Central Bank Digital Currency

CENTRAL BANK DIGITAL CURRENCY (CBDC)

• CBDC is a digital version of fiat currency that may be exchanged using blockchain-based wallets and is controlled by the central bank. It is a digital type of legal money issued by a central bank.

An official digital currency would lower the cost of currency administration while allowing real-time payments to be made without the need for interbank settlement.

Another advantage of CBDC is that, to the degree that huge amounts of cash can be replaced by CBDC, the cost of printing, transporting and keeping paper money may be significantly decreased.

• The Indian government has declared in its Budget 2022- 23 that its central bank will issue a digital currency as early as 2022

Objectives

• Reducing hazards and expenses associated with handling actual currency, phasing out soiled notes, transportation, insurance and logistics are the major goals.

• It will also gradually wean people off of using

cryptocurrency to send and receive money.

Significance of CBDC

• Cross-Border Transactions: CBDCs have special qualities that have the power to completely transform cross-border transactions. One major benefit of CBDCs is their instantaneous settlement function, which makes cross-border payments more affordable, quicker and secure.

• Both traditional and innovative: by lowering the cost of handling currency, CBDC can progressively bring about a cultural shift towards virtual currency.

• The goal of CBDC is to combine the best aspects of both worlds: The benefits of digital currency such as their security and convenience and the traditional banking system, which circulates money under strict regulation and reserve backing.

• Financial Inclusion: To promote improved tax and regulatory compliance, the informal economy might be pushed into the formal sector by exploring the expanded use of CBDC for a variety of different financial activities. Additionally, it may open the door for increased financial inclusion.

Difference between CBDC and Cryptocurrency

• Central Bank Function: Both digital currencies with a blockchain foundation are cryptocurrencies and CBDCs. Nonetheless, private businesses or people typically manage cryptocurrency. Conversely, a central bank of a nation controls and monitors a CBDC, which is equivalent to the fiat currency of that nation.

• Unpredictability: In a little amount of time, the price of bitcoin could fluctuate by hundreds or even thousands of dollars. Conversely, the ideal value of a CBDC would be equal to that of its physical counterpart.

• Investment vehicles: Purchasing Bitcoin and other cryptocurrencies in bulk with the intention of profiting from them is a common practice among investors. As CBDCs are not intended to be investment vehicles, this is absurd in their case.

Global Trends

• The first economy to introduce the Sand Dollar, a national CBDC, was Bahamas.

• Nigeria rolled out eNaira in 2020.

• In April 2020, China became the first major economy in

the world to test the use of e-CNY, a digital money.

• A number of countries have started testing their digital currencies, including Jamaica, Ukraine, Sweden and Korea. Many more may do so shortly.

Benefits

• A Combination of Traditional and Innovative: CBDC can slowly bring a cultural shift towards virtual currency by the reducing currency handling costs.

• Easier Cross-Border Payments: CBDC provides an easier way to speed up a reliable sovereign backed domestic payment and settlement system partly replacing the physical or paper currency.

• It could also be applied to cross-border payments, doing away with the requirement for a costly correspondent bank network in order to settle such transactions.

Challenges

• Privacy Concerns: The first problem to address is the increased risk to users’ privacy especially since the central bank may wind up managing a massive quantity of data about user transactions.

• Disintermediation of Banks: If sufficiently large and broad-based, the shift to CBDC can impinge upon the bank’s capability to plough back funds into credit intermediation.

Way Forward

• The utilization of CBDCs should be payment-focused in order to enhance the payment and settlement system and mitigate some of its short comings.

• Then it can steer away from serving as a store of value to avoid the risks of disintermediation and its major monetary policy implications.

• There would be serious security risks associated with the data kept by the central bank in a centralised system, necessitating the installation of strong data security measures to guard against data breaches.

• Therefore, it’s critical to use the appropriate technology to support the CBDC issue.

• To introduce CBDCs, the RBI will need to carefully select the right technology and map out the state of technology.