any given digital money network — just as it is between accounts of the same bank, they say.

“This form of digital money (which we have called synthetic currency in the past) could well coexist with a central bank digital currency. It will require a licensing arrangement and a set of regulations to fulfil public policy objectives, including operational resilience, consumer protection, market conduct and contestability, data privacy, and even prudential stability,” says the blog.

At the same time, financial integrity could be ensured via digital identities and complementary data policies. Partnering central banks requires a high degree of regulatory compliance, say the authors.

An inter-ministerial committee, headed by former finance secretary Subhash Chandra Garg, had first suggested a draft Bill to ban cryptocurrencies. It defined virtual currency as a “cryptocurrency, by whatever name called, means any information or code or number or token not being part of any official digital currency, generated through cryptographic means or otherwise, providing a digital representation of value which is exchanged with or without consideration, with the promise or representation of having inherent value in any business activity which may involve risk of loss or an expectation of profits or income, or functions as a store of value or a unit of account and includes its use in any financial transaction or investment, but not limited to, investment schemes”.

A committee of secretaries, chaired by the Cabinet secretary, has also given its report on cryptocurrencies.

The Supreme Court, in March 2020, had struck down the Reserve Bank of India’s restrictions on banks to stop providing services to crypto trading platforms. This led to uncertainty about the status of virtual currencies in India. The new legislation will clear the government’s stand on cryptocurrencies.