The disruptive ability of blockchain technology, especially its visible manifestation — the bitcoins — is well known. On April 6, 2018, RBI exercised its statutory powers to comprehensively prohibit all regulated entities from dealing with bitcoin and its providers. The ban includes facilitation of clearing and settlements, maintaining accounts, registering trading, settling and clearing, loaning against virtual tokens, accepting bitcoin as collateral, opening accounts of exchanges of bitcoins, etc.
Earlier, on Feb 1, 2017 and December 5, 2017, RBI cautioned public on the matter. Central banks and banking systems across countries have been seized of the existing and possible impact of this technology. Several central banks like Bank of England (working paper 605 of 2016) and commercial banks have articulated their approach. What could be the causes of concern, caution and discussions? It is pertinent to examine.
One of the primary roles of a central bank is to preserve and protect the monetary system and ensure its smooth functioning. This role includes currency management, clearing and settlement, overseeing activities of banks which are custodians and operate upon the values of monetary instruments. Larger related responsibilities are around the balance of payments (BOPs), preventing misuses like money laundering, drug trafficking, etc. All these are anchored on currency as a unit of account, store of value and medium of exchange. In a classical central banking structure and banking system, either physically or electronically, these characters of the currency are decipherable, controllable and intervenable.
Blockchain is a paradigm shift. With instruments like distributed ledgers, digital currencies, smart contracts and intelligent programmable currency units, the ability of unknown entities to influence and cause potential disruption and relative unpreparedness of the ecosystems are causing the concern.
Gartner, the famous research firm, puts the dilemma on a 2X2 matrix. It puts the systems responsibility on the twin pillars of ‘asset trust’ and ‘execution trust’. The central bank and banking system’s response have been put between ‘defensive’ and ‘offensive’.
Thus, central banks have the unenviable role of balancing between furthering new generation technology for productivity and efficiency and preventing a possible chaos due to players getting too ahead of the time.
Despite bitcoin doubts, the use of blockchains in other monetary and operational systems of economy is on the rise. Distributed ledger technology is increasingly being adopted as a complement and an alternative to centralised clearing and settlement processes like ACH, RTGS and SWIFT. The main driver for adoption being cost efficiency and risk management.
The Monetary Authority of Singapore and Bank of Canada have reportedly conducted POCs for interbank payments using blockchain. However, relative immaturity of the technology and non-concrete nature of the security protocols are likely to prolong the POC phases.
Another approach, which some of the central banks are toying with, hovers around small transformative changes to get ready for the new age, if it were to come. These include putting digital identifiers in currencies both physical and electronic, technology for tracking distribution and usage and use of technology to preserve anonymity of currency and chain of ownership.
Clearly, the situation is fluid. As the regulatory stance in India is evolving, the banks must prepare themselves to face the unknown future. Both macroeconomic factors and the maturity of the underlying technology are likely to delay the adoption of usage of digital currencies even for benign purposes like interbank settlement.
Banks are trusted custodians and market makers. Both custody and information exchange could be the first experiments on blockchain.
Binary and peer-to-peer settlements and the creation of blockchain-based instruments as storage of values for such settlements could be the first quick wins. At present, blockchain is an expensive technology with limited use cases. So, leading banks like SBI should lead experimentation and innovation as banks in general are likely to be wary of being the first movers.
At the same time, RBI and leading players should continuously collaborate to understand the evolution of this tremendously potent technology, identify risk mitigated adoption and put operating framework in place, lest our country might be left behind.
The author is Deputy Managing Director & CIO, State Bank of India