Context

As per a recent update, the Reserve Bank of India (RBI) is planning to introduce its own version of Central Bank Digital Currency (CBDC). The Currency is to be introduced in a phased manner after proper assessment on issues such as- 

• how it could hamper the deposit mobilization abilities of banks
• its potential effect on the conduct of the monetary policy

Background

• The idea of a digital rupee has been explored in India at various times but has not gained much traction.
• In the last few years, the issue of CBDC has crept up with the advent of private virtual currencies, such as bitcoins. 

RBI Report: In its 2017-18 annual report, the Reserve Bank of India said that “an inter-departmental group has been constituted by the Reserve Bank to study and provide guidance on the desirability and feasibility to introduce a central bank digital currency.” Panel recommendation: In 2019, a panel headed by then Finance Secretary Subhash Chandra Garg recommended a digital rupee, while simultaneously suggesting a crackdown on private cryptocurrencies.

Analysis

Understanding the CBDC Structure

• Central Bank Digital Currency (CBDC) is nothing but a digital version of so-called “fiat money”. 
• Fiat money is the regular currency a country uses, as established and regulated by its government. 
• CBDC is a digital payment instrument that is denominated in a national currency.
• Issued by: Central bank.

Today, India is the leader in the world in terms of digital payments systems, growing at 55 per cent compounded annual growth rate for the past five years.

How it can be compared to cryptocurrency?

• Similarity:CBDC is similar to cryptocurrencies as 
  • It uses blockchain technology as its core means of representation.
  • It’s digital.
• Difference:It differs from cryptocurrency because unlike the latter, the former is issued, centralized and regulated by the monetary authority (in most cases governments) of the issuing country.

How is it different from private virtual currency?

• The value of private virtual currencies is based on its ownership, distribution and trading on exchanges
• A CBDC’s intrinsic value is equivalent to any other form of money issued by the central bank.

Important points to be discussed by RBI

In particular, the Indian central bank would evaluate the following scope of the digital currency:

• Usage:  Whether they should be used in retail payments or also in wholesale payments. 
• Technology: The underlying technology, whether it should be a distributed ledger or a centralized ledger, is also being evaluated. Whether the underlying technology should vary based on use cases is being debated at the central bank.
• Mechanism: Besides, other modalities such as token-based or account-based validation mechanism, distribution architecture (direct issuance by the RBI or through banks).
• Anonymity: What would be the degree of anonymity granted for such CBDCs are also being determined at the RBI.

Significance of the transition

• Cost effective: With the adoption, large cash usage can be replaced by CBDCs, the cost of printing, transporting, storing, and distributing currency can be reduced.
• Multiple benefits: It would provide significant benefits, such as reduced dependency on cash, higher seigniorage due to lower transaction costs, reduced settlement risk.
• Reduced disintermediation: CBDCs can cause a reduction in the transaction demand for bank deposits and will reduce the intra-day liquidity for settlement of transactions. They could also cause a shift away from bank deposits.
• Safety: In an environment of virtual currencies, CBDCs are necessary to protect the general public.

Assessing the challenges

• Lack of proper jurisdiction: While these private currencies have their own benefits, they are not backed by any government and therefore do not follow any proper jurisdiction. 
• Threat to established currency: The wide adoption of these currencies threatens to upend the established model of fiat currencies issued by countries within a border.
• Cyber security: The risk of cyber crime will continue to pose challenges in the case of CBDCs.
• Social and economic consequences: In case, if the digital currencies gain recognition, national currencies with limited convertibility are likely to come under threat. Adding such private currencies can therefore have potentially damaging social and economic consequences.

Major countries leading adoption of CDBC

• As of now, no country has officially adopted the CBDC, but many nations such as China, Russia, Japan, United States, China, and the UK are planning on launching CBDC.
• They have all launched the initial test program and research projects to test the credibility of CBDC programs. 
• England was among the first countries to propose this idea. China joined soon after.
• Russia is on the verge of making its own ‘crypto rubel.’

Wrapping Up

Introduction of CBDC will lead to a more robust, efficient, trusted, regulated and legal tender-based payments option. However, as of now, the central bank is exploring all the pros and cons of the introduction of CBDCs. RBI would also draw upon the lessons from other countries that are in different stages of introducing such a fiat currency.