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RBI Tokenisation

RBI Tokenisation Explained: What is tokenisation and Why RBI has issued new guidelines

by Sonal Shukla

The Reserve Bank of India (RBI) announced in a statement on Friday that all bank notes issued by the Bank after March 31, 2017 and which remain “even partially as banknotes” will gradually be withdrawn from circulation. The announcement was made under Section 24 of the Reserve Bank of India Act, 1934.

The Cash Payment Systems Act 2007 has been amended to provide for restrictions on payments with old series notes; and to prescribe certain limits on the amount for transactions with bank notes in denomination higher than Rs 5000.

This article addresses tokenization, what it is and why RBI has started issuing new guidelines for tokenization.

What is Tokenization?

According to Oxford Dictionaries, tokenization is the conversion of something into a token, a unit of measurement. However, in the context of this blog, tokenization is to turn an asset into an equivalent digital format as a means to buy and sell assets/securities digitally.

For instance, companies could use tokens as an alternative form for equity shares. The company would be issuing tokens which are in return for investment. The investors would be trading directly with the company without any middlemen or brokers. Tokenisation is mainly carried out by clearing houses which make it easier for investors to trade on exchanges and keep track of their balances using blockchain technology.

Will RBI’s New Guidelines Favour Tokenization?

RBI has stated that “The legal tender status of the paper bank notes will continue to be applicable for all payments made to any person, entity or institution outside India in accordance with the provisions of the Foreign Exchange Management Act, 1999.” The amendment was made by adding a notification in relation to the notes issued after March 31, 2017. It clearly states that “These bank notes… shall be accepted by banks for transactions with counterpart banks and for clearing purposes”. This directive is not applicable within India.

The language used suggests that it is stating that these banknotes can still be considered a legal tender in transactions outside India when they are transacted at par with foreign currency. This makes sense when you consider the provisions of the Penal Code and Schedule-I to the Central Bank Act, 1948, which state that “No person shall without lawful authority use as any such obligation with reference to India (whether or not he holds or claims to hold a legal right to their possession) any bank note as such instrument of payment”.

Why did RBI Announce a Regulation?

RBI was previously in favour of the paper currency transition process; but with so much chaos and confusion for the citizens in India, along with loss of livelihood for many people, who had lost all their savings in a matter of seconds, RBI decided to take on a new policy provision.

“The Reserve Bank has made it clear that it will not hesitate to take further measures as and when required to address the matter in the larger public interest. The eventual phase out of bank notes is likely to create many problems for the economy and for the people.” – RBI Press Release on November 8, 2016.

The announcement was necessary in order to maintain a level playing field in India. If banks could not accept paper currency, then money lenders would have few means of recovering bad debts, which they would be stuck with. The Bank believes that this situation would discourage people from paying back their loans, thus increasing distress among banks and the financial system overall.

The announcement was not a surprise as the Reserve Bank had already commenced proceeding towards the ending of paper currency. Since November 4, 2016 RBI had made it clear that it would release an official communication on December 2, 2016 (which has now been published.)

Financial executives across the world are starting to accept that the end of cash is inevitable. In order to ensure that disruption is kept to a minimum, and no legal loopholes are left open which could lead to people losing their money through criminal activity or transaction fraud, they have started first by issuing guidelines which in turn would force banks and payment gateways to follow suit. This would pave way for creating new digital payment systems which will be more secure than those that still exist today.

In Conclusion

The RBI guidelines will most likely kick-start the tokenization process. This would create new ways for companies to raise capital by issuing tokens which can be used to trade stocks, commodities and other assets. Tokens would provide liquidity and efficiency of transactions in a blockchain based ledger system which will reduce cost, computing power and time required to process any transaction.

Tokenization would in turn reduce counter-party risk while maintaining anonymity and security; it also provides an opportunity for investors to gain exposure to an array of emerging markets/companies with a focus on hard-to-reach economies for traditional equity investors.

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