Working of Central bank digital currency (CBDC)

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Working of Central bank digital currency (CBDC)

  • The Reserve Bank of India is likely to soon start pilot projects to assess the viability of using digital currency to make wholesale and retail payments.
  • The projects shall help adjust RBI’s strategy for introducing a full-scale central bank digital currency (CBDC).
  • A high-level inter-ministerial committee set up by the Finance Ministry had recommended the introduction of a CBDC with changes in the legal framework including the RBI Act, which currently empowers the RBI to regulate issuance of bank notes.

What is The Central Bank Digital Currency (CBDC)?

  • It is a legal tender and liability of a nation’s central bank in the digital form.
  • It is denominated in a sovereign currency and appears on the balance sheet of a nation’s central bank.
  • CBDC is a digital currency which can be converted/exchanged at par with similarly denominated cash and traditional central bank deposits of a nation.
  • At present, central banks of various nations are currently examining the positive implications that a digital currency contributes to financial inclusion, economic growth, technology, innovation and increased transaction efficiencies.

What are the Benefits of CBDC?

  • Alternative to physical cash
  • Instantaneous process: Transacting with CBDC would be an instantaneous process.
  • The need for inter-bank settlement would disappear as it would be a central bank liability handed over from one person to another.
  • Reduces cost of currency management: India’s fairly high currency-to-GDP ratio holds out another benefit of CBDC.
  • Large cash usage can be replaced by CBDC. Also, the cost of printing, transporting and storing paper currency can be substantially reduced.
  • Need of the hour: If the private currencies gain recognition, national currencies with limited convertibility are likely to come under some kind of threat.
  • CBDCs thus become the need of the hour.
  • Volatility: CBDCs, being the legal tender by Central Bank, will not witness any volatility as in the case of cryptocurrencies.
  • Easy tracking of currency: With the introduction of CBDC in a nation, its central bank would be able to keep a track of the exact location of every unit of the currency.
  • Curbing Crime: Criminal activities can be easily spotted and ended such as terror funding, money laundering, and so forth
  • Scope in Trade: Foreign trade transactions could be speeded up between countries adopting a CBDC.

What is the difference between CBDCs and cryptocurrency?

  • Cryptocurrencies, such as Bitcoin, are digital tokens created by a distributed network or blockchain using cryptographic tools. CBDC are legal tenders by Central Bank.
  • While cryptocurrencies are decentralized, CBDCs are centralized
  • Cryptocurrencies offer anonymity, CBDCs would allow central banks to know exactly who holds what.
  • CBDCs are also not stablecoins, which are a form of cryptocurrency that is pegged to another asset, for example, Tether.
  • A CBDC would not be pegged to any fiat currency; it would be the fiat currency. A CBDC version of a dollar would be the same as a dollar bill.

SC Garg Committee recommendations (2019):

  • Ban anybody who mines, hold, transact or deal with cryptocurrencies in any form.
  • It recommends a jail term of one to 10 years for exchange or trading in digital currency.
  • It proposed a monetary penalty of up to three times the loss caused to the exchequer or gains made by the cryptocurrency user whichever is higher.
  • However, the panel said that the government should keep an open mind on the potential issuance of cryptocurrencies by the Reserve Bank of India.

Challenges in rolling out National Digital Currency:

  • Potential cybersecurity threat.
  • Lack of digital literacy of population.
  • Introduction of digital currency also creates various associated challenges in regulation, tracking investment and purchase, taxing individuals, etc.
  • Threat to Privacy: The digital currency must collect certain basic information of an individual so that the person can prove that he’s the holder of that digital currency.