Central Bank Digital Currencies (CBDCs)

Table of Contents

Context: The State Bank of India has announced the implementation of UPI interoperability in its Digital Rupee (eRupee) also called Central Bank Digital Currency (CBDC).

What is Central Bank Digital Currency?

Central Bank Digital Currencies (CBDCs) are digital forms of money issued by central banks.
They are designed to provide a secure and convenient alternative to physical cash and to make digital payments easier for individuals and businesses.
CBDCs are backed by the central bank, which means they hold the same value as traditional fiat currencies and can be used in the same way.
Unlike cryptocurrencies, which are not regulated by a central authority, CBDCs are issued and controlled by the central bank.

Global Scenario of CBDCs

Globally, more than 90 per cent of central banks are exploring the implementation of CBDC.
It has been already launched in counties like the Bahamas, Nigeria and the East Caribbean Currency Union.
Pilot projects/testing of CDBC is being undertaken in countries such as China, Sweden, Ukraine and Jamaica.
- China has also commenced a pilot of the e-yuan (e-CNY).
- Further, France, Switzerland and Singapore have launched a joint trial of their experimental CBDC.

RBI and CBDCs

The Reserve Bank of India (RBI) has released a concept note outlining its plans for a Central Bank Digital Currency (CBDC), also known as the Digital Rupee or e-Rupee.
This digital form of the Indian rupee will be interchangeable one-to-one with the physical currency and will have the same value and sovereignty as the fiat currency.
The RBI announced the pilot program for the wholesale Digital Rupee segment on November 1, 2022, and the first pilot for CBDC-Retail was announced on December 1, 2022.
Types: Based on the usage and functions of the CBDC, the RBI has proposed issuing two versions of the CBDC – a general purpose, retail CBDC (CBDC-R) and CBDC-W for wholesale use.

Wholesale CBDC (CBDC-W)	Retail CBDCs (CBDC-R)
They are intended for use by banks and financial institutions. These CBDCs would be used in interbank settlements and other financial transactions. They would not be accessible to the general public.	They are intended for use by the general public. These CBDCs would be accessible to anyone with a digital wallet. They could be used for making everyday purchases, just like physical cash.

How Does the Digital Rupee Work?

The RBI will create tokens, and issue them to financial entities called Token Service Providers (TSPs), which are the banks selected for the Digital Rupee Pilot Program.
The TSP will then distribute the tokens to interested parties/customers.
The digital Rupee tokens will work in the same way as bank notes/coins, and one can use them in lieu of cash.

Motivations for issuing a CBDC in India

Reducing Cash Usage and Expenses: CBDCs can redirect preference for cash towards digital payments, minimizing the use of physical cash, and reducing costs associated with cash management.
- Data compiled from RBI’s annual reports shows the cost of printing currency notes in 2021-22 at ₹4,984.8 crore.
- Apart from this, there is environmental, social, and governance (ESG) cost associated with the currency management.
Promoting Financial Inclusion: CBDCs can be accessed without needing a bank account, enabling more individuals, especially those in remote areas without banking access, to participate in digital transactions and access credit facilities.
Facilitating Cross-Border Transactions: Implementing CBDC technology can benefit cross-border transactions, particularly given India’s status as a significant recipient of cross-border remittances. Collaboration with other central banks is being explored.
Countering Private Virtual Currencies: CBDCs provide a risk-free digital currency option, countering the risks associated with private cryptocurrencies like money laundering, terrorism financing, and parallel economies. They also restore trust in the central bank currency.Top of Form

Advantages and Disadvantages of CBDCs

Advantages of CBDCs

Disadvantages of CBDCs

CBDCs could make financial transactions faster and more efficient.
They could make it easier for people to access and use money, especially in remote or underserved areas.
CBDCs could provide an additional form of money that is more stable and less susceptible to inflation than other digital assets.
CBDC transactions can settle instantly, reducing the time and risk associated with traditional settlement systems, such as clearinghouses.
Central banks can use CBDCs as a tool to implement monetary policy, such as controlling interest rates or managing the money supply.

Introducing CBDCs could be complex and require significant technological and logistical infrastructure.
It could also raise privacy and security concerns, as the use of digital currencies could make it easier for governments and other parties to track individuals’ financial transactions.
CBDCs could also pose a threat to traditional banks and financial institutions, as they could potentially displace existing payment systems.
There may also be concerns about the potential for CBDCs to be used for illegal activities, such as money laundering or financing terrorism.
While CBDCs aim to promote financial inclusion, they may inadvertently create a digital divide if certain segments of the population do not have access to the necessary technology or digital literacy.

Way Forward

Robust Regulatory Framework: Before implementing CBDC technology, it’s imperative to develop a strong regulatory framework.
- This framework should be flexible enough to adapt to changing circumstances and incorporate ongoing learning in CBDC design.
Prioritize Cybersecurity: Maintaining high standards of cybersecurity is paramount in the implementation of CBDC.
- Simultaneously, efforts to enhance financial literacy should be pursued to ensure the safe and informed use of digital currency.
User Privacy and Data Protection: It is essential to consider and implement measures that respect user privacy and protect data within the CBDC system, emphasizing the importance of data security and privacy in the digital currency ecosystem.
Protect Financial Markets: Address the implications of CBDC and other emerging digital assets to safeguard the interests of consumers, investors, and businesses within the financial markets.