Central Bank Digital Currency (CBDC)

Context:

The Reserve Bank of India is likely to soon kick off pilot projects to assess the viability of using digital currency to make wholesale and retail payments to help calibrate its strategy for introducing a full-scale central bank digital currency (CBDC).

About Central bank digital currency:

• India is already a leader in digital payments, but cash remains dominant for small-value transactions, he said, stressing that an official digital currency would reduce the cost of currency management while enabling real-time payments without any inter-bank settlement.
• Some key issues are being examined: whether they should be used in retail or wholesale payments, the underlying technology, if the validation mechanism should be token-based, etc. Conducting pilots in wholesale and retail segments may be a possibility in the near future.
• 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.
• 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.
• The advent of private virtual currencies is another reason… If these private currencies gain recognition, national currencies with limited convertibility are likely to come under some kind of threat.
• Transacting with CBDC would be an instantaneous process as the need for inter-bank settlement would disappear as it would be a central bank liability handed over from one person to another, Mr. Sankar pointed out. Moreover, foreign trade transactions could be speeded up between countries adopting a CBDC.
• They could enable a cheaper and more real-time globalisation of payment systems — it is conceivable for an Indian exporter to be paid on a real-time basis without any intermediary…The risks of dollar-rupee transactions, the time zone difference in such transactions would virtually disappear.

Digital Currency:

• It is a payment method which exists only in electronic form and is not tangible.
• It can be transferred between entities or users with the help of technology like computers, smartphones and the internet.
• Although it is similar to physical currencies, digital money allows borderless transfer of ownership as well as instantaneous transactions.
• Digital currency is also known as digital money and cybercash.
• E.g. Cryptocurrency

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. 

Types of CBCDs:

• Retail: Retails CBCDs are meant for use by individuals, households and corporations. 
• Wholesale: Wholesale CBCDs are meant for use by financial institutions. 

Why India needs a digital rupee?

• Online transactions: India is a leader in digital payments, but cash remains dominant for small-value transactions.
• High currency in circulation: India has a fairly high currency-to-GDP ratio.
• Cost of currency management: An official digital currency would reduce the cost of currency management while enabling real-time payments without any inter-bank settlement.

Features of CBDS

• High-security instrument: CBDC is a high-security digital instrument; like paper banknotes, it is a means of payment, a unit of account, and a store of value.
• Uniquely identifiable: And like paper currency, each unit is uniquely identifiable to prevent counterfeit.
• Liability of central bank: It is a liability of the central bank just as physical currency is.
• Transferability: It’s a digital bearer instrument that can be stored, transferred, and transmitted by all kinds of digital payment systems and services.

Benefits of CBDC:

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. 

1. Real-time money transfer: Money transfers and payments can be made in real-time from the payer to payee without relying on intermediaries such as banks. 
2. 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. 
3. Income Tax: Tax avoidance and tax evasion will be near to impossible as methods such as offshore banking and unreported employment cannot be practised to hide financial activities from the central bank. 
4. Curbing Crime: Criminal activities can be easily spotted and ended such as terror funding, money laundering, and so forth. 
5. Alternative to physical cash: Digital currencies issued by central banks would provide for a modern alternative to physical cash. 
6. Seigniorage income: Issuance of digital currency would avoid a reduction of seigniorage income for governments in the event of the disappearance of physical cash.
   1. Seigniorage income refers to the difference between the value of money and the cost to produce and distribute it. 
7. Volatility: CBDCs will be pegged to assets such as gold and thereby will not witness

Issues:

• Some key issues under RBI’s examination include, the scope of CBDCs, the underlying technology, the validation mechanism and distribution architecture.
• Also, legal changes would be necessary as the current provisions have been made keeping in mind currency in a physical form under the Reserve Bank of India Act.
• Consequential amendments would also be required in the Coinage Act, Foreign Exchange Management Act (FEMA) and Information Technology Act.
• Sudden flight of money from a bank under stress is another point of concern.

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.

RBIs direction

• In 2018, the RBI did send a circular to banks directing them not to provide services for those trading in cryptocurrencies.
• Regulatory bodies like RBI and Sebi etc also don’t have a legal framework to directly regulate cryptocurrencies as they are neither currencies nor assets or securities or commodities issued by an identifiable user.

Supreme Court’s judgement

• But this was eventually set aside by the Supreme Court, which found the circular to be “disproportionate,” given that the central bank had consistently maintained that virtual currencies were not banned in India.
• Also, the RBI could not show that entities that it regulated were adversely impacted by exchanges dealing in virtual currencies.

So, what will the Bill seek to do?

• Cryptocurrency exchanges, which have sprung up, are reportedly lobbying with the government to make sure these currencies are regulated rather than banned outright.
• Smart regulation is preferable, as a ban on something that is based on a technology of distributed ledger cannot be implemented for all practical purposes.

Findings of India inter-ministerial committee

• Even in China, where cryptocurrencies have been banned and the Internet is controlled, trading in cryptocurrencies has been low but not non-existent, as an India inter-ministerial committee found out.
• Despite this and the fact that most countries it studied had opted for regulation, this committee still went ahead to recommend an outright ban.
• Of course, it encouragingly also batted for an official digital currency as well as for the promotion of the underlying blockchain technology.

Significance of CBDC:

• It would reduce the cost of currency management while enabling real-time payments without any inter-bank settlement.
• India’s fairly high currency-to-GDP ratio holds out another benefit of Central Bank Digital Currency (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.
• It will also minimize the damage to the public from the usage of private virtual currencies.

Way Forward

• The creation of a Digital Rupee will provide an opportunity for India to empower its citizens and enable them to use it freely in our ever-expanding digital economy and break free from an outdated banking system.
• Looking into its impact on macroeconomy and liquidity, banking systems and money markets, it is imperative of policymakers to thoroughly consider the prospects of Digital Rupee in India.

Source: The Hindu

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