Avoidable ‘Lakshmi’
India does not need its own cryptocurrency
The government is reportedly considering the possibility of introducing its own cryptocurrency, code-named “Lakshmi”. Being backed by fiat, this would provide an alternative to popular non-fiat cryptocurrencies such as bitcoin and ethereum. If it is introduced, “Lakshmi” would run on some variation of the blockchain technology employed by bitcoin that verifies every trade and rules out dual transactions employing the same coin. The introduction of such a new cryptocurrency, which would be legal tender alongside the rupee, requires legislative action in amendments to the Currency Act. The new currency would also, presumably, be subject to the same capital account controls as the rupee in terms of cross-border transactions. Users would have to submit to the usual know-your-customer norms.
Before launching such a currency, the Reserve Bank of India (RBI) would have to solve several tricky questions. Would it decide on a peg to the rupee and hence an exchange rate tied to rupee fluctuations? Or would it allow free-float of Lakshmi? The RBI would also have to devise a method of money supply. Bitcoin and ethereum have mathematically exact generation processes and the total coinage in existence is capped. The money supply at every instant is known and cannot be manipulated, unlike with normal fiat currencies. Moreover, the blockchain method makes standard procedures such as fractional reserve banking very difficult. The only way to carry out such operations is via an exchange of the cryptocurrency for normal currencies (be it the rupee or the US dollar). But doing so leads to complex transactions that affect exchange rates.
Even assuming the RBI successfully solved all these issues, a key question still remains: Why would the RBI bother? Cryptocurrencies are popular for several reasons and all of those are unacceptable to a normal central bank. Cryptocurrencies are useful in providing anonymity, especially when making cross-border transactions. In fact, China recently imposed controls on these coins because these have been used to enable vast capital flight out of the mainland. Japan and South Korea have picked the more pragmatic alternative of recognising bitcoin as legal tender and laying down strict rules for usage. Moreover, “cryptos” are also extensively used for money-laundering purposes and to fuel criminal activities such as drug deals on the Dark Web and for ransomware payments. It is hard to see the RBI allowing users to avail of greater anonymity than is the case with digital rupee transactions. Another reason why “cryptos” are popular is the high-volume speculative trading of these as potential stores of value; traders bet on bitcoin movements in the same way that they bet on the price of gold and crude oil. Once again, it is hard to see the RBI taking a policy decision to allow for a free float where the value of Lakshmi could swing by vast amounts.
India already has a currency that is extensively used and traded digitally. The mechanics of trading and managing its money supply are well known. There may be a case for easing capital controls and allowing a more free-float of the rupee, given massive reserves. But introducing a new digital cryptocurrency, which cannot reasonably be a substitute for the currently popular ones, does not seem like a good idea. The RBI should consider adopting the Japanese model of regulation instead.