Why CBDC may not be the silver bullet for addressing crypto-asset risks
This may have been because a clear assessment of the use of crypto-assets for different use cases and their impact on the economy seems to have so far eluded policy makers: the same survey indicated that a majority of central banks characterized the use of crypto-assets in their jurisdictions to a large extent – both in relation to domestic payments and cross-border payments, such as “use by niche groups” and “trivial or no use”.
Earlier in February 2022, the Financial Stability Board (FSB) had acknowledged significant data gaps that made an assessment of the effect of cryptoassets on financial stability difficult to identify and quantify.
The RBI’s stated expectation is that e₹ will provide the benefits of virtual currencies, while protecting financial consumers and avoiding the “harmful social and economic consequences” of crypto-assets. If it’s too good to be true, it usually is, and this seems to be the case with the RBI’s projection of e₹ as a panacea to the many risks associated with cryptoassets and stablecoins.
Several motivations drive the use of cryptoassets, which do not overlap with e₹ alone. Clients sensing a falling rupee (below today’s exchange rates) are more likely to turn to asset-backed stablecoins linked to a global currency reserve such as the US dollar.
This entails direct dollarization risks, as identified by the G7 Working Group on Stable Coins. It is unlikely that e₹ will provide compelling reasons to prevent this occurrence of dollarization by converting Indian rupees to US dollar-denominated stablecoins.
Stablecoins can also provide a faster, cheaper and easier channel for cross-border money transfers that largely bypass the formal financial system (and by extension foreign exchange laws). An e₹ cannot address it directly until India is a member of the many cross-border money transfer projects being built around CBDCs and the projects are realised.
Retail investors in private crypto assets (not stablecoins) usually do so for the potential benefits arising from wild volatility and arbitrage opportunities between different crypto exchanges. The promise of relatively higher returns compared to de-fi stakes (which are roughly similar to fixed deposits) or de-fi lending (similar to P2P lending) that motivates retail investors in private crypto assets cannot be matched by a non-interest-bearing instrument that e.g. as e₹.
For the RBI and the government to manage risks that cryptoassets bring to the economy, a legal framework to govern various aspects of cryptoassets remains the need of the hour. Regulation of cryptoassets in India is still too uncoordinated and sparse: there is a CERT-In (Indian Computer Emergency Response Team) circular that requires virtual asset service providers to follow KYC norms formulated by the Reserve Bank of India and the Securities and Exchange Board of India (for cyber security reasons).
In parallel, government enforcement agencies have moved against exchanges of cryptoassets under the Foreign Exchange Management Act, 1999, and the Prevention of Money Laundering Act, 2002, although the nature and extent of the application of these laws to cryptoassets is unclear.
It is unlikely that one piece of legislation can regulate all these aspects related to cryptoassets and stablecoins – but without a framework that identifies and empowers various regulators and agencies to act, delegated legislation – rules and regulations from specialized agencies necessary to implement the provisions in the legislation. in practice cannot proceed. At the root of all this is the fundamental question: the primary question of banning or regulating both cryptoassets and stablecoins is unshakable. This comes with more than its fair set of challenges.
RBI’s duty under the Reserve Bank of India Act of 1934 is to ensure monetary stability in India and to operate the currency system in its favour. This duty may cause it to view stablecoins and crypto-assets in a harsher light that may not necessarily align with the views of the Ministry of Finance, which may arguably have broader macroeconomic goals. In this potential divergence between the roles of regulator and state, the nature of the outcome remains unclear.
But this could also mean that the RBI and the government take a more conservative position on stablecoins, arguably a more direct threat to currency, as opposed to cryptocurrencies, which can potentially be regulated, subject to adequate regulatory interventions such as registration measures. / licensing of exchanges, business continuity requirements, KYC, rules around token listing, disclosure requirements, circuit breakers during volatility, governance norms and so on, to target possible points of market failure.
This approach is not new, and the FSB in particular provided impetus to solve this conundrum: on October 11, the FSB and other standard-setting organizations reviewed the FSB’s previous high-level recommendations for the regulation, oversight and supervision of ‘global stablecoins’ as these assets delivered were more likely to be used for use cases such as payments and as a store of value.
On the same day, the FSB separately published its contributions to the G20 on approaches to regulation, supervision and adequate oversight of crypto-asset activities and markets.
While the FSB leaves room for regulators to independently determine the regulatory approach (including following a conservative approach such as a ban or a ban), it broadly prescribes high-level principles aimed at helping regulators and authorities design regulations built on proportionality and regulatory coordination.
The FSB Principles aim to guide governments to draft laws that are appropriate
regulators with the right powers and tools and helps regulators design comprehensive governance frameworks and direct intermediaries to implement effective risk management frameworks. In some ways, the message is clear: should the government decide to embark on a regulatory approach (as opposed to prohibition), the FSB guidelines demonstrate that there is a path to regulation that satisfactorily mitigates the harms associated with stablecoins and cryptoassets.
However, it remains to be seen whether the RBI sees this message through the same lens: in any case, e₹ will be an inadequate response.
Arjun Goswami, Head – Public Policy; and Ganesh Gopalakrishnan, Senior Associate, Cyril Amarchand Mangaldas
