Knowledge Nugget Economy I Stablecoins and Central Bank Digital Currencies: Must-know topic for UPSC exam
RBI Governor at the annual meeting of the World Bank Group and International Monetary Fund (IMF) has urged other central banks to promote CBDCs.
Stablecoins and Central Bank Digital Currencies are crucial topics for the UPSC exam.
Take a look at the essential concepts, terms, quotes, or phenomena every day and brush up your knowledge. Here’s your UPSC current affairs knowledge nugget on Stablecoins and CBDCs.
Knowledge Nugget: Stablecoins and Central Bank Digital Currencies
Subject: Economy
(Relevance: In 2019, UPSC Mains examiners asked a question on cryptocurrency. As blockchain technology use increases, applications diversify. India’s Finance Minister and RBI Governor have articulated the government’s stance and discussed the pros and cons of these currencies. With the launch of a pilot project on RBI-backed digital currency, it becomes significant for you to know the basics about stablecoins and CBDCs.)
Why in the news?
Reserve Bank of India (RBI) Governor Sanjay Malhotra urged other central banks to use and promote Central Bank Digital Currencies (CBDCs) instead of stablecoins to facilitate international payments.
While speaking at the annual meeting of the World Bank Group and International Monetary Fund (IMF) in Washington, DC, Malhotra reiterated the Indian central bank’s stance on cryptocurrencies, saying their usage had implications for monetary policy, capital account flows, and money laundering.
Key takeaways:
1. According to the Bank for International Settlements, stablecoin can be defined as a cryptocurrency that aims to maintain a stable value relative to a specified asset, or a pool or basket of assets. They are blockchain-based digital assets designed to maintain a consistent value over time. They are backed by reserves such as fiat currencies, commodities, or other crypto assets.
2. According to JP Morgan, there are two categories of stablecoins: fully reserved stablecoins and algorithmic stablecoins.
* Fully reserved stablecoins: These types of stablecoins are backed one-to-one by high-quality, liquid assets like fiat currency or short-term government securities held in the reserve. It offers a stable price as each issued coin is supported by an underlying asset.
* Algorithmic stablecoins: “These maintain their peg through smart contracts that respond to supply and demand imbalances by minting or burning tokens. If an algorithmic stablecoin trades above its peg, the protocol mints additional tokens to reduce its price. Conversely, if it trades below its peg, the protocol burns tokens to increase its price.”
3. In June, the US Senate passed the Guiding and Establishing National Innovation for US Stablecoins Act (GENIUS Act). In the same month, South Korea’s National Assembly passed the Digital Asset Basic Act to legalize South Korean Won (KRW) denominated stablecoins. In May, Hong Kong ‘s Legislative Council passed a stablecoin legislation to establish a licensing regime for local ‘fiat-referenced stablecoins’ issuers.
4. Globally, U.S. dollar stablecoins have amassed a market capitalisation of over $300 billion, while the overall market cap of crypto tokens has climbed to more than $4 trillion, according to industry data provider CoinGecko. At present, Tether and USDC are the top two stablecoins globally. Both are pegged to the US dollar and make up around 90 per cent of the $285 billion global stablecoin market
5. According to the RBI, “CBDC is the legal tender issued by a central bank in a digital form. It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different.” The digital fiat currency or CBDC can be transacted using wallets backed by blockchain.
6. In December 2022, the Reserve Bank of India (RBI) launched India’s CBDC, known as the digital rupee or e-rupee, on a pilot basis for retail users. Currently, RBI is conducting pilot projects of two types of CBDCs – retail and wholesale.
7. Though the concept of CBDCs was directly inspired by Bitcoin, it is different from decentralised virtual currencies and crypto assets, which are not issued by the state and lack the ‘legal tender’ status. CBDCs enable the user to conduct both domestic and cross-border transactions which do not require a third party or a bank.
8. CBDCs “is fiat (money), it has all the advantages of stablecoins, it can be tokenised…and (has) the advantages of singleness of money, the integrity of money. So, all of us need to promote that. Only then we will be able to actually roll it out at a large scale,” Malhotra said in a conversation with Krishna Srinivasan, the Director of the IMF’s Asia and Pacific Department.
9. According to the World Economic Forum, the main difference between a central bank digital currency and a cryptocurrency is that a CBDC is – as its name implies – issued by a central bank. This means it is also a “direct liability” of the central bank.
10. “CBDCs are direct liabilities of the central bank, just as paper cash is,” adds the Harvard Business Review. “This makes CBDCs a safer form of digital money than commercial bank-issued digital money.”
BEYOND THE NUGGET: Advantages of Rupee-backed stablecoin
Nilesh Shah, in the Express Opinion, wrote that a Rupee-backed stablecoin has several advantages. It would protect Indian users from foreign exchange volatility and reduce reliance on foreign currencies. Integration with India’s remittance and trade ecosystems will drive demand for INR-backed stablecoins. A rupee-based stablecoin could address several economic pain points and enhance India’s financial ecosystem.
1. India is the world’s largest recipient of remittances
India is the world’s largest recipient of remittances ($125 billion annually). Stablecoins could reduce transaction costs by up to 90 per cent and enable instant settlements, benefiting migrant workers and their families.
Cross-border trade: Tokenising export contracts on blockchain could streamline payments for small and medium enterprises (SMEs) and enhance India’s trade efficiency.
Financial inclusion: Stablecoins could complement the e-rupee and provide access to digital finance to underserved populations, especially in rural areas.
Soft power and global reach: An INR-backed stablecoin could increase the rupee’s global adoption, reducing reliance on USD-based stablecoins and enhancing India’s fintech influence areas.
Lower cost of borrowing: The entity issuing rupee-based stablecoin will borrow at zero to low interest rates. It can share the benefit with the issuing banks or the GOI.
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