Context

As per recent reports, the Reserve Bank of India's (RBI) digital rupee—the Central Bank Digital Currency (CBDC)—may be launched in stages, initially with wholesale enterprises this fiscal year.

The RBI suggested changes to the Reserve Bank of India Act of 1934 that would allow it to establish a CBDC.

What is Central Bank Digital Currency (CBDC)?

  • CBDCs are a digital version of paper currency that, unlike cryptocurrencies that operate in a regulatory vacuum, are issued and backed by a central bank.
  • It is the same as fiat cash and may be exchanged for it one for one.
  • A national currency that is not connected to the price of a commodity, such as gold or silver, is known as a fiat currency.
  • CBDC, or digital fiat money, may be traded using blockchain-backed wallets.
  • Though the concept of CBDCs was directly inspired by Bitcoin, it differs from decentralized virtual currencies and crypto assets, which are not issued by the state and do not have the status of 'legal cash.'

Goal:

  • The primary goal is to reduce the hazards and expenses associated with handling physical cash, including the price of phasing out dirty notes, transportation, insurance, and logistics.
  • It will also dissuade individuals from using cryptocurrency as a form of money transmission.

Global Trends: 

  • The Bahamas was the first economy to establish a national CBDC, the Sand Dollar.
  • Nigeria is another country that announced to launch eNaira in 2020.
  • In April 2020, China became the world's first major economy to test a digital currency, e-CNY.
  • Korea, Sweden, Jamaica, and Ukraine are among the nations that have begun testing their digital money, with many more expected to join shortly.

What are the CBDC advantages and disadvantages?

Advantages:

A Blend of Traditional and Innovative:

  • By lowering currency handling expenses, CBDC can gradually bring about a societal shift toward virtual money.
  • CBDC is intended to combine the best of both worlds:
  1. The ease of use and security of digital forms such as cryptocurrency demonstrate
  2. The traditional banking system's controlled, reserve-backed money circulation.

Simplified Cross-Border Payments: 

  • CBDC can provide a simple way to accelerate the development of a dependable reliable sovereign-backed domestic payment and settlement system that partially replaces paper money.
  • It might also be used to settle cross-border payments, thereby eliminating the need for a costly network of correspondent banks.

Financial Inclusion: 

  • The increased use of CBDC for many other financial activities could be investigated in order to push the informal economy into the formal zone and ensure better tax and regulatory compliance.
  • It may also pave the way for greater financial inclusion in the future.

Disadvantages:

Concerns About Privacy: 

  • The first problem to address is the increased danger to users' privacy, given that the central bank may wind up holding a massive quantity of data about user transactions.
  • This has severe ramifications since digital currencies do not provide users with the same level of privacy and anonymity that cash does.
  • Another big concern is the compromise of credentials.

Bank disintermediation: 

  • If the CBDC transition is significant and broad-based enough, the bank's capacity to reinvest funds in credit intermediation may suffer.
  • If e-cash becomes widespread and the Reserve Bank of India (RBI) does not impose any limits on the amount that may be saved in mobile wallets, weaker banks may struggle to retain low-cost deposits.

Other consequences include:

  • Faster obsolescence of technology may represent a challenge to the CBDC ecosystem, necessitating greater upgrade prices.
  • Intermediary operational risks since workers will need to be retrained and groomed to function in the CBDC environment.
  • Increased cyber security concerns, vulnerability testing, and the price of firewall protection
  • The central bank's operational load and expenditures in managing CBDC.

The Next Step

  • To address some of CBDC's shortcomings, use of CBDC should be payment-focused in order to enhance the payment and settlement system.
  • Then it may escape the risks of disintermediation and its large monetary policy consequences by shifting away from functioning as a store of value.
  • Data held with the central bank in a centralized system will pose serious security threats, necessitating the implementation of comprehensive data security solutions to avoid data breaches.
  • As a result, it is critical to apply the appropriate technology to support the CBDC issue.
  • If payment transactions are conducted using the same approach, scaling the infrastructure necessary for the CBDC would remain difficult.
  • The RBI will need to extensively examine the technological ecosystem before selecting the appropriate technology to introduce CBDCs.
  • The financial data acquired on digital currency transactions will be sensitive, and the government must carefully consider the regulatory framework.
  • This would necessitate tight collaboration between banking and data protection regulators.

Source: IE