Reversing or averting dollarization requires strong macroeconomic policies

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Question – Reversing or averting dollarization requires strong macroeconomic policies, but these may not by themselves be enough. How crypto ecosystem can help in this regards. Discuss. 8 March 2022

AnswerCountries that want to fend off dollarization will need to strengthen monetary policy credibility, safeguard the independence of central banks, and maintain a sound fiscal position along with effective legal and regulatory measures to dis-incentivize foreign currency use.

In this context the rapid development of the crypto ecosystem presents new opportunities. Technological innovation is ushering in a new era that makes payments and other financial services cheaper, faster, more accessible, and allows them to flow faster across borders. Crypto asset technologies have potential as a tool for fast and cheap cross-border payments. Bank deposits can be converted into stable coins that allow instant access to a wide range of financial products from digital platforms and allow for instant currency conversion. Decentralized finance can become a platform for more innovative, inclusive and transparent financial services.

For more than a decade, India has consistently been among the world’s largest recipients of remittances. As remittances often involve high fees and long waiting times for fund transfers, their operating model have key implications for developing countries like India. With their aforementioned benefits, crypto-currencies offer a viable solution to make global remittances cheaper and faster.

India – An emerging adopter of crypto currency

Increased crypto-currency adoption, is improving financial inclusion. In a country like India, where many people are underserved by traditional financial institutions or unable to access their services, crypto finance enables them to make financial transactions quickly and cheaply. Moreover, crypto currencies open up a new asset class for consumers to grow their wealth, as a form of investment.

Crypto investments in the country grew more than seven-fold, from $923 million to nearly $6.6 billion, between April 2020 and May 2021. These developments, along with increasing rural Internet penetration, are improving financial access in the country.

Young Indians aged 18 to 35 are also finding crypto-currency a better investment option, when compared to gold due to the ease of process – a fact borne out by recent World Gold Council data.

Challenges Posed by the Crypto Ecosystem

As per IMF, the market capitalization of crypto assets has almost tripled in 2021 to an all-time high of $2.5 trillion but they present several risks, such as:

  • Risks due to absence of formal governance structure:

Because of limited or inadequate disclosure and oversight, investors always remain at substantial risk. Anonymity of crypto assets creates data gap for regulators, and opens door for money laundering, terrorist funding and other illicit transactions. Different countries have different regulatory frameworks for crypto assets. Hence, coordination becomes difficult.

  • Risks associated with financial stability:

It lead to a phenomenon called “Cryptoization” i.e., reduction in the ability of the central banks to effectively implement monetary policy. Hence, it creates financial stability risks. Increased demand may facilitate tax evasion, reduce the profits out of seigniorage for the government, and can also lead to capital outflow impacting foreign exchange market. Thus, it poses a threat to fiscal policy.

  • Cyber Risks

Cyber risks include high-profile cases of hacking-related thefts of customer funds. Such attacks take place on centralized elements of the ecosystem (for example, wallets and exchanges), but can also arise on the consensus algorithms that underpin the operation of blockchains.

Recently, it was said that India’s very own official digital currency is likely to debut by early 2023, which will mirror any of the currently available private company-operated electronic wallets, but with a change that it will be a sovereign-backed facility.

The government has already said that private crypto-currencies will never be a legal tender. The RBI has been strongly opposing private crypto-currencies as they could have implications on national security and financial stability.

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