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Post at: Sep 08 2021

Central Bank Digital Currency (CBDC)

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  • On July 22, 2021 the deputy governor of Reserve Bank of India (RBI) T. Rabi Sankar discussed about the need of Central Bank Digital Currency and informed that the regulatory body (RBI) is considering to introduce a central bank digital currency (CBDC) in a phased manner.

Understand the Digital Currency

  • Digital currency is a form of currency that is available only in digital or electronic form, and not in physical form. It is also called digital money, or cyber cash.
  • Digital currencies are currencies that are only accessible with computers or mobile phones, as they only exist in electronic form.

What is Central Bank Digital Currency (CBDC)?

  • A CBDC is a legal tender issued by a central bank in a digital form. In effect, it is just a digital version of the fiat currency, which in India’s case is the rupee (₹).
  • The digital currencies issued by the central banks differ on one fundamental aspect of cryptocurrencies and that is decentralization i.e., it will be directly controlled by the central bank (RBI).

Why are Central Banks issuing Digital Currencies?

  • An official digital currency would reduce the cost of currency management while enabling real-time payments without any inter-bank settlement.
  • Central bank digital currencies are promised as reliable, sovereign-backed alternatives to private currencies which are volatile and unregulated.
  • The need for inter-bank settlement would disappear as it would be a central bank liability handed over from one person to another.
  • The rise of private digital currencies such as bitcoin and also to the increasing use of digital payments are yet less or not regulated and hence there are higher possibilities of fraudulent activities.

Central Bank’s Effort for Digital Currency (A Timeline)

Committee Recommendations on Digital Currency (2019): SC Garg Committee  

  • Ban anybody who mines, hold, transact or deal with cryptocurrencies in any form.
  • It recommended 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.

Advantages of Digital Currencies  

  • The move to bring out a CBDC could significantly improve monetary policy development in India –
  • The digital currencies have all the intrinsic advantages of fiat currency like it is durable, portable, fungible and divisible. Being digital, it will make it easily verifiable, more secure and traceable. Hence, improving upon the existing advantages of paper currency.
  • The enhanced surveillance and real-time situational monitoring enabled by the central bank digital currencies can go a long way in stimulating these processes.
  • “RBI's move to enable CBDC provides all participants a framework to fully realize the potential of digital currency.
  • Digital fiat currencies create greater barriers to illicit activity, as physical cash can help conceal and transfer funds outside of regulated financial systems.
  • With the growing adoption of CBDCs, payments and transfers will be easier to identify and trace to previous sources, significantly reducing the risk of fraud and money laundering.
  • India’s fairly high currency-to-GDP ratio holds out another benefit of CBDC — to the extent large cash usage can be replaced by CBDC, the cost of printing, transporting and storing paper currency can be substantially reduced.

Related Concerns   

  • There are also certain negatives attached to the CBDCs –

Opportunity Available for India   

  • In the cross-border payments domain, India can take a lead by leveraging digital Rupee especially in countries such as Bhutan, Saudi Arabia and Singapore where NPCI has existing arrangements with respect to digital payments.
  • Retail CBDCs can make cross border payments and settlements real-time.
  • China’s e-CNY (Digital Currency Electronic Payment) is not blockchain based.
  • On the other hand, the Bank of England does not advocate a blockchain based system for CBDCs. However, the French Central Bank, which used wholesale CBDCs for interbank settlement, has started experiments on public blockchain for settlement of listed and unlisted securities.
  • Therefore, Indian digital currency may leap forward by using blockchain technology.

Global Status on Central Bank Digital Currencies     

  • On July 14, 2021 the European Central Bank launched its Digital Euro Project, approving an “investigation phase” that could ultimately lead to a virtual currency being implemented later in this decade.
  • Most major central banks have followed China where the Digital Yuan has already been in circulation in several cities.
  • The US Federal Reserve and the Bank of England are also looking into the possibilities of digital currency for their economies.
  • Around 86% of global central banks were actively researching the potential for central bank digital currency, while 60% were experimenting with the technology and 14% were launching pilot projects, according to a survey by the Bank for International Settlements.
  • There are some countries which have launched, or are going to be launching digital currencies, like Ecuador, Tunisia, Senegal, Sweden, Estonia, China, Russia, Japan, Venezuela, Israel etc.

Conclusion   

  • If governments, like India, adopt the technology and find a way to regulate digital payment flows, we can expect more competition in the coming years.
  • But one should keep this in mind that these changes cannot be done overnight as consequential amendments would also be needed in the legal framework i.e., in Paper Currency Act of 1861, the Foreign Exchange Management Act (FEMA), 1999 and the Information Technology Act, 2000.

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