When the Indian government this week announced plans to tax cryptocurrency and launch a central bank digital currency, the news drew a mixed response. Some in the Indian crypto community gave it a glass-half-full reading while others reported their drinking vessels as half empty.
The former were relieved Narendra Modi’s government didn’t ban cryptocurrencies, as was previously threatened. The latter were angered they’d now have to shave 30% off each crypto trading profit they make.
You’re reading Money Reimagined, a weekly look at the technological, economic and social events and trends that are redefining our relationship with money and transforming the global financial system. Subscribe to get the full newsletter here.
Both missed the bigger picture, one that goes beyond India to the wider world. That is, in betting on a digital monetary future, the financial authorities of the world’s second-most populous nation are joining those of other nations to hasten the arrival of a multi-currency international monetary system – whether they want that outcome or not. In that world, cryptocurrencies will inevitably occupy a key place.
There are important messages here for the U.S. government, the steward of the current, mono-currency international monetary system, which, according to a report in Barron’s last week, is viewing the need for new crypto regulations as a “matter of national security.”
How the U.S. approaches this national security issue will be key. With an openness that encourages a global free market model of financial innovation? Or with a defensive posture aimed at protecting the existing centralized system and the dollar’s reserve status? It’s hard to overstate how much rests on that choice.
Taxation vs. legitimacy
First, let’s acknowledge that India’s move imposing taxation on cryptocurrencies and postponing a more detailed regulatory step that could yet include some kind of prohibition, is less than ideal for the domestic crypto industry’s short-term outlook.
Policy 4.0 founder Tanvi Ratna tweeted that “taxation does not imply legality” because even illegal transactions are taxed in India.
Still, there was no real hostility in the statement from Finance Minister Nirmala Sitharaman, who spoke only of “a phenomenal increase in transactions in virtual digital assets,” which “made it imperative to provide for a specific tax regime.”
Regardless, moves to tax an activity are often seen as de facto legitimation of that activity. (It was one reason I took my own glass-half-full reading of last year’s battle over the crypto provision in the U.S. infrastructure bill.) So, on balance, it seems crypto has a moderately clearer pathway to adoption in India. That pathway will be laid, in part, by the other development to emerge from Sitharaman’s announcement: plans for a central bank digital currency (CBDC).
CBDCs as crypto’s adrenaline boost
It’s fair to assume the Indian government, like China’s, believes developing a CBDC will curtail the expansion of decentralized cryptos such as bitcoin. There is already overwhelmingly greater demand for national currencies such as theirs, the thinking goes, so making those government monies digital will neutralize the only appealing competitive advantage of non-national digital currencies.
This is flawed zero-sum thinking. It assumes there’s some fixed pie of demand for currencies, and when usage of one currency rises the amount tapped by the other must fall. It fails to foresee the second-round effects that a rush to CBDCs will have on the wider crypto ecosystem.
How will CBDCs boost crypto?
First, once digital fiat bearer instruments, be they CBDCs or stablecoins, are used for payments inside other blockchain-based services such as supply chain management, gaming or non-fungible tokens (NFT), it will boost that wider crypto ecosystem – the decentralized metaverse of Web 3 – as it goes mainstream.
This will, in turn, generate demand for the cryptocurrencies and other native crypto tokens that decentralized finance (DeFi) and Web 3 services require for governance. If a CBDC fund infusion boosts demand for NFTs, for example, there will be more smart contract transactions on platforms such as Ethereum or Solana, which will then drive demand for ETH and SOL.
The second factor is that once they are entrenched globally, CBDCs could challenge the supremacy of the dollar. However that plays out, it’s hard to see how cryptocurrencies lose.
The dollar’s end or a golden age?
The programmable nature of CBDCs will allow for direct, atomic settlement between holders of two different countries’ currencies, which will negate the need for an intermediating reserve currency in international trade deals. Some central banks, such as China’s, Singapore’s, Thailand’s and that of the United Arab Emirates, are already experimenting with direct interoperability between their respective CBDCs.
The endgame here is the eventual disruption of the SWIFT network for international currency settlement, a system that is built around the centrality of the dollar and of U.S. financial institutions’ prime role as international correspondent banks. Its demise will, in turn, reduce demand for the dollar and diminish the international influence of Wall Street, which will curb Washington’s ability to harness the U.S. currency’s exorbitant privilege to police other countries’ transactions and secure cheap foreign financing for Americans’ consumption habits.
In response, the U.S. has two options.
First, it could do nothing, hoping the existing dollar-centric international monetary system persists by weight of its own dominance. (Or it could do something that is effectively nothing, such as having the Federal Reserve issue its own CBDC and embedding the existing Wall Street-dominated banking model.)
In this scenario, the dollar will fall from its pedestal. But it won’t be supplanted by China’s digital yuan, or another country’s currency for that matter. The world will no longer have a single reserve currency but many digital currencies competing against each other.
It’s a more financially uncertain environment, one where governments are more likely to go rogue and engage in currency wars – or worse, physical wars – generating economic, political and social instability. If so, demand for an apolitical alternative store of value could rise. It won’t be a fun time. But it could be great for bitcoin.
The United States’ other option is a more radical departure from the status quo. Rather than putting the Federal Reserve and U.S. banks in the same old driving position, it could encourage the growth of non-government U.S. dollar-backed stablecoins that freely and rapidly flow internationally across decentralized blockchain protocols. In that case, one could imagine the greenback becoming even more sought after by foreigners as it will become readily available.
Under that scenario – one that USDC issuer Circle laid out in full-page U.S. newspaper ads this week – we might see the U.S. and its values of open, free trade gain even more influence worldwide. It would come at the expense of the Wall Street-centric model for moving money around the world, but it would drive global financial innovation broadly in U.S. interests.
In that setting, both stablecoins and native blockchain currencies such as ether and bitcoin would thrive. The freer flow of dollars globally would feed into a wider cryptocurrency, blockchain and Web 3 ecosystem and stir up demand for tokens.
One way or another, governments like India’s are hastening crypto’s expansion.