CBDC or Central Bank Digital Currency is legal tender in digital form, which means it holds the same value as the physical currency in your purse and is exchangeable at par with cash. Also known as the “digital rupee,” this digital currency will be issued by the RBI, which also means that it will be backed by the central bank. Unlike other cryptocurrencies, which have no intrinsic value because they have no underlying assets, the “digital rupee,” on the other hand, will have sovereign trust as its backing.
The underlying technology behind the digital rupee is similar to that of other cryptocurrencies, which is the blockchain. The foremost difference is that CBDC is “centralized,” meaning it is controlled by the RBI, while crypto is decentralized, i.e., not linked to or regulated by any government. CBDC is a legal tender and can be kept in bank accounts, while cryptocurrencies need to be stored in digital wallets. CBDC is much safer as compared to crypto because of the government’s hand in this. Cryptocurrencies such as Bitcoin, Ether, and others are being used for money laundering, tax invasion, and terror financing.
Benefits of Central Bank Digital Currency:
- It will benefit from lower transaction costs. A digitized currency will make it easier for the government to access all transactions within authorized networks.
- It will help governments regulate the flow of foreign and domestic currency. There is no way to escape the government’s scrutiny through CBDC.
- It is impervious to physical loss, damage, or destruction. When compared to physical notes, it is more robust.
- The use of digital rupees is intended to improve the efficiency of the interbank market.
- Additionally, it will reduce dependency on the dollar.
Types of CBDC
- Retail CBDC (e-R): It may be used by the general public and would be accessible to all.
- Wholesale CBDC (e-W): It is designed for restricted access to specific financial institutions.
Why do we need a digital rupee?
India’s dependence on cash: In terms of the Cash to GDP Ratio, India ranks third in terms of usage of banknotes, just behind Japan and Hong Kong. In the fiscal year 2022, the share of currency in circulation (CIC) to the gross domestic product in India was nearly 14 percent. Since the demonetization in 2017, the CIC ratio has considerably grown again. Cash is difficult to handle. But its anonymity enables its use for money laundering and funding illicit and terrorist activities. A move to digital payments and digital currency could reduce dependence on cash.
Overcoming infrastructure constraints and improving resilience: As a global leader in digital payment transactions, our economic infrastructure must be protected from coordinated terrorist attacks. Any significant attack will reduce banking operations, compromise data, and result in losses. Since DLT-enabled payment systems are intrinsically more secure than highly centralized systems, an alternative system built on DLT will increase system resilience. The adoption of a digital rupee would contribute to the diversification of India’s payment system by providing alternative payment rails.
Where did the borrowed money go?
One of the major reasons contributing to bank fraud is improper end-use of money lent. For example, a business might borrow money to purchase stocks rather than divert the fund for its own personal gains. The current system relies on stock statements and audits conducted by CAs, but a proactive measure would be tracing the end use of the fund, which is possible via the digital rupee.
Reducing costs in cross-border payments: The use of the central bank digital currency (CBDC) in cross-border remittances is intended to drastically reduce transaction costs for clients. Customers currently have to pay the bank a charge, which is either a percentage or a fixed sum of money transferred. The cost applies to both inbound and outbound remittances. There will be a decrease in both the price and the amount of time needed to settle accounts.
Targeted policies for economic and social betterment: The digital rupee will give policymakers real-time visibility and insights into the economy; they will be able to analyze money movement at a granular level, and future government intervention will be more precise and faster. In terms of societal implications, the digital rupee would aid in plugging leakages such as welfare money being moved to unrelated bank accounts.
- The first digital rupee trial in India will start on November 1 in the wholesale segment (e₹-W), with the settlement of secondary market transactions in government securities as the use case. Settlement in central bank money would lower transaction costs because it provides settlement finality and lowers settlement risk in the financial system because it is a sovereign currency.
- The first retail pilot (e₹-R) is scheduled to begin in a month in select regions with limited user groups. Every person will, by definition, have a wallet with the RBI under the retail CBDC. It also means it will be possible to track how and where people use the currency.
- Nine banks (State Bank of India, Bank of Baroda, Union Bank of India, HDFC Bank, ICICI Bank, Kotak Mahindra Bank, Yes Bank, IDFC First Bank, and HSBC) have been selected to take part in the pilot.
- The central bank wants to use digital money to give the general population a risk-free virtual currency that will give them legitimate benefits without the risks associated with trading in cryptocurrencies.
In short, a CBDC serves the key roles of a medium of exchange, a unit of account, a store of value, and a standard of deferred payment. It is an electronic record or digital token of a nation’s official currency.
What is the status of other countries?
Compared to the 35 nations that were investigating a CBDC in May 2020, there will be 87 countries (representing over 90% of the global GDP) exploring one by December 2021. Nine of them—the Bahamas, seven nations in the eastern Caribbean, and Nigeria—have now completely introduced digital currencies. The e-Naira, the first CBDC outside the Caribbean, was introduced by Nigeria as the most recent CBDC. 14 nations have CBDCs that are currently in the pilot stage and preparing for a potential full launch shortly, including China and South Korea. The US, the Euro Area, Japan, and the UK are the major nations with the four largest central banks, but they fall far behind.
Writer: CA Suraj Kar
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