By Sunil Rongala, Senior Vice President –Strategy, Innovation and Analytics, Worldline India
Some years ago, the first time most people heard of digital currencies was likely Bitcoin. It was envisioned to change the way people paid for goods and services because of its decentralised nature and anonymity. Digital currencies, specifically cryptocurrencies, and stablecoins, are referred to as Decentralised Finance currencies or DeFi because there is no central authority like a central bank that runs or manages the currency. Bitcoin has spawned many competitors but none of them have really changed, in a material way, the way we pay for goods and services – the hype has been much louder than the reality. These days most of these digital currencies have been relegated to speculation rather than being used to buy goods and services but this could soon change.
First a primer on Digital Currencies. As the name suggests, these are not physical currencies and are used strictly through digital methods. There are three types of digital currencies; cryptocurrencies, stablecoins, and CBDCs. These currencies may or may not use blockchain technology but most are.
Cryptocurrencies: These are currencies like Bitcoin, Ethereum, etc. While there are some stores and websites that accept these currencies, it is not widespread by any stretch. They are better known as speculative instruments and their value generally depends on the demand as well as the supply of the currency. Figure 1 shows the indexed value of three cryptocurrencies over the space of a year. While BNB has fallen 20%, Bitcoin and Ether have lost close to 50% of their value.
Stable Coins: The Economist in an article writes: “Stablecoins are so named because they are pegged to a fixed quantity of another asset, such as a dollar. This means their prices should hardly fluctuate at all. There are two main ways in which they are backed. In one category are coins that claim to be fully backed by liquid assets such as cash or safe bonds stored in banks. Coins in the second category are backed by other cryptocurrencies.” Theoretically, the value of these stablecoins should be fairly stable because of their peg but it may not be the case if linked to a volatile cryptocurrency. Figure 2 shows the value of 4 Stablecoins over a year; 3 of them have remained near constant and about $1 but the value of Terra seen a massive drop to near 0 because its backing asset was the Luna cryptocurrency which crashed precipitously. According to The Economist, for stablecoins to be stable, their collateral should be “verifiable, liquid and of high quality.”
CBDCs: Central Bank Digital Currencies or CBDCs is fiat money in a digital format and can be used exactly like physical cash. As the name suggests, it has the full backing of the government and the value of the CBDC is identical to that of the currency. Currently, 2 countries, Bahamas and Jamaica, have fully launched their CBDC while a number of countries, including India, are in the pilot phase.
The acceptance of Digital Currencies
For any currency or instrument to be accepted at a merchant location, physical or online, it must necessarily meet 2 conditions; be trusted and have a stable value. For example, if you go to a physical store, the merchant will readily accept cash or digital payment instruments such as credit cards, debit cards or UPI, because the merchant has trust in the store of value and its stability. In the case of digital currencies, only CBDCs and some stablecoins fit the bill. The merchant is also sure that they will be paid for digital transactions done at the store.
That said, there are 2 elements that are going to drive digital currency acceptance.
CBDCs – Given that CBDCs come into the market with the highest level of trust and acceptance, they will be readily accepted. In the case of India, as the Digital Rupee moves past the pilot phase this will become a game changer in the next few years. The India CBDC is mobile-driven and there is already sufficient muscle memory built for users through UPI usage. The fact that merchants will be instantly paid is a huge plus point.
Metaverse – The Metaverse is in its infancy but could potentially grow into something larger. The Metaverse combines Web 3.0 (decentralised, trust, etc.), immersive experiences (AR/VR, 2D, 3D) and digital assets management (digital currencies, NFT, blockchain). As this takes off, there is a very good chance that both CBDCs and Stablecoins (at least the ones whose collateral or backing assets are verifiable, liquid, and of high quality) will see a surge in usage.